Speech by DPM Lee Hsien Loong at the 25th Anniversary Dinner of the Association of Banks in Singapore

Date: 8 Jun 1998

INTRODUCTION

1   I am happy to celebrate with you ABS' 25^th anniversary. Your growth as an industry association has mirrored Singapore's emergence as an international financial centre. Over the last 25 years, total assets in the domestic banking units have grown on average by 15% per annum, faster than nominal GDP. The offshore banking sector has expanded even more spectacularly, averaging 23% per annum. Our Asian Dollar Market, with assets totalling more than US$500 billion, is one of the largest offshore banking sectors in Asia.

2   Major credit for these achievements belongs to Dr Goh Keng Swee. I join the Association of Banks of Singapore in honouring Dr Goh tonight for his seminal contributions to our financial services sector. His vision, determination and courage in the face of immense difficulty led us to build the Asian dollar market, the 4^th largest foreign exchange centre in the world, and SIMEX as the region's leading futures exchange. He showed us how to strive for achievements that seemed beyond our reach, and to attain them. That timeless lesson is especially relevant in a difficult year and in the midst of a regional financial crisis.

3   High growth figures, by themselves, do not prove success as a financial centre. Rapid expansion, in the absence of proper controls and adequate supervision, can be a recipe for disaster, as the regional crisis has vividly illustrated. Fortunately Singapore's banking system is sound. Our local banks have strong capital adequacy ratios and good credit ratings. They have avoided excessive credit growth and risk concentrations, and the consequential problems that now beset several Asian countries. Our emphasis on high prudential standards has allowed us to sustain strong financial sector growth over a long period.

4   But our banks have not been unscathed by the regional crisis. Bank earnings were down sharply last year, as banks made exceptional general provisions for their regional exposures. This year loan demand will probably shrink, and banks will make more provisions for regional exposures. An early rebound in bank profits is unlikely.

5   This does not mean that our banks should not have lent or invested in the region. They were right to seek new growth opportunities abroad. If they had forgone these opportunities altogether, they would have failed to diversify their sources of growth, and been forced to accept the constraints of our domestic economy. And they might still not have succeeded in reducing their risk. For by not diversifying gradually out of Singapore, they would have been unable to hedge against ups and downs in the Singapore economy itself, which no matter how skilful our economic management can never be eliminated.

6   The right approach is to accept the risks but manage them carefully, and build up strong capital as a buffer against adversity. This is what our banks have done. They have also established a modest but growing presence in the region which will stand them in good stead when these economies recover.

7   Foreign banks too need to take a long view of the region's prospects, and be alert to opportunities as the region begins to recover. Right now investible funds from the US and Europe are flowing to Eastern Europe and Latin America instead of Asia. But the day will come when Asia will again buffer the risks and downside of other emerging markets. Meanwhile there is opportunity for advisory work and merger and acquisition services. Many Asian corporations require help to restructure and consolidate. Foreign corporations looking for acquisitions also need investment banking assistance.

8   Even as banks in Singapore draw lessons from the regional crisis and address pressing short-term contingencies, they must build on their strengths and prepare for fresh challenges and opportunities after the crisis is over. The crisis has not provided us any respite from the driving forces in the global financial landscape. The international banking industry continues to be transformed by globalisation, technological change, increased customer sophistication, relentless competition, and mergers and consolidation. But the crisis has improved Singapore's competitive position, because we have avoided the serious problems faced by the others. We must press on with the reforms to our financial sector, to position ourselves as a leading financial centre in Asia.

9   As part of its review, MAS has been studying the banking industry. This is a major and complex task, because banking is the pivotal activity in financial services. The study is therefore not yet complete. Nevertheless, MAS has so far decided to take several steps for Singapore's banking system to thrive and grow in this bracing environment:

RAISE BANK DISCLOSURE STANDARDS

10   We will raise our bank disclosure norms to international standards. The Committee on Banking Disclosure, chaired by Mrs Elizabeth Sam, has completed its work, and will release its report soon.

11   The Committee has recommended that local banks stop the current practice of maintaining hidden reserves. It recommends they disclose the market value of their investments, which have largely been valued at book cost and hence contributed to their hidden reserves. They should also disclose the level of their non-performing loans, and past and future provisions. Local banks have also agreed to equity account for their investments in associated companies.

12   These new accounting practices are consistent with international standards, and the global trends towards greater transparency in both the banking and corporate sectors. Indeed the Committee's report goes beyond the disclosure requirements of some developed countries.

13   Raising disclosure standards will benefit the banking industry. In the absence of information, in times of uncertainty investors fear the worst and tend to overreact. This penalises sound, well-managed institutions together with weaker institutions facing real problems, and can undermine the financial system. The problems in Japan, where sound and unsound financial institutions have not been clearly differentiated, illustrate how a lack of transparency can undermine confidence in the entire banking system.

14   As our local banks are well-capitalised and financially strong, better disclosure should strengthen market confidence in them. Better disclosure and market scrutiny will also put banks under pressure to operate efficiently, and deploy resources to uses which yield the highest risk-adjusted returns. This discipline will sharpen their competitive edge.

15. MAS has accepted all the Committee's recommendations on the local banks' disclosure and provisioning practices. So have the 6 local banks, who have already started raising their disclosure standards. The disclosure of their regional exposures in their 1997 financial statements exceeded the levels of disclosure by most international banks.

RISK-FOCUSSED BANK EXAMINATION

16   MAS will adopt a risk focussed approach to bank examination. The traditional approach to inspection is no longer practical or adequate, because it cannot cope with the growing complexity of banks' activities and organisational structures, increased linkages with non-bank financial institutions and institutions abroad, and technological advancements.

17  . MAS will change its inspection procedures from a bottom-up, micro approach, to a top-down, risk-focussed approach. Inspections will focus on the institution's management quality and processes, and its risk management and control systems. They will be tailored to fit the size of the bank and the risk profile of its activities. Inspectors will concentrate on the process by which a bank's management itself addresses its risks, instead of tooth-combing the books for control deficiencies. They will test and evaluate individual transactions selectively rather than extensively.

18   MAS will inform banks of upcoming inspections beforehand, unlike the current system of purely surprise inspections. This way MAS can hold pre-consultations with bank management that will shorten the actual inspections and make them less onerous on the bank's resources. MAS will still conduct surprise inspections when circumstances make one necessary.

19   This more focussed, top-down approach will allow the MAS to deploy limited supervisory resources to the higher risk areas. MAS will inspect the banks more frequently and regularly, ideally at least once in two years. This is the practice of supervisors in other major financial centres.

20   More frequent inspections will enable MAS to distinguish stronger banks, with well-developed systems of internal control, from weaker ones. MAS can then give more flexibility to the strong banks, while maintaining stricter controls on the weaker ones. MAS will also disseminate information on best practices to the industry, by providing insights based on knowledge gained through supervising a large number of banks.

21   MAS will start to implement this new approach to bank inspection this year. Full implementation will be phased in over the next few years. The new approach will require a different mindset and fresh skills, which will take time to develop. MAS needs to train and build up its supervisory staff. We also have to ensure that in changing our approach, we do not inadvertently lower standards. High quality inspections and supervision are the cornerstone of a sound banking system.

22   MAS is not the only bank supervisor shifting its approach in this way. The Federal Reserve Board in the US is in the midst of shifting to a more risk-focussed supervisory approach, having conducted a formal review of its examination process, for essentially the same reasons as us. So is the Bank of England, and now the Financial Services Authority that has taken over its bank supervision function. MAS will continue to study and adapt international best practices in bank supervision.

23   MAS as the regulator will promote sound risk management practices among banks, especially those banks whose activities have the most impact on depositor confidence and systemic stability. MAS will require banks with inadequate management control systems to take corrective actions, and will seek to minimise the disruptions that problem banks can cause to the rest of the system.

24   However, the regulator's task is not to take over the job of bank management in controlling risks, and even less so in preventing internal malpractice within the bank. No amount of MAS inspection of financial institutions can totally prevent irregularities and malpractice. No regulator can do so, even with a more pervasive and intrusive system of inspections than the industry is willing to bear. It is the institutions themselves - their boards and management, supported by internal control teams - who are responsible for preventing fraud and malpractice, and detecting it when it happens.

REDUCE BANKS' MINIMUM CASH BALANCE

25   We will lower banks' Minimum Cash Balance (MCB) from 6% to 3%. This is part of MAS' effort to align its prudential stipulations with international best practice. Banks in Singapore have been required to maintain a Minimum Cash Balance with MAS of 6% of their liabilities base of their domestic banking units, and Minimum Liquid Assets (MLA) of 18% of their liabilities base. The purpose is to ensure that banks maintain adequate cash and liquid reserves to meet any sudden withdrawals by depositors.

2  . The MCB requirement imposes costs on banks. There is the direct cost of cash balances held at MAS which do not earn any interest, and an opportunity cost for sound banks, with good liquidity management systems, to keep more cash than is necessary. Customers bear this cost indirectly, in the form of higher cost of funds.

27   The MCB and MLA also put banks at a competitive disadvantage vis-a-vis non-banks. Institutions like merchant banks, fund managers and insurance companies compete with banks in several areas, but are not required to meet equivalent liquidity requirements. This is a regulatory distortion.

28   MAS has reviewed the MCB requirement. It has concluded that maintaining a large cash buffer is less relevant today than it was in the past. Most banks in Singapore have improved on their liquidity management systems over the years. The money and capital markets have developed significantly in depth and breadth, and banks today hold a wide variety of liquid instruments which can be converted to cash at short notice.

29   Other countries have moved in the same direction as their markets have become more developed. Many have reduced or eliminated their MCB requirements. Hong Kong, the UK, Canada, Norway, Sweden and New Zealand, among others, have no MCB. Australia intends to remove its MCB this year.

30   In July, MAS will be introducing the Real Time Gross Settlement (RTGS) system for bank payments, to replace the current end-of-day net settlement system. The RTGS will enable banks to settle payments on each individual transaction during the day, and thus avoid the liquidity risks inherent in deferred end-of-day settlement. However, banks will need to keep some cash balances with MAS to settle gross payments efficiently during the day.

31   The reduction in MCB requirement to 3% will take effect in July 1998. Banks can use the 3% MCB for intra-day settlement of payments under the RTGS, but must top up their balances with MAS to 3% at the end of each day. Other countries with RTGS systems and MCB requirements also allow banks to use their MCBs to settle payments on an intra-day basis. MAS will impose stricter MCB requirements on banks which are experiencing financial difficulties that could threaten depositor confidence, or those which show themselves to have poor liquidity management systems.

32   This MCB reduction will allow banks the opportunity to earn more interest income. Assuming an interest rate of 3.5%, MAS expects the change to save banks in Singapore $135 mn a year in foregone earnings. The local banks alone will save $90 mn a year. Some of the cost saving will ultimately be passed on to customers.

33   The reduction in the MCB does not compromise our prudential requirements. The 18% MLA, together with the 3% MCB, is a sufficient regulatory safeguard against liquidity risks, and is well above the requirements on banks in the developed countries. As banks enhance their internal liquidity management systems further, the MAS will review the current 18% MLA to bring it closer to levels in other developed financial markets.

34   Nor does the reduction signal any easing of monetary policy or credit conditions. The target of monetary policy in Singapore is the exchange rate, not interest rates or money supply. MAS does influence bank liquidity through its money market operations, as one way to achieve its exchange rate objectives. But it has never had to use the MCB to influence bank liquidity, as a tool of monetary policy. For this reason the 6% MCB has stood unchanged since 1975. MAS will ensure that the one-off release of liquidity to banks when they reduce their cash holdings with MAS will not have any monetary impact.

PROGRESSIVELY ALLOW MORE FOREIGN COMPETITION

35   We will progressively open up the financial sector to greater foreign competition. We will create a more level playing field for local and foreign institutions in the banking, securities and insurance sectors.

36   Globalisation and technological change make this opening up inevitable. Competition is already lapping at our doorstep. It is better to embrace liberalisation proactively, at our own pace, than face the prospect of one day being swept away by the floodwaters of competition. By taking measured steps now, we maximise our chances of building up strong Singapore entities.

37   A more competitive environment is critical to our further development as an international financial centre. First, greater participation by strong foreign financial institutions can bring to Singapore new technology, management expertise and financial innovation.

38   Second, more foreign participation can attract more international investors and business to Singapore and enlarge the pie for everyone, so that levelling the playing field for foreign institutions will not necessarily mean less business for local institutions.

39   Third, more foreign competition will help local institutions to upgrade. Competition will drive them to offer better services, develop new capabilities, and become more efficient. This is the way for local institutions to develop into significant players in the region, and to provide financial services to businesses and consumers in Singapore, equal to anything available in London, Tokyo or New York. Without access to first class banking services, our whole economy will be hobbled.

40   Levelling the playing field applies both ways. MAS will review existing regulations governing the operation of local banks to ensure that they are not disadvantaged in competing against foreign banks or operating abroad. We will adjust our rules to make sure that local banks do not bear a heavier regulatory burden than is required to maintain prudential standards. The reduction in MCB is one example.

41   The local banks will naturally take a more cautious view of the benefits of more foreign competition, pointing out correctly that Singapore's financial sector is already one of the most open in Asia. But MAS has to adopt a slightly different perspective, reflecting the overall interests of the Singapore economy.

42   MAS is still studying the specific steps and timing of the opening up, but the overall direction is clear. We will make this change progressively, over the next five years. There is no shortage of suggestions from the foreign banks - allow sub-branches, allow off-premise ATMs, grant membership of NETS. MAS will examine all these ideas as part of its review of the financial sector.

43   As a modest first step, MAS will raise the Singapore dollar resident loan limit on offshore banks from S$200 mn to S$300 mn, although I do not expect the offshore banks to make quick use of the relaxed limit in the current conditions.

DEVELOP STRONG LOCAL BANKS

44   While we open up the financial sector to greater competition, we should also build up our domestic institutions. Strong local banks are important to the stability of our banking system. They should hold their own in the domestic market, even when this becomes more open. Some should become significant players in the region. We would not be happy with what the Japanese ruefully describe as a Wimbledon outcome. In Wimbledon, the tennis courts are British, but the winners are all foreign. This is what happened in Mexico and Argentina, when they opened up their banking industries after their economies ran into crises.

45   Our local banks are profitable and well run, for their size. International comparisons regularly rate them highly, when compared with most other Asian banks. But our benchmark should not be regional best practice; it has to be international best practice. And this is a constantly moving target, because the pace of change is relentless.

46   Singapore's smallness should not stop our banks from becoming more than domestic institutions. SIA is one of the best airlines in the world. Changi is the best airport, and PSA is the best seaport. In banking, Switzerland, another small country, produced SBC, UBS, and Credit-Suisse. Holland has ABN-AMRO and ING. All are leading global players, including in Asia. So for Singapore banks to aim to become significant international players is not an unrealistic ambition.

47   The local banks must develop realistic strategies and work concertedly to achieve this goal. They need to form new alliances, cooperate with foreign institutions, and enhance their technology and IT. Talent is the key success factor, and also the most important constraint. The local banks should attract the best professionals for their management teams, not just Singaporeans, but talent from the region and around the world. The more cosmopolitan and less parochial our approach, the more successful our banks will be.

48   It is more than just having the ablest people. A Singaporean management team which has integrated Malaysians, Thais, Filipinos, Indians from India, Chinese from the PRC, Japanese, Americans, and Europeans, will have the richness of experience and diversity of backgrounds to understand international best practices and business conditions wherever the bank operates. This is how the top American banks function - with a large proportion of non-American executives in their top echelons. This attitude of mind and corporate culture is a major competitive strength of American banks, compared for example to Japanese banks which for cultural reasons have more homogenous managements.

49   Talent is also a major reason to consolidate the local banks. Singaporean bankers are well regarded internationally for their integrity, professionalism and competence. But building world-class banks requires world-class management teams. It is very difficult to assemble 6 top-notch management teams to run 6 banks, or even 5 after the Keppel and Tat Lee merger. If we concentrate our top banking talent on fewer teams, we will improve our chances of producing one or two winners.

50   Besides talent, a second major issue is size. Size matters in international banking. Advances in information technology and telecommunications have provided banks with new delivery channels to expand their operations geographically, reduce costs, and improve efficiency. To exploit this technology to the full, banks must make large capital investments, which can only be justified by sufficient economies of scale. This is one reason for the wave of mergers and consolidation sweeping the financial industry worldwide. Even large institutions, like Bank of America, and Citicorp, have found it necessary to merge with other leading players to maintain their position.

51   The local banks are not exempt from these economic realities. By international standards, they are small. They need to grow large enough to enjoy the economies of scale, and to have the reach and resilience to go regional, and eventually make a mark in global markets.

52   This is why MAS has encouraged local banks to consider mergers. MAS will also be supportive if local banks wish to bring in foreign equity partners as part of their business strategy. However, the Government cannot force the pace or dictate the outcome. These are commercial decisions that the banks have to make for themselves. But as the industry continues to become more competitive, and the environment becomes more open, the pressure on local banks to change will grow stronger.

CONCLUSION

53   I have outlined five policy areas where the MAS will be taking action over the next few months. Some of the initiatives are focussed and definite. Others involve a programme of changes over a period of time. But each will help prepare our banking industry for the future.

54   The ferment in the global banking industry brings fresh surprises almost daily. The end game is impossible to forecast. But one thing is certain: our banks will face ever-growing competitive pressures. Now is the time - when we are in a position of strength and have the luxury of choice - to start thinking and preparing how to meet this competitive challenge. If we do this right, we will be well-positioned to become the premier banking centre in Asia.