Aziz shin (eds ) global shock, risks, and asian financial reform (2014)

Global Shock, Risks, and Asian Financial
Reform



Global Shock, Risks,
and Asian Financial
Reform
Edited by

Iwan J. Azis
Asian Development Bank and Cornell University, USA

Hyun Song Shin
Professor of Economics, Princeton University, USA

Co-publication of the Asian Development Bank
and Edward Elgar Publishing

Edward Elgar
Cheltenham, UK • Northampton, MA, USA


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Contents
ix
xi

List of contributors
List of abbreviations
PART I  OVERVIEW AND SUMMARY
  1Overview and summary

Iwan J. Azis and Hyun Song Shin

3

PART II Macro-­Prudential Supervisory System
and Development Impact
Introduction
Hyun Song Shin

15

  2Monetary aggregates and procyclicality of the financial
system: an Asian perspective

Joon-­Ho Hahm, Hyun Song Shin and Kwanho Shin

22

  3Non-­core bank liabilities and vulnerability to crisis:
implications for Asia

Joon-­Ho Hahm, Hyun Song Shin and Kwanho Shin

74

  4Monetary aggregates and global liquidity: evidence from
individual firm data from Asia

Hyun Song Shin and Laura Yi Zhao
  5Economy-­wide vulnerability in Asia: flow-­of-­fund analysis

Iwan J. Azis and Damaris Yarcia

102
150

PART III Issues and Challenges on THE Legal
and Institutional Framework for
Emerging Asia
Introduction
Fariborz Moshirian

197

v

vi

Global shock, risks, and Asian financial reform

  6Addressing systemic risk in East Asia: financial regulatory
design
Rolf H. Weber, Douglas W. Arner, Evan C. Gibson and
Simone Baumann

204

  7Financial innovation and development in East Asia: balancing
risks and opportunities

Ross P. Buckley, Douglas W. Arner and Michael Panton

246

  8Implications of global financial and regulatory policies on
systemic risk in Asia

Fariborz Moshirian

284

PART IV Financial Integration and
Cooperation to Support Financial
Stability

Introduction
Noritaka Akamatsu

335

  9Equity home bias, financial integration, and regulatory
reforms: implications for emerging Asia

Cyn-­Young Park and Rogelio V. Mercado, Jr

347

10Regional financial arrangements: lessons from the Eurozone
crisis for East Asia

Emilios Avgouleas, Douglas W. Arner and Uzma Ashraf

377

11The role of deposit insurance in financial stability: issues and
options in the ASEAN13

A. Michael Andrews

416

12Effective resolution regimes for financial institutions in
ASEAN13

A. Michael Andrews

464

13Capital structure and the issuance of corporate bonds in
emerging Asia

Paul Mizen, Frank Packer, Eli Remolona and Serafeim Tsoukas

510

PART V Financial Supervision and Development
Challenges in Asia
Introduction
Ramesh Subramaniam

543




Contents­vii

14 Financial monitoring in the new ASEAN-­5 countries

Se Hee Lim and Noel G. Reyes

554

15 Financial inclusion and regulatory implications

Qifeng Zhang and Josephine B. Valle-­Sison

600

16Innovative financing models for SMEs and the regulatory
implications

Shigehiro Shinozaki
17Global financial regulatory trends and challenges for the
development of the insurance and pensions sector in the
Asia-­Pacific region

Arup Chatterjee

628

676

18Impact of the global financial crisis on trade finance in Asia
and the cooperative effort to respond

Steven Beck

701

Index

717

Contributors
Noritaka Akamatsu, Deputy Head of the Office of Regional Economic
Integration, ADB.
A. Michael Andrews, A. Michael Andrews and Associates Limited.
Douglas W. Arner, Asian Institute of International Financial Law, Faculty
of Law, University of Hong Kong, China.
Uzma Ashraf, Asian Institute of International Financial Law, Faculty of
Law, University of Hong Kong, China.
Emilios Avgouleas, University of Edinburgh, UK.
Iwan J. Azis, ADB and Cornell University, USA.
Simone Baumann, University of Zurich, Switzerland.
Steven Beck, Head of Trade Finance, Private Sector Operation, ADB.
Ross P. Buckley, CIFR King & Wood Mallesons Professor of International
Finance Law, University of New South Wales, Australia.
Arup Chatterjee, Principal Financial Sector Specialist, ADB.
Evan C. Gibson, Asian Institute of International Financial Law, Faculty of
Law, University of Hong Kong, China.
Joon-­Ho Hahm, Professor of International Economics and Finance at the
Graduate School of International Studies, Yonsei University.
Se Hee Lim, Financial Supervisory Service, Korea.
Rogelio V. Mercado, Jr, Economics Research Department, ADB.
Paul Mizen, University of Nottingham, UK.
Fariborz Moshirian, Institute of Global Finance, University of New South
Wales, Sydney, Australia.
Frank Packer, Bank for International Settlements.
Michael Panton, Asian Institute of International Financial Law, Faculty
of Law, University of Hong Kong, China.
ix

x

Global shock, risks, and Asian financial reform

Cyn-­Young Park, Assistant Chief Economist, Economics and Research
Department, ADB.
Eli Remolona, Bank for International Settlements.
Noel G. Reyes, Office of Regional Economic Integration, ADB.
Hyun Song Shin, Professor of Economics, Princeton University, USA.
Kwanho Shin, Professor of Economics at Korea University.
Shigehiro Shinozaki, Office of Regional Economic Integration, ADB.
Ramesh Subramaniam, Deputy Director General, Southeast Asia
Department, ADB.
Serafeim Tsoukas, University of Glasgow, UK.
Josephine B. Valle-­Sison, Office of Regional Economic Integration, ADB.
Rolf H. Weber, University of Zurich, Switzerland.
Damaris Yarcia, Consultant, Department of Social Welfare and
Development, Government of the Philippines; graduate student, School
of Statistics, University of the Philippines Diliman.
Qifeng Zhang, Office of Regional Economic Integration, ADB.
Laura Yi Zhao, Office of Regional Economic Integration, ADB.


Abbreviations
93 SNA
1993 System of National Accounts
ABF
Asian Bond Fund
ABF

asset-­based finance
ABF2
Asian Bond Fund 2
ABIF
ASEAN Banking Integration Framework
ABL
asset-­based lending
ABMF
ASEAN13 Bond Market Forum
ABMI
Asian Bond Market Initiative
ABMIF
Asian Multicurrency Bond Issuance Facility
ABS
asset-­backed securities
ACC
Asian Consultative Committee
ACE
Access, Certainty, Efficiency
ACMF
ASEAN Capital Markets Forum
ACU
Asian currency unit
ADB
Asian Development Bank
ADF
Asian Development Fund
ADF
augmented Dickey-­Fuller
AEC

ASEAN Economic Community
AFAS
ASEAN Framework Agreement on Services
AFC
Asian financial crisis
AFSD
Asian Financial Stability Dialogue
American Insurance Group
AIG
AIGFP
American Insurance Group Financial Products
AIM
Alternative Investment Market
AMBD
Autoriti Monetari Brunei Darussalam
AMBIF
Asian Multicurrency Bond Issuance Framework
anti-­money laundering
AML
AML-­CFTanti-­money laundering and combating the financing of
terrorism
AMRO
ASEAN13 Macroeconomic Research Office
APEC
Asia-­Pacific Economic Cooperation Conference
APRA
Australian Prudential Regulatory Agency
ASEAN 5Indonesia, Malaysia, the Philippines, Thailand, and Viet
Nam
xi

xii

Global shock, risks, and Asian financial reform

ASEAN
Association of Southeast Asian Nations
ASEAN13ASEAN plus the PRC, Japan, and the Republic of
Korea
ASEAN-­4
Indonesia, Malaysia, the Philippines, and Thailand
ATM
automated teller machine
AVC
asset value correlation
Basel IIIBasel Capital Accord
BCBSBasel Committee on Banking Supervision
BCMLVBrunei Darussalam, Cambodia, Myanmar, the Lao
People’s Democratic Republic and Viet Nam
BISBank for International Settlements
BNBrunei Darussalam
BNDBrunei Darussalam dollar
BNMBank Negara Malaysia
BOKBank of Korea
BOLBank of Lao
BPSBadan Pusat Statistik (Central Bureau of Statistics)
BSEBombay Stock Exchange
BSPBankgo Sentral ng Pilipinas
BSPBankgo Sentral ng Pilipinas

CAMELcapital adequacy, asset quality, management quality,
earnings, and liquidity
capital adequacy ratio
CAR
CBM
Central Bank of Myanmar
CBOE
Chicago Board Options Exchange
CCF
credit conversion factor
CCP
central counterparties
CCT
conditional cash transfer
certificate of deposit
CD
CDO
collateralized debt obligation
credit default swap
CDS
CEBS
Committee of European Banking Supervisors
CEIOPSCommittee of European Insurance and Occupational
Pensions Supervisors
CES
constant elasticity of substitution
CESR
Committee of European Securities Regulators
CET
constant elasticity of transformation

combating the financing of terrorism
CFT
CGAP
Consultative Group to Assist the Poor
CGE
computable general equilibrium
CGIF
Credit Guarantee and Investment Facility
China Insurance Regulatory Commission
CVIRC




Abbreviations­xiii

CMG
Crisis Management Group
CMI
Chiang Mai Initiative
CMIM
Chiang Mai Initiative Multilateralization
CMIM-­PL
CMIM Precautionary Line
CML
Capital Markets Law
CN
China PRC
Chinese yuan
CNY

CoCos
convertible contingent capital
ComFrameCommon Framework for the Supervision of
Internationally Active Insurance Groups
commercial paper
CP
CPA
certified public accountant
CPIS
Coordinated Portfolio Investment Survey
CPSS
Committee on Payment and Settlement Systems
CSIF
Cross-­border Settlement Infrastructure Forum
CSRC
China Securities Regulatory Commission
DATC
Debt and Asset Trading Company
DBN
De Nederlandsche Bank
DCC
dynamic conditional correction
DDR
deposit reserve ratio
DFID
Department for International Development
deposit guarantee scheme
DGS
DICJ
Deposit Insurance Corporation of Japan

deposit reserve ratio
DRR
D-­SIFI
domestic systematically important financial institution
debt to income
DTI
DVI
Deposit Insurance of Viet Nam
EBAEuropean Banking Authority
EBUEuropean Banking Union
ECA
export credit agency
ECBEuropean Central Bank
EDP
excessive deficit procedure
EECEuropean Economic Community
EIOPAEuropean Insurance and Occupational Pensions
Authority
EME
emerging market economy
EMEAPExecutives’ Meeting of East Asia Pacific Central Banks
EMSEuropean Monetary System
EMUEuropean Monetary Union
ERM
enterprise risk management
ERM IIExchange Rate Mechanism II
ERPDEconomic Review and Policy Dialogue


xiv

Global shock, risks, and Asian financial reform

ESAEuropean Supervisory Authority
ESCBEuropean System of Central Banks
ESFSEuropean System of Financial Supervision
ESMEuropean Stability Mechanism
ESMAEuropean Securities and Markets Authority
ESRBEuropean Systemic Risk Board
ETPElectronic Trading Platform
EUEuropean Union
FAS
Financial Access Survey
FASB
Financial Accounting Standards Board
FATF
Financial Action Task Force
FCI
Factors Chain International
FCL
flexible credit line
FCY
foreign currency
FDI
foreign direct investment
Federal Deposit Insurance Corporation
FDIC
Federal Reserve
Fed
Swiss Financial Market Supervisory Authority

FINMA
FINMASA
Swiss Financial Market Supervisory Act
FOF
flow of funds
FPC
Financial Policy Committee
FSA
Financial Services Authority
FSAP
Financial Sector Assessment Program
FSAP
Financial Services Action Plan
FSB
Financial Stability Board
FSC
Financial Services Commission
FSF
Financial Stability Forum
FSS
Financial Supervisory Service
Free Trade Area of the Asia-­Pacific
FTAAP
FX
foreign exchange
G20/G-­20
Group of 20
GAAP
generally accepted accounting principles
GARCH

generalized autoregressive conditional heteroskedasticity
gross domestic product
GDP
GEM
Growth Enterprise Market
GFC
global financial crisis
GISC
Global Industry Classification Standard
Global Findex Global Financial Inclusion Database
GPFI
Global Partnership for Financial Inclusion
GRIF
general rule of international factoring
global systematically important financial institution
G-­SIFI
global systemically important insurer
G-­SII




Abbreviations­xv

HKMA
Hong Kong Monetary Authority
HLA
higher loss absorbency
HP
Hodrick-­Prescott

HRE
Hypo Real Estate
HSX
Hanoi Stock Exchange
IADI
International Association of Deposit Insurers
Initiative for ASEAN Integration
IAI
IAIG
internationally active insurance group
International Association of Insurance Supervisors
IAIS
international accounting standards
IAS
IASB
International Accounting Standards Board
IBF
international banking facility
IBRA
Indonesian Bank Restructuring Agency
ICAPM
International Capital Asset Pricing Model
ICC
International Chamber of Commerce
ICP
Insurance Core Principle
ICRG
International Co-­operation Review Group
information communications technology
ICT

identity
ID
ID
Indonesia
IDIC
Indonesia Deposit Insurance Corporation
IDR
Indonesian rupiah
IDS
Information Disclosure System
IDSA
International Derivative and Swap Association
International Finance Corporation
IFC
IFG
International Factors Group
IFRS
International Financial Reporting Standards
International Financial Statistics
IFS
International Investment Position
IIP
IIX
Impact Investment Exchange Asia
IMF
International Monetary Fund
INFE
International Network on Financial Education
INVA
investment over total assets

International Organization of Securities Commissions
IOSCO
IPO
initial public offering
IRDA
Insurance Regulatory and Development Authority
information technology
IT
JBIC
Japan Bank for International Cooperation
Japan International Cooperation Agency
JICA
Japan Securities Dealers Association
JSDA
KOFIAKorea Financial Investment Association
KONEXKorea New Exchange


xvi

Global shock, risks, and Asian financial reform

KOSDAQKorean Securities Dealers Automated Quotations
KRWKorean won
KRXKorea Exchange
KYC
know your client/customer
LAKLaotian kip
L/C
letters of credit

Lao PDRLao People’s Democratic Republic
LCR
liquidity coverage ratio
LCY
local currency
LOLR
lender of last resort
LSXLao Securities Exchange
LTCMLong Term Capital Management
LTV
loan to value
mai
market for alternative investment
MASMonetary Authority of Singapore
MCR
minimum capital requirement
MEBMyanmar Economic Bank
MEFMinistry of Economy and Finance
MES
marginal expected shortfall
MESDAQMalaysian Exchange of Securities Dealing and
Automated Quotation
MetLifeMetropolitan Life Insurance Company
MFB
microfinance banks
MFI
microfinance institution
MiFIDMarkets in Financial Instruments Directive
ML
maximum likelihood

MNO
mobile network operator
MOFMinistry of Finance
MOUMemorandum of Understanding
MPI
macro-­prudential indicators
MPS
macro-­prudential policy and surveillance
MSECMyanmar Securities Exchange Center Company Limited
MSMEs
micro, small, and medium-­sized enterprises
MYMalaysia
NAFMIINational Association of Financial Market Institutional
Investors
NBCNational Bank of Cambodia
NCD
negotiable certificate of deposit
NDF
non-­deliverable forward
NBFI
non-­bank financial institution
NDRCNational Development and Reform Commission
NGO
non-­governmental organization




Abbreviations­xvii

NIEs
newly industrialized economies
NPL
non-­performing loan
NPV
net present value
NSENational Stock Exchange
NSFR
net stable funding ratio
NYUNew York University
OECDOrganisation for Economic Co-­operation and
Development
OFIDOPEC Fund for International Development
OLS
ordinary least squares
OMT
outright monetary transaction
OPECOrganization of Petroleum-­Exporting Countries
OREIOffice of Regional Economic Integration
ORSAOwn Risk and Solvency Assessment
OTC
over the counter
PBOCPeople’s Bank of China
PCL
precautionary credit line
PCR
prescribed capital requirement
PDICPhilippines Deposit Insurance Corporation
PDRPeoples’ Democratic Republic
PPP

public–private partnership
PRAPrudential Regulatory Authority
PRCPeople’s Republic of China
Q3
quarter 3
Q4
quarter 4
QAB
Qualified ASEAN Bank
QE
quantitative easing
QIB
qualified institutional buyer
risk appetite framework
RAF
Reserve Bank of Australia
RBA
Reserve Bank of India
RBI
RCC
rural credit cooperative
Regional Comprehensive Economic Partnership
RCEP
RDB
Regional Development Bank
repo
overnight repurchase agreement
renminbi
RMB
RP

repurchase agreement
RRP
recovery and resolution plan
RSI
Regional Settlement Intermediary
R-­SIFI
regional systematically important financial institution
risk-­weighted asset
RWA
RYMMalaysian ringgit


xviii

Global shock, risks, and Asian financial reform

S&P 500
Standard and Poors 500 Stock Index
SBV
State Bank of Viet Nam
SCF
supply chain finance
SCR
solvency capital requirement
SEACEN
Southeast Asian Central Banks
SEC
Securities and Exchange Commission
Securities and Exchange Commission of Cambodia
SECC

SECO
Securities and Exchange Commission Office
SES
systemic expected shortfall
SET
Securities Exchange of Thailand
SGD
Singapore dollar
SGP
Stability and Growth Pact
SIB
systemically important bank
SIFI
systematically important financial institution
small and medium-­sized enterprises
SMEs
SNB
Swiss National Bank
SOE
state-­owned enterprise
SRISK
systemic risk
SRM
single resolution mechanism
SRO
self-­regulatory organization
SSC
State Securities Commission
SSM
single supervisory mechanism

SZSE
Shenzhen Stock Exchange
TARPTroubled Asset Relief Program
TBTF
too big to fail
TFEUTreaty on the Functioning of the European Union
TFPTrade Finance Program
THThailand
THBThai baht
TRACETrade Reporting and Compliance Engine
UKUnited Kingdom
UNUnited Nations
USUnited States of America
USDUnited States of America dollar
VAMCViet Nam Asset Management Company
VASViet Nam accounting standards
VIXVolatility Index
VNViet Nam
VNDVietnamese dong
VS
vertical specialization
WMP
wealth management product
WTOWorld Trade Organization


PART I

Overview and Summary

1. Overview and summary
Iwan J. Azis and Hyun Song Shin
The growth of financial markets has clearly outpaced the development
of financial market regulations. With growing complexity in the world
of finance and the resultant higher frequency of financial crises, all eyes
have shifted toward the current inadequacy of financial regulation. With
financial innovation and securitization becoming more popular, interconnectedness in the financial system is at its height, both for intra-­ and
extra-­sovereign jurisdictions. Geographical boundaries have less relevance
for financial flows than they do for trade in goods. During good economic times in the past, supported by financial innovation, financial and
non-­financial institutions alike were eager to participate in the expanding
financial sector with its promise of high returns. The risk compression was
widespread. Seen from this perspective, the 2008–09 global financial crisis
(GFC) that occurred in the US, and the subsequent crisis in the Eurozone,
should not be too surprising. Meanwhile, the policy response has been
unprecedented. And surely it affects Asia.
The book is about what this episode means for Asia’s financial sector
and its stability, and what will be the implications for the region’s financial
regulation.
Fluctuations in US and Eurozone interest rates since 2000 could not
have been more pronounced. Responding to the 2000 recession and the
events of 11 September 2001, the US Federal Funds rate fell precipitously
from over 6 percent in 2001 to a mere 1 percent by summer of 2003.
Over the same period, the European Central Bank (ECB) rate dropped
from over 4 percent to 2 percent. Fears of asset bubbles subsequently
led to interest rate increases in the US and Europe. By late 2007, on the
eve of recession and the subprime crisis, rates had doubled in Europe
and increased more than fivefold in the US. As the recession began in
December 2007, the Federal Reserve drastically shifted gears again, lowering interest rates steadily from more than 5 percent to 2 percent by mid-­

2008. The subsequent collapse of Lehman Brothers in September forced
the Federal Reserve to be even more aggressive in pushing down rates, with
the Federal Funds rate reaching 0.25 percent by the end of 2008, which
3


4

Global shock, risks, and Asian financial reform

is where it remains at the time of writing. The fall of interest rates in the
Eurozone was not much less dramatic, with a steady decline from over 4
percent in 2007 to 1 percent shortly after the Lehman crisis, to 0.5 percent
in mid-­2013, and 0.25 percent at the time of writing.
Amid financial globalization, such sharp swings in interest rates in
developed economies have generated waves of capital flows to developing
economies, including in Asia which has already held considerable excess
savings since the aftermath of the 1997–98 Asian financial crisis. What
are the impacts of such flows in terms of the risks of financial instability,
and to what extent do the excess savings affect the investment decisions of
agents? These fundamental questions are dealt with in Part II.
Much of the flow of capital into Asia has been intermediated by the
banking sector as evidenced by the increasing share of banks’ non-­core
liabilities, which also reflects changes in the wholesale funding market.
This poses the risk of procyclicality and it also reduces the sensitivity of
non-­core liabilities to output changes and monetary policy. The resulting
financial cycle is not in synchronization with the business cycle, making
monetary policy alone insufficient to deal with the procyclicality and
financial instability caused by such bank-­led flows. This is the reason why
macro-­prudential policy needs to complement standard macroeconomic

policy.
Given changes in global financial conditions, the importance of the non-­
core liability ratio as part of an early warning system cannot be overemphasized. The power of this ratio to predict financial and currency crises,
under different levels of capital market openness, is shown in Chapter 3,
which suggests that macro-­prudential policy must take into account the
complex relationship between banks’ non-­core liabilities and capital flows.
Any efforts to further liberalize the financial sector also must account for
such a relationship.
However, not all countries in Asia have a liberalized system of capital
flows. Those economies that still control flows can insulate themselves
from risk. At least that is what many would expect. Yet, even in a relatively closed banking system, non-­financial firms can take up the role of
financial intermediation by depositing external funds and their proceeds
in the domestic banking system, which in effect influences domestic credit
conditions. Thus, the risks of procyclicality remain in place even in a closed
banking system. In such circumstances, decomposing M2 into core and
non-­core liabilities is more useful for the purpose of gauging financial stability. By using the case of the PRC and utilizing firm-­level data, this issue
is analyzed in detail in Chapter 4.
With the emergence of excess savings after the 1997–98 Asian financial
crisis, massive inflows of capital also meant additional liquidity in the




Overview and summary­5

region’s economy. The cost of capital fell markedly as a result. This environment has changed the investment decisions and behavior of banks,
firms, and households, as they lean toward more risky spending and
prefer investing in financial assets. The macro-­financial implications and
how they affect the real sector, including socioeconomic conditions, are
discussed in the last chapter of Part II. It is shown that the composition

of excess savings differs across countries in the region, and that the visible
trends are also unequal. The rise of corporate savings is notable, largely
caused by improved current accounts and growing per capita income
across the region.
Prior to the GFC, a growing share of capital inflows was intermediated
through the banking sector, and hence was labeled bank-­led flows. After
the GFC, the flows going through debt or bond markets became significant, and hence were labeled debt-­led flows. In addition to the exchange
rate pressure exerted by capital inflows, these two types of flows are particularly volatile. As bank-­led flows lead to rapid growth in credit, especially in the property and consumer goods sectors, and also raise banks’
preferences for risky financial assets, the risk of procyclicality can be high.
The reaction to the Federal Reserve’s announcement in mid-­2013 that it
was considering tapering its quantitative easing measures also shows that
the reversals of debt-­led flows can easily cause fluctuations in exchange
rates and rattle bond markets. This can undermine long-­term financing in
capital markets. Clearly, policymakers and regulators are faced with a very
serious challenge.
The rise of agents’ preference for financial assets is largely driven by the
lure of high returns in the fast-­growing financial sector, the perception of
low risk compared with investing in the real sector (owing to numerous
difficulties associated with a less-­than-­favorable business climate), and the
greater number of financial instruments created through financial liberalization and innovation. Yet, the fact that in most countries only a tiny share
of the population has access to the financial sector may have exacerbated
already skewed income and asset inequality. This phenomenon is highlighted in the last section of Part II by using an empirical case study based
on an economy-­wide model where a large portion of the increased income
of financial asset holders (mostly the urban rich) is generated from asset
returns, leaving those with no financial assets in a relatively disadvantaged
position. The development impact of investing the excess savings in financial assets rather than in real sector investment is also apparent in the labor
market. To the extent that the job-­creating capacity of financial investment
is smaller than that of real sector investment, this contributes to falling
employment elasticities observed throughout Asia.
The analysis in Part II shows that the risks of procyclicality associated

6

Global shock, risks, and Asian financial reform

with increased non-­core liabilities through bank-­led flows and volatility in
capital markets are not only manifest in macro-­financial vulnerability, but
also in development terms through rising income inequality and unemployment. Based on this premise, therefore, if appropriately designed and
effectively enforced, the proposed macro-­prudential policy may provide
benefits beyond just ensuring financial stability.
The resulting effect of the procyclicality risks can also interrupt business and financial cycles, which may reduce the effectiveness of standard
macroeconomic policy, as discussed in detail in Part III. More seriously,
given the dominant role of banks, including their influence over capital
markets in the region, the risks can be systemic. This is where the rules and
standards play an essential function, especially in relation to systematically important financial institutions (SIFIs). The supervision of SIFIs –
whether domestic (D-­SIFIs), regional (R-­SIFIs), or global (G-­SIFIs) – is
critical as their failing can result in severe financial instability impacting a
nation’s financial system and economy, and further spreading into regional
and global financial systems. Although the economies of emerging Asia
are typically characterized by relatively large D-­SIFIs with only a handful
of G-­SIFIs, hence international financial regulatory standards may not
currently be a priority, increasingly more D-­SIFIs in the region have transformed into R-­SIFIs. As this will increase the amount of cross-­border
operations, the regulatory design and standards must eventually address
issues surrounding how to supervise the cross-­border operations of SIFIs.
This topic is discussed in Chapter 6. It is also argued in this section that
a regulatory structure must vary according to the nature and size of its
financial sector, its domestic and international importance, and the skills
and resources of regulators and the particular government.
To the extent that financial liberalization offers benefits but also carries

risks of financial crisis, the discussions in Chapter 7 put the whole concept
of financial liberalization and innovation into a more balanced perspective, whereby all the potential risks are matched with the benefits and
opportunities of liberalization, including opportunities associated with
development-­related matters (for example, mortgage markets, small and
medium-­sized enterprises – SMEs – finance, non-­bank finance, trade
finance, and mobile financial services). By focusing on legal and institutional frameworks, this section elaborates on various issues and challenges
in terms of how financial liberalization can maximize the benefits and
minimize the risks of crisis.
Understanding the importance of systemic risk is important, but measuring it is another issue. What elements and factors need to be incorporated
in the measure of systemic risks? To the extent that banks’ operations are
becoming more interconnected, especially between large and medium-­sized