Sunday, March 18, 2012 Business

The future of Asian banking

Vehicles are seen in the congested traffic of Bangkok. Thailand's economy, affected y floods in !ecem er, is no" on the mend. #hoto$ %&#%ndre" Sheng

This "eek "as my first 'isit to Bangkok since the floods in !ecem er. The city seems to ha'e reco'ered and the economy is on the mend. %fter an estimated 0.1 (ercent gro"th in real )!# in 2011, the *nternational *nstitute of &inance +**&, is forecasting a ro ust (ercent gro"th reco'ery in 2012, hel(ed y a multi.year fiscal stimulus that "ould ring the fiscal deficit to an estimated /./ (ercent of )!# for the fiscal year 2011.2012. The (ackage of fiscal stimulus included a 00 (ercent hike in minimum "ages from %(ril and an aggressi'e cut in cor(orate income ta1 rate from current 20 (ercent to 22 (ercent and a further cut to 20 (ercent for 2012. This "ould (ut Thai cor(orate ta1 rate closer to those of its neigh ours. The com ination of increase in minimum "age rates and generous (rice su((ort (rogramme for rice mean that the go'ernment is serious a out tackling income ga(s and (ushing consum(tion. The (ur(ose of the Bangkok tri( "as to de ate the future of %sian anking usiness models. The central 3uestion is ho" to recycle %sian sa'ings "ithin %sia. Because of its demogra(hics and (rudence in consum(tion, 4ast %sia has al"ays run a net current account sur(lus, "ith its accumulation in sa'ings (laced largely in the ad'anced markets. 5hy can't some of these sa'ings e used to fund much needed infrastructure "ithin the region6 *n 2002, !ooley, &olkerts.7andau and )ar er named the current cross.#acific arrangement Bretton 5oods **, "here %sia funded the 8S current account deficit y rein'esting its sa'ings ack in the ad'anced markets. This arrangement can also e called the )rand Bargain. Basically %sia s"a((ed dollars for 9o s for the youth entering the la our force and the e1(loitation of its natural resources. The )rand Bargain is ending as %sians realise that their holdings of dollars may e e1(osed to future de(reciation and that %sian la our force and natural resources should not e chea( fore'er. The )rand Bargain had im(lications for the ad'anced country anking usiness models. % deficit country "ill 'ery soon find that its anking system must ha'e loans:de(osit ratios running higher than 100 (ercent, ecause the e1cess consum(tion has to e funded y credit. *n %sia, the a'erage loans:de(osit ratio is lo"er than 100 (ercent, ecause sa'ings are larger than de t. The %merican anking system had to shift from retail anking into a "holesale anking system, relying on securitisation of its assets +mortgages and loans, and selling them into the glo al market to fund its loan ook. ;uite a lot of %%%.rated securities ended u( in 4uro(ean (ortfolios, ecause the (rudent %sians stuck mostly to Treasuries. Thus, "hen the su (rime crisis eru(ted in 200-, the 4uro(ean anks "ere one of the igger 'ictims.

There are good reasons "hy 8S and 4uro(ean anks e'ol'ed into le'eraged "holesale anks tur ocharged y deri'ati'e markets. <inety (ercent of =T> deri'ati'e trading in the 8S are dominated y fi'e large anks. 4uro(e as a region accounts for -0 (ercent of total glo al interest rate deri'ati'e trading. The %tlantic anks "ent into (ro(rietary trading and financing engineering ecause y the 1?80s, under com(etition from the @a(anese anks, net interest margin usiness + asically the margin et"een lending rate and de(osit rates, ecame less and less (rofita le. This shift out of traditional retail anking usiness "as also due to the free market ideology to reduce market friction to Aero y lo"ering transaction costs +such as transaction ta1es and commissions,. *n the old days "hen rokers made money from fat commissions, they "ere "illing to (ro'ide research for their customers. 5hen margins ecame near Aero "ith com(uterised trading, securities firms engaged more and more into (ro(rietary trading and le'eraged trading in order to make money. )ood 3uality research ecame scarce. Banks made more money from B(ushingC deri'ati'e (roducts to their retail in'estors, ecause they could earn more fees u(.front and from granting credit to their customer from le'eraged trading. The com ination of (ro(rietary trading and le'eraged deri'ati'e financial engineering mor(hed anking usiness a"ay from eing a trusted agent of the real sector into a com(etitor or (rinci(al that may trade sometimes in conflict against the interest of its customers. The financial sector ecame a (rinci(al in its o"n right, "ith total assets larger than the real sector and therefore Too Big to &ail. This change in culture "as e1em(lified y the remarka le =(.4d y )reg Smith, a former e1ecuti'e director in )oldman Sachs, (u lished in the *nternational Derald Tri une on March1/, 2012, "hich * read on the (lane ack to Dong Eong. De asically highlighted the de ate "hether one should e making money for the ank or making money for the client. Because %sia as a "hole did not run into deficit, the anking system has not strayed from its retail anking roots. %fter the (ainful lessons of the 1??-.?8 %sian financial crisis, %sian regulators ha'e een much more cautious in allo"ing %sian anks to go the deri'ati'e route. The game is changing dramatically ecause %sian interest margins are also eginning to e s3ueeAed as com(etition intensifies. Some %sian anks are already eing ra((ed on the knuckles for not (aying enough attention to client suita ility in selling ina((ro(riate "ealth management (roducts to customers. So the de ate on "hether %sian anks should make more money from ca(ital market usiness is 'ery much on the ta le. This raises a fundamental 3uestion "hich the current glo al regulatory reforms ha'e not addressed. * ha'e gone on record to say that if green engineers are (aid less than financial engineers, "ill "e e1(ect a green economy to emerge efore asset u les6 Similarly, if anks are to ser'e their real sector customers etter, "hat (olicies are re3uired to induce them to make more money from real customer ser'ice than le'eraged (ro(rietary trading6

This means that regulators need to (ursue less "hat anks should not do, ut "hat usiness models are a((ro(riate for the anks to ser'e the real sector etter6 This o 'iously re3uires the regulators and the industry to ha'e a etter con'ersation than the current lines of engagement.