Implications of the Crisis for Emerging Market Financial Systems' - Transcript of Remarks by Mr Tharman Shanmugaratnam, Minister for Finance Singapore - Panel Discussion on "Reforming Global Finance", Russia Singapore Business Forum, 29 September 2009

1. The focus of financial reforms over the last several months has been on the problems of the banking and financial systems in the most developed markets, which are what led to this financial crisis.

2. It is understandable that the first priority has been to fix the banking and financial systems of the advanced world. But it is important for the rest of the world not to derive the wrong lessons as the advanced financial systems move towards re-regulation - as they move towards a return to traditional norms of prudent banking supervision and avoid the excesses on both unregulated derivatives markets and unregulated securisation. It is important that we don’t derive wrong lessons for the rest of the world.

3. The basic problem in the most advanced financial markets was the tragic failure of policy. There was a failure to address the remarkable buildup of leverage - both explicit leverage, and leverage embedded in financial products. There was also a failure to address regulatory arbitrage between the banking and the shadow banking systems. The very growth of the shadow banking system was motivated by the desire of market participants to avoid the capital charges and other requirements that banks were obliged to meet.

4. Through the process now taking place at the Basel Committee, the Financial Stability Board (FSB) and other fora, including the G20, the advanced financial systems are moving the direction of re-regulation, tightening capital requirement particularly for the trading books of banks; and more so for systemically significant institutions. They will also require better quality capital. And they are moving towards a more level playing field in regulation between banking and the non-banking sector.

5. But the basic direction of travel for the emerging world is different from the most advanced markets. In the sense we will have to move from two ends of the spectrum towards a position that is closer to one another. The basic direction of travel in the emerging world has to be towards continued, gradual opening up and further diversification of their financial systems.

6. The financial systems of the emerging world, particularly in Asia, are still heavily dominated by banks, with underdeveloped capital markets. And in many cases the financial system on the whole is either state directed or not sufficiently open to competition from foreign institutions, or both.

7. So the basic direction of travel should continue towards diversifying financial systems away from heavily bank-centric systems by deepening capital markets, and towards the gradual opening up of financial systems to foreign competition. It has to be done while learning the right lessons from the problems from the advanced markets - ensuring that the capital markets are well-regulated and transparent, and ensuring that we do not allow the excessive leverage build up in the system as a whole even as we regulate each segment of the system, in other words, to keep our sights on macro prudential regulation.

8. As we gradually liberalise and diversify emerging market financial systems, we have to avoid purist approaches. It is not an “all or nothing” approach. In particular, we should avoid about a “Wimbledon” strategy - where you go for any competitive market outcome regardless of whether home country banks retain a role in your system.

9. The more judicious approaches appear to be in the middle ground. This ground has two main features. First, it involves a gradual, calibrated process of admitting foreign participants, ensuring that they have sufficient capital in their home jurisdictions; and ensuring that where they are not subsidiarised and hence do not keep capital in the host jurisdiction, they are subject to maintain some form of asset maintenance regime - requiring that they maintain the right proportion of domestic assets and liquid assets to back their liabilities in the host jurisdiction.

10. Second, it involves mitigating risks by having a few strong domestic banks as the anchors of your system. That is one of the lessons from this crisis. Canada, Australia, Singapore and Hong Kong, each with its few strong domestic banks, have each survived the crisis well, and indeed had avoided the excesses that led to the crisis. And these are not closed systems. They are open systems, open to foreign competition, with a relatively high degree of foreign participation in their financial systems compared to most.

11. This combination of having strong domestic anchors, and adequate foreign competition particularly in wholesale and capital markets, is a middle ground that is workable. It requires diligent regulation and supervision. But it allows us to maximize the benefits of globalization while avoiding excessive risks.

12. To summarise, the lessons from this crisis are not the same for different regions of the world. We should avoid translating the lessons that are applied to the West directly to the rest of the world, particularly to the emerging world.