Asian Financial Crisis and Market Prospects of the Financial Sector
by Services 2000 Research Team
City University of Hong Kong
The Asian financial crisis started on 2 July 1997. Then the Bank of Thailand allowed the baht to float, after it failed to defend the currency. Hong Kong was involved in the crisis as the Hang Seng Index dropped by 23% between 20 and 23 October. At least up to early 1999, the crisis is not yet over and the general atmosphere in the economy is still pessimistic. The financial sector was the first to be hurt in the economic turmoil while Hong Kong as a whole suffered an economic recession throughout 1998. Although some people may blame “short-term” capital flows for causing the economic downturn, the Asian governments cannot ignore the converse, which is that economic boom can be led by capital flows too. Actually, there is no evidence that any single element is to blame for the financial crisis. For example, a conference on Asian crisis in December 1998 at Seattle suggested that the Asian financial crisis could have been the result of many different problems, such as too much government intervention or subsidies in the banking sector, or psychological panic about currency devaluation.
Positive Effects of the Asian Financial Crisis
Although the entire financial sector has shrunk in the aftermath of the crisis, the sector needs to become more open to foreign competition in the future. It is natural to worry that the governments may try to restrict liberalization of the financial sector in the face of the financial crisis. Fortunately, as revealed by the Leader’ Declaration of Asia-Pacific Economic Cooperation (APEC) in November 1998, the Asian governments have understood that expansion of trade and investment was “essential element” for economic recovery. The APEC leaders also expressed support for the World Trade Organization (WTO) negotiations. In addition, the financial crisis should speed up the pace of financial sector reforms, the APEC leaders having already delivered the message to restructure the financial sector.
The Asian financial crisis has exposed the weaknesses plaguing the financial sector in many Asian economies. Regulators need to re-capitalize ailing banks and improve their efficiency. Stricter regulations and more transparent information disclosure are needed to overhaul the problematic financial markets. Financial institutions in those economies can no longer operate under an implicit guarantee from the government. Instead, they have to learn how to run a business and assess their own risks carefully. For example, the implicit guarantee of the registered foreign debts by the Chinese government is the reason for the over-lending to the Guangdong International Trade and Investment Corporation (GITIC) by the banks in Hong Kong. This incident could have been prevented if the special priorities had not been given to banks outside China. Before the Chinese government announced that registered foreign loans would not be given priority, a bank located in Hong Kong lending to the GITIC and registering the loan would expect a much lower risk than the same bank located in China. As a result, the implicit guarantee encouraged “cross-border supply” and discouraged “commercial presence”. This is also a market distortion and can be eliminated by providing “national-treatment” commitments.
Business Opportunities from the WTO Financial Services Agreement
Many Asian governments lack the experience of managing prudent and innovative institutions. The mountain of bad debts waiting to be restructured poses another hurdle in the rehabilitation process. Opening the financial sector to foreign participation seems to be an essential step as liquidity has practically dried up in some of the economies still haunted by the crisis. Reforms of the financial sector are already under way in most economies. Although the WTO failed to reach a compromise in the 1993 and 1995 negotiations, WTO members successfully concluded a financial services agreement under the General Agreement on Trade in Services (GATS) in December 1997. The financial crisis speeded up the commitments on trade liberalization even further. For example, Korea is moving beyond the commitments it made in the 1997 Agreement.
From March 1999, the Agreement has come into effect. Under this Agreement, except for some least developed economies in the world, the governments of most major economies have made binding commitments on the way they treat foreign financial services providers. The commitments include “market access” – the admission of foreign companies to their markets and “national treatment” – the permission for foreign companies to operate in the same way as domestic counterparts. The commitments are “bound” so that the governments can never treat foreign companies worse in the future. They can only treat foreign companies better. The governments make the commitments on a most-favoured-nation (MFN) basis, that is, the governments treat all foreign companies from different economies the same as each other although each government may put down exemptions on some particular committed items. The Agreement is now covered by the WTO dispute settlement mechanism, so if a government fails to fulfil its commitments, it has to make corrections or face the prospect of trade penalties which need not be restricted to financial services.
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The WTO Financial Services Agreement covers 95% of the international trade in financial services. It is classified into two types: banking and insurance. Commitments in insurance cover life and non-life; reinsurance; brokerage and agency business; and auxiliary services. Commitments in banking include commercial banking – deposit taking, lending and payments systems; investment banking; securities business; asset management; financial information and data processing; and advisory and auxiliary services. The commitments have both trade and investment aspects. The trade categories are “cross border supply” and “consumption abroad”. The investment categories are “commercial presence” and “presence of national persons”: the former is particular important for financial services while the latter can assist the success of “commercial presence”.
Optimistic Prospects of Further Trade Liberalization in Financial Sector
With almost all important economies having already made commitments, the only major economies that are excluded are the non-WTO members such as China, Taiwan, Russia, Vietnam and Saudi Arabia. The developed economies generally make more open commitments while those of developing economies are more limited and selective. Nevertheless, the coming Services 2000 negotiations provide a chance for more commitments to be made from the WTO members.
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The prospects of further trade liberalization in financial services are optimistic. Governments and regulators increasingly realize that foreign financial institutions can broaden the scope of services at lower prices and put pressure on the domestic companies to be more efficient and productive. Moreover, an open and competitive financial sector will attract more foreign capital in-flows which are vital to the domestic infrastructure investment. At least a lesson from the Asian financial crisis is the unreasonable capital portfolio due to weak supervisory system of some financial institutions. Foreign financial institutions usually have much better record of supervisory rules. More open regulations will allow these foreign companies to raise the professional standard of the domestic companies.