Speech by Mr Heng Swee Keat, Managing Director MAS, at the 32nd Annual Dinner of the Association of Banks in Singapore, 14 July 2005
"Managing Risks, Fostering Innovation"
1 Chairman ABS, ladies and gentlemen. It's a privilege to address this very distinguished gathering and I thank you for the honour. Allow me this evening to share some thoughts on "Managing Risks, Fostering Innovation in Singapore."
A. AFTER REFORMS, A MORE VIBRANT FINANCIAL SECTOR THAT REMAINS SOUND
2 Let me begin with a quick review of the key developments in Singapore's financial sector.
3 Eight years ago, the government and MAS launched a comprehensive review of the financial sector. We started off from a position of relative strength. Our tightly regulated though somewhat protected environment had produced a strong and well capitalized banking system. But with rapid technological advances and consolidation sweeping the global financial industry, we could not sit still. Over the next few years, MAS fundamentally shifted our supervisory approach, to give more room for free play and innovation. Due to the strong foundation that had been laid previously, we were able to do this at a time when many countries were still reeling from the effects of the Asian financial crisis and liberalising would not have seemed the obvious thing to do in such a risky environment. We also gradually allowed more foreign competition, and spurred local banks to upgrade their capabilities. We made major efforts to develop the capital markets, including the easing of restrictions on the lending of the Singapore dollar to non-residents and the establishment of the yield curve for the SGS market
4 These reforms have borne fruit, and our financial industry is now more dynamic and vibrant while still retaining its reputation for soundness and resilience. The retail banking sector is now more competitive, with six foreign banks awarded Qualifying Full Bank (QFB) licences, and local banks have responded through consolidation, improved solutions to meet increasingly sophisticated customer needs and investments in new technologies. The insurance industry has likewise been liberalised, and standards of professionalism raised. Capital markets have grown in breadth and depth, with strong growth in debt issuance from a variety of local and international corporates and supranational agencies. The wealth management industry has also grown rapidly, on the back of stronger international investor interest in Asia, as well as the robust growth of institutional and private wealth in the region. An increasing number of foreign companies are now listing on our stock exchange. Importantly, all these have been achieved without compromising our high prudential standards.
B. OPPORTUNITIES AND RISKS
5 What are the prospects for the financial sector in the coming years?
6 I believe global financial markets will continue to grow in scope and sophistication. In the last few decades, financial services have grown faster than GDP, especially in emerging markets.
7 Asia, in particular, is entering an exciting phase, where almost all economies are powering ahead. This growth will generate new demands for financial services - from Asian corporates which are expanding, and from individuals who have acquired substantial wealth and governments. The greater interaction between Asia and the Middle East will also spark new opportunities. Financial institutions based here are well positioned to serve these dynamic regions, and to make use of Singapore's extensive hard and soft infrastructure, including the networks of trade and investment agreements.
8 While opportunities abound, there are also many challenges. Tonight, I will focus on one of the key challenges - the capacity of the industry as a whole and that of individual financial institutions to manage risks well and to provide customers with innovative products for investment and hedging.
9 Managing and intermediating risks is at the heart of financial services. Indeed, many types of risks have not changed fundamentally. These include credit, market, operational and technology risks. However, the scale and impact of some of these risks have increased. Let me just cite a few examples.
10 External events, such as terrorist attacks, SARS and natural disasters have raised concerns about operational risks. The extensive use of IT has improved efficiency, but also heightened technology risks. Today, business continuity management and disaster recovery have become standard vocabulary.
11 In banking, the complexity and scale of operations of many banks make it harder to insulate against risks from different parts of the banks. Financial markets have also become more complex and closely integrated. Problems that occur in one part of the world can have contagion effects on another part. The very benign inflation and interest rate environment in the last decade has also led some analysts to question if risks have been properly priced, and if institutions have sufficient buffers to meet unexpected developments. This is not to suggest that we have concerns over financial stability in Singapore. The results of MAS's past stress testing exercises have shown our banking system to be resilient even under severe conditions.
12 At the same time, financial products that un-bundle and repackage the various types of risks have grown. In many cases, these innovative products can facilitate risk management. However, some may be so complex that investors may not fully understand the underlying risk characteristics.
13 I recently visited several major banks in London and New York, and was struck by the deep investments they have made in risk management. They were very clear that risk management capabilities must grow in tandem with business development. The consequence of mishandling risks is not just the impact on a financial institution's balance sheet, but increasingly, on its reputation.
14 To meet the challenges of a riskier environment, I believe we should work in close partnership, as supervisors, as an industry, and as individual financial institutions, to promote growth and innovation, while maintaining high prudential standards and reputation.
C. THE ROLE OF MAS
15 First, let me touch on the role of MAS in maintaining this balance between risk management and growth.
16 Our aim is to maintain a supervisory framework that is robust and responsive. A supervisory framework that contributes to a safe and sound financial system, and at the same time fosters the growth of the sector. A well-respected system gives confidence to international financial institutions to set up here, and gives confidence to customers to deal with these institutions. This is a key strength which we must preserve.
17 To better understand the risks of a more inter-connected system, MAS has put more resources into macro-prudential surveillance. In particular, we have been undertaking analysis of macroeconomic and financial developments and their implications for the stability of the financial system. Our assessments are published in the Financial Stability Review (FSR) on a semi-annual basis, starting from December 2004, to communicate our views and findings on the risks and vulnerabilities of Singapore's financial system.
18 For the supervision of individual institutions, we have over the years shifted from a one-size-fits-all approach to one that is risk-based and stakeholder-reliant. This is to facilitate innovation and well-managed risk-taking. For the most part, our regulations do not require banks launching new products to come to MAS for approval, as long as the bank as a whole keeps within our prudential supervisory framework. We systematically review our rules to sieve out those which are no longer relevant or necessary. For example, we lifted limits on car loans and aggregate investments in equity, when we assessed that banks could manage these risks. We recently reviewed our requirements on securitization transactions, and will soon be replacing the requirement for prior approval with just the need for notification. This will enable banks to bring securitization transactions to the market more quickly.
19 Where the systemic impact is small, MAS is prepared to give an interim approval, and fine-tune the policy as the activity develops. This is what we have done for REITs. But we seek your understanding that this means rules may subsequently need to be revised. So in some other cases, it is better to take a little more time to put in more robust rules, as frequent rule changes create uncertainty and could lead to an un-level playing field.
D. THE ROLE OF FINANCIAL INSTITUTIONS
20 Let me now turn to the role of financial institutions.
21 In line with the shift towards risk-focused and stakeholder-reliant supervision, there is now a greater focus on the quality of an institution's own risk management processes. Risk decisions ought to be overseen and taken at the most appropriate level, by the people with the right expertise and incentives.
22 In that regard, the Board and management of financial institutions hold primary responsibility for the oversight of risks undertaken by the institution. The effectiveness and independence of the Board, and the governance process, are very important. For local banks, we have instituted requirements for board nomination and compensation committees and a majority of directors who are separately independent of management and substantial shareholders.
23 Board directors and management need to understand the nature and risks of the businesses and products that their banks engage in and not take comfort that the specialists should know the risks in what they are doing.
24 MAS' supervisory approach towards all banks here has moved away from tooth-combing for compliance with regulations towards one of assessing the quality of governance, controls and risk management processes. Hence, all banks operating here need to have in place systems and risk management practices that are commensurate with the scale and complexity of their operations.
25 The implementation of Basel II presents an opportunity for banks to substantially improve their risk management capabilities and internalize risk management into their business. While the Basel Committee has recommended a timeline for implementation, this is not a short sprint to the finish line. Instead this should be seen as a preparation to run a marathon. In deciding whether to allow a Singapore bank to adopt the more advanced approaches under Basel II, MAS would focus on whether a bank has adopted risk management practices that are commensurate with its risk profile. Instead of ticking off a checklist of minimum requirements, MAS would want to be assured that the bank's management culture and governance framework supports continuing improvements in risk management. At all levels, the thinking and processes relating to risk management must be tightly integrated with business strategy and execution. In the case of foreign banks with significant operations here, we will work closely with their home supervisors to achieve similar aims in these banks' Basel II implementation.
E. DEVELOPING CAPABILITIES IN RISK MANAGEMENT AND FINANCIAL INNOVATION
26 Let me now turn to what MAS and the financial industry could do together to raise risk management capabilities, especially in financial risks.
27 Risk management plays a critical role in maintaining the safety and soundness of banks. But risk management goes beyond meeting regulatory requirements. The core expertise behind risk management can be a strategic enabler, for financial institutions to develop innovative financial products and tap new markets. The ability to identify, dis-aggregate and re-synthesize risks is essential to the structuring and customization of financial products. Indeed, such analytical capability regarding risks is the foundation of financial innovation.
28 Financial institutions need professionals who understand market, credit, and liquidity risks in an integrated manner. It is no longer sufficient to understand each risk on a standalone basis. Unbundling and repackaging risks into products that can be more readily distributed and traded have meant that a more integrated and holistic approach to risk management is necessary. Increasingly, financial institutions are making use of quantitative skills in modeling and risk analyses to develop pricing and hedging models. Asia currently imports many of these skills from leading jurisdictions. But as Asia's financial needs become more complex, there is scope for products that better meet the risk requirements here. More Asia-focused research will be essential to growing the market depth and liquidity for Asian instruments.
F. RECENT RISK MANAGEMENT INITIATIVES
29 I am encouraged that financial institutions are using Singapore as a base for overseeing the risk management of their regional operations, and to undertake product structuring for the Asian time zone. Many have located their regional risk management and compliance functions in Singapore. The market has also grown in sophistication. In the Singapore dollar corporate bond market, structured products form more than half of the issuance. Trading and structuring of credit derivatives and warrants have grown, aided in part by the presence of structuring expertise of trading teams based in Singapore. In foreign exchange, many large players carry out not only forex trading but also product structuring here, encouraged by the depth and sophistication of the market. Activities on commodity derivatives have risen, and in the last few months, 8 financial institutions have set up, or are setting up, commodities trading desks in Singapore to trade energy and metals.
30 Responding to these trends, our universities are stepping up education in risk management and product structuring. NUS and NTU both offer Masters programmes in financial engineering, the latter in collaboration with Carnegie Mellon University. These courses are multi-disciplinary, drawing together expertise in finance, mathematics and computer science. SMU offers a wide range of executive programmes in finance, some in collaboration with Wharton. INSEAD's newly established Asia Pacific Institute of Finance (APIF) will soon be launching several programmes, including enterprise risk management and structured products.
31 At a more general level, the Professional Risk Managers' International Association and the Risk Management Association are also active in sharing expertise in specialized areas of risk management. Local trade associations, including ABS, and international ones, such as the International Swaps and Derivatives Association (ISDA) also play an important role in advancing the understanding of risk management and promoting sound risk management practices.
G. CENTRE OF EXCELLENCE FOR RISK MANAGEMENT AND FINANCIAL INNOVATION
32 The interest shown by the industry, universities and professional bodies is very encouraging. We believe that Singapore has the conditions to develop as a centre of excellence for risk management and financial innovation in asia. We envisage global researchers and industry practitioners congregating to conduct leading edge research into Asian markets and risk characteristics that can then be translated into new products, services and risk models. Financial institutions can, apart from using Singapore as the hub for risk management oversight and control, also develop and test-bed new risk mitigation products here.
33 A strong partnership between the industry and academia on education and research, and an infrastructure to attract leading players will be essential. To add momentum to the current efforts, MAS will establish a "Programme on Risk Management and Financial Innovation". We will set aside S$10m from the Financial Sector Development Fund to co-fund projects in these areas, including the set-up of new risk management programmes, research and development of product structuring expertise. MAS will bring together the industry, universities and training providers to develop these ideas further, and we welcome your suggestions.
34 Before concluding, let me briefly summarise the key points. We believe that there are many growth opportunities, especially in Asia. But managing risks will be a key challenge, and as supervisors, as Board and management of individual financial institutions, and as an industry body, we can each play our role to institute the necessary framework to enhance risk management capabilities. But beyond minimising problems, the expertise in risk management, especially in financial risk management, can be a core capability that enables innovation and growth. Working together, we can raise these capabilities in the coming years, and build Singapore as a centre of excellence for risk management and financial innovation. Thank you.