Asian Development Outlook 2015:
Financing Asia’s Future Growth
Donghyun Park
Principal Economist
Asian Development BankGRIPS,
Tokyo, Japan, 15 May 2015

The views expressed in this document are those of the author and do not necessarily reflect the views and policies of the
Asian Development Bank or its Board of Governors or the governments they represent.

2Outline• The case for financial sector
deepening in Asia
• Financial development for growth• Financial access for inclusion• Financial stability to safeguard inclusive
growth• Financing Asia’s future growth: key
overall messages
3Case for financial development• Real-financial dichotomy in developing
Asia–Dynamic real economy versus backward
financial system–This is an old issue, so why re-visit it now?

• The global financial crisis (GFC) gave
finance a bad name
–Sophisticated financial innovations
triggered GFC–Too much finance?
4

Case for financial development• But Asia is well inside the global financefrontier– Asia is not New York or London– In Asia, financial development refers to much
more basic task of building up a sound andefficient financial system• More fundamentally, finance can give Asia a
growth dividend– Asia’s growth has slowed down since GFC– In the past, Asia grew rapidly despite a backward
financial system, not because of it– Therefore, the case for financial development isstronger now than ever before
5Asia’s growth decelerated since GFC%
12

9Average
2000-2007

Average
2008-2016

6

3

0

2000

2002

2004

2006

2008

2010

2012

2014 2016
Forecast

6Case for financial development• In addition, financial development cancontribute to equity and stability– Government must take action to foster
inclusive finance– Safeguarding financial stability promotes both
growth and equity• Convergence of 3 strategic challenges adds
sense of urgency to financial development– Re-igniting growth– Tackling rising inequality– Maintaining financial stability
7

Asia’s finance has improved since AFC…..
2000
%
15

2013

Ratio of bank capital to total assets

12
9
6
3
0
Indonesia

Republic of Korea

Malaysia

Philippines

Thailand8

…..but still lag OECD economies in size
% of GDP

Banking system deposits

Bonds

150

120

90

60

30

0

Developing Asia

Latin America & Caribbean

OECD
9

…..and in efficiency%

Interest Rate Spread, 2011
18

15

12

9

6

3

0

Developing Asia

Latin America &CaribbeanOECD
10And, while Asia performs well relative toother developing regions…..
Liquid liabilities to GDP, 2011
Hong Kong, China
China, People's Rep. ofSingapore
Malaysia
Thailand
Viet Nam
Maldives
Vanuatu
Korea, Rep. of
India
Nepal
BhutanBrunei Darussalam
Bangladesh
FijiPhilippines
Mongolia
Samoa
Papua New Guinea
Tonga
Cambodia
Solomon Islands
PakistanIndonesia
Sri Lanka
Kazakhstan
Afghanistan
Timor-Leste
Georgia
Armenia
Azerbaijan
0

50

100

150

200
%

250

300

350

11

….the favorable aggregate picture masks
enormous heterogeneity
Private credit to GDP, 2012
Hong Kong, China
Korea, Rep. of
PRC
Malaysia
Singapore
Thailand
Viet Nam
VanuatuFiji
Nepal
Mongolia
India
Bangladesh
Samoa
BhutanMaldives
Armenia
Cambodia
Kazakhstan
Georgia
Philippines
Indonesia
Brunei Darussalam
Sri Lanka
Tonga
Papua New Guinea
Azerbaijan
FSM
Solomon Islands
PakistanTajikistan
0

50

100
% of GDP

150

200

12

Evidence confirms growth benefits of finance• Many cross-countries support a positive
impact of financial depth on growth– King and Levine (1993), Rajan and Zingales(1998), Beck and Levine (2004), Cihak,
Demirguc-Kunt, Feyen, and Levine (2013)– Arcand at al (2012), Cecchetti et al (2012), andothers find a non-linear relationship• Two big problems with the literature– Measures of financial development or
financial depth are highly imperfect– Two-way causality → growth may promote
finance too
13

Evidence confirms growth benefits of financeMeasurement problems, but aroughly suggestive correlation…..
400

300

200

100

0
0

20

40
Lending-deposit spread (% )

1980
2000
D eveloping Asia ( 1980, 1990, 2000, and 2011)

60

80

1990
2011

15

Evidence confirms growth benefits of finance• Estrada, Park, and Ramayandi (2015)
perform additional empirical analysis–Updates data to 2011, and expands
sample to 108 countries [20 from Asia]–Incorporates country characteristics →e.g. developed vs developing– Incorporates financial openness– Incorporates foreign exchange rate
regime– Use GMM to address endogeneity
16

Evidence confirms growth benefits of finance• Key results from Estrada, Park, andRamayandi (2015)–Re-confirm positive effect of financial
depth on economic growth–Positive effect is especially evident indeveloping countries, especially Asia
–Both banks and capital markets have apositive impact–Financial openness has a positive effect–Foreign exchange regime is insignificant
17

Measurement problems, but anotherroughly suggestive correlation…..
400

300

200

100

0
0
1998

5
2005

10
15
O verhead costs to total assets (% )
2011

20

D eveloping Asia ( 1998, 2005 and 2011)18

Evidence confirms growth benefits of finance• Key results from Estrada, Park, andRamayandi (2015)–For example, boosting developing Asia’s
average ratio to GDP of liquid liabilities—
currency plus checking and interestbearing accounts in financial institutions—from about 65% to 75% adds almost 0.4
percentage points to average annual
growth of GDP per capita.
19

Finance-equity link is conceptually ambiguous• Conceptually, finance can either reduce
inequality or worsen inequality– Financial development can reduce inequality
if it leads to more and better financial services
to the poor
• The poor can borrow to finance their education– On the other hand, financial development canworsen inequality if it mainly raises returns tocapital or the pay of financial professionals• The US before the global financial crisis
20

Empirical evidence is mixed too
Log Gini in market income

0.15

y=0.008x2 ─ 0.045x + 0.063(0.002)*** (0.013)*** (0.021)***

0.10

0.05

0.00

-0.05

-0.10
0

1

2

3

4

5

6

Log private credit to GDP

Park and Shin (forthcoming)

21

Empirical evidence is mixed too• More precisely, we find evidence of a Ushaped relationship–Financial development reduces inequality,
but only up to a point• Financial development does notnecessarily promote equity• Therefore, it must be accompaniedby concerted government efforts toboost financial inclusion
22

Finance-inequality nexus
Gini index of inequality in equivalized household
disposable income

Negative correlation between
income inequality and financial inclusion
60
50

40
30
y = -0.3635x + 39.264(0.1696)20(1.8424)

10
0
0

5
10
15
20
25
Loan from a financial institution in the past year, income, bottom 40%(% age 15+), 201130

23

Financial instability harms growth, andexacerbates poverty and inequality
Pre- and post-Asian financial crisis
growth rates
1990-1996

Pre- and post-global financial
crisis unemployment rates

1998

2000-2007

15

25

10

20

5

2008-2013

15

0
10

-5
-10

5

-15

0
INO

KOR

MAL

PHI

THA

INO=Indonesia; KOR=Korea, Rep. of; MAL=Malaysia; PHI=Philippines;
THA=Thailand

GRE

IRE

POR

SPA

GRE=Greece; IRE=Ireland; POR=Portugal; SPA=Spain

24

Outline• The case for financial sector deepening
in Asia• Financial development for growth• Financial access for inclusion• Financial stability to safeguard inclusive
growth• Financing Asia’s future growth: key
overall messages
25

Financial development for growth• Ample and efficient finance boosts investment,
productivity, and growth• Banks underlie sound and efficient financial
systems in Asia
• Capital built by long-term finance is vital for
productivity growth and innovation• Bond market development deepens pool of longterm financing• The approach to developing the financial sector
must fit each country’s circumstances
26

Financial sector efficiency
raises credit availability and lowers credit cost
Private credit and lending-deposit
spread, developing Asia
250

Real lending rate and lendingdeposit spread, developing Asia
40

Real lending rate ( % )

200

150

100

20

0

50

0

-20
0

10
1980

20
Lending-deposit spread(% )
1990

2000

2011

30

40

0

10
1980

20
Lending-deposit spread(% )
1990

2000

30

40

2011

27

Tighter link between finance and investment in
Asia than elsewhere
All countries

Developing Asia
Investment to GDP (% )80

Developing Asia
Rest of the world
Investment to GDP (% )
80

MON
BHU

60
MON

60

BHU

PRC

40

PRC

40

IN D
IN O TONSRI GEONEP
BAN
ARM
AZE KAZ
TAJ PHIAFG
PAK BRU

20

0

0

50

VIE

THA
SIN

IN D
IN O TONSRI GEONEP
BAN
ARM
AZE KAZ
TAJ PHIAFG
PAK BRU

KOR
HKG

20

MAL

100
150
Private credit to GDP (% )

200

250

0

0

50

THA
SIN

KOR

VIE
MAL

100
150
Private credit to GDP (% )

HKG

200

250
28

Banking sector development contributes toinvestment, which feeds into growth
Banking sector and investment

Investment and economic growth12

Latin American countries
Asian countries

10

PRC

GDP growth, %

8
IND
VIE

PER

6

SRI
INS

PHI
ARG MAL
CHL
THA
COL
KOR
VEN
BRA

4

MEX

2

0
0

10

20

30

40

50

Gross investment, % of GDP (2000-2013)29

Long-term finance and investment
enhance productive capacity30But the range of long-term finance instruments
in Asia remains narrow…..
Debt financing of nonfinancial corporations by region,
year-end 2011
Corporate loans
Bonds

Securitizedloans(% of GDP)

100% =
11.6

68%

O ther developed

3.3

3%

W estern Europe

13.2

13%

O ther developing Asia

0.8

4%

Latin Am erica

0.8

0%

Japan

5.6

2%

People's Republic of China

8.6

0%

M iddle East & Africa

1.2

0%

India

0.8

0%

Central & Eastern Europe &Com m onwealth of Independent States

1.5

0%

U nited States

0

20

40

60
%

80

100

31

….pointing to a need for a broader and morediversified long-term investor base
Ratio of pension assets to GDP in selected economies, 2013
% of GDP
120
100
80
60
40
20

United States

Australia

United Kingdom

BrazilMexicoPakistan

India

People's Republic of China

Indonesia

ThailandRepublic of Korea

Hong Kong, China

032

Asia’s bond markets are bigger than thoseof other developing regions…..
Advanced

Total

Total
$ billion
74,371

Local currency denominated$ billion % GDP % total % govt.
67,912
164
91
49

economies

Euro area
Other
US

22,10622,857
29,40920,147
19,134
28,630

157
140
191

91
84
97

39
72
40

Emerging
marketTotal
Europe

8,119
699

7,070
500

32
24

87
72

59
89

economies

Lat Amer.
Asia
Other

1,406
5,667
347

1,053
5,260
255

22
41
11

75
93
74

80
50
75
33

…..but masks a great deal of heterogeneity
Total
2011

Local currency denominated
2006

2001

$ billion$ billion% of GDP% of total% of GDP% of total% of GDP% of total

Asia

5,667

5,260

41

93

39

90

33

88

China, People's
Rep. of

2,956

2,938

40

99

27

98

18

95

Hong Kong, China

116

45

18

39

19

53

15

54

India

515

489

26

95

30

95

25

97

Indonesia

113

84

10

74

15

87

27

96

Korea, Rep. of

1,265

1,117

100

88

94

91

85

91

Malaysia

260

233

81

90

59

79

57

77

Pakistan

34

32

15

94

15

90

22

96

Philippines

101

63

28

62

26

50

21

48

Singapore

130

90

37

69

40

60

35

69

Thailand

175

170

49

97

37

89

28

80

34

Lots of progress in bond market developmentin Asia, but scope for further growth• Asian EMEs experienced rapid improvement in
the currency structure of bond markets– The proportion of foreign-currency bonds falling from
10% around 2000 to just 4% in 2013
• In the PRC, India, Malaysia, Pakistan, and Thailand, morethan 90% of bonds are now denominated in local currency• Big differences exist across Asia, and bondmarkets in many financially underdeveloped
countries are still embryonic or nonexistent• Furthermore, in the region as a whole, the market
for corporate bonds remains less developed thanthe market for sovereign bonds

35

Thailand’s local-currency bonds outstanding90% of GDP
Government

80

Corporate

Total

2005

2009

70
60
50
40
30
20
10
0
1995

1997

1999

2001

2003

2007

2011

2013
36

Financial development
must fit country circumstances• Low-income countries that rely heavily on banks
can benefit from reform that mobilizes domestic
savings, lowers credit costs, improves access, andpromotes credit allocation to most productive
sectors• Middle-income countries can reap productivity
gains from developing equity and bond markets
that can lower long-term capital costs to facilitate
investment and innovation37

Outline• The case for financial sector deepening
in Asia• Financial development for growth• Financial access for inclusion• Financial stability to safeguard inclusive
growth• Financing Asia’s future growth: key
overall messages
38

Financial inclusion is a vital ingredientof inclusive growth• Although financial development promotes
growth, it does not necessarily promote equity• What matters more for inclusive growth isfinancial inclusion – i.e. broadening financial
access to poor households and smaller firms• Financial services can raise the well-being of thepoor and increase their income potential• They facilitate the entry of new and smaller firms,
and thus promote competition and dynamism• Yet the region fares relatively poorly in financial
inclusion

39

Low degree of financial inclusion% of adults with account at a formal
financial institution

Formal account penetration across the world
100
90
80
70
60
50
40
30
20
10
0

Global medianHigh
incomeEuropeLatin
Developing Middle East
SubAmerica &Asia
and North Saharan
Caribbean
AfricaAfrica40

Limited access to banks
ATMs per 100,000 adults

Commercial bank branches per 100,000 adults

90
80
70
60
50
40
30
20
10
0
High Income

EuropeLAC

MENA

Developing
Asia

SSA

LAC=Latin America & Caribbean; MENA=Middle East and North Africa; SSA=Sub-Saharan Africa
41

Low financial usage and access for firms% of enterprises with checking/savings account% of enterprises with credit line/loan
100
90
80
70
60
50
40
30
20
10
0
EuropeLatin America & Developing Asia
Caribbean

AfricaMiddle East &North Africa
42

Financial access is low in poorer Asian countries
Adults with an account at a formal financial institution, bottom 40 percentile by income, 201143

A range of barriers impede Asianhousehold and corporate access to finance• More than simply a lack of money holds Asianhouseholds back from opening bankaccounts.
• Household surveys find that account fees,difficult geographic access, and stiff
documentation requirements get in the way.
• For Asian firms, the major deterrents toborrowing are unfavorable interest rates,
complex application procedures, and highcollateral requirements.
44

Innovations and policies to improve financial
inclusion in Asia must address cost and risk
• The fixed costs of extending traditional
financial services, such as establishing abranch in a rural area, often make itprohibitively expensive to reach the poor
• More cost-effective delivery channels, such as
mobile phones and banking agents, canreduce costs by as much as 19%

45

Innovations and policies to improve financial
inclusion in Asia must address cost and risk
• Further, serving clients with no steady income
flow, formal property title, or even personal
identification entails high risk
• However, biometric identification initiatives
such as India’s Aadhaar program, for example,
can address the lack of proper identificationand facilitate access for the poor to financial
services46

Outline• The case for financial sector deepening
in Asia• Financial development for growth• Financial access for inclusion• Financial stability to safeguard
inclusive growth• Financing Asia’s future growth: key
overall messages
47

Financial stability for growth and equity• Financial sector development can sometimes
lead to instability and volatility in financial
institutions and financial markets– Especially, if financial development is accompanied byfinancial liberalization and opening up• Yet, as we saw earlier, financial instability canharm both growth and equity• Therefore, a major strategic challenge formany Asian countries is to further develop
their financial sectors in a stable way– For example, this is a huge priority for the PRC

48

External and domestic risks to stability• Asia’s financial systems have become much
healthier since reform following the Asianfinancial crisis of 1997–1998• Even so, external shocks have the power to
unsettle local markets, as they did in May 2013,
when news of a possible change in US monetary
policy decimated Asian stock prices and currency
values in the so-called taper tantrum• Lurking in the background, meanwhile, are suchhomegrown risks as large shadow banking
systems in some economies and unrestrainedhousehold debt expansion in others
49

Asia is vulnerable to global financial shocks
Nominal rate changes against the US dollar during the taper tantrum, 23 May–30 June 2013
%

0

-2

-4

-6

-8
India

Indonesia

Republic of Korea

Malaysia

Philippines

Thailand50

Bank regulation is first line of defense• International experience during the global financial
crisis provides valuable lessons for Asian bankregulators• Above all, the crisis underlined that sound andeffective bank regulation is vitally important tofinancial stability• The crisis reflected the failure of the regulatory
authorities to keep pace with financial innovation• The sobering lesson for Asia is that even financiallyadvanced economies are susceptible to risks fromlax regulation and reckless lending.
51

Advent of Basel 3 further complicates the task of
Asian bank regulators
Comparison of Basel II and Basel III capital requirements
Additional macro prudential
overlay

Capital requirements% of risk weighted
assetsCommon equity

Tier 1 capital

Total capitalCounter-cyclicalbuffer

Minimum

Required

Minimum

Required

Minimum

Additional lossabsorbing
capacity forsystemicallyimportantfinancial
institutions

Required

Range

10.5

0.0–2.5

ConservationbufferBasel II

2.0

4.0

8.0

Memo:
Equivalent to about 1% of an averageinternational bank under the new definition

Basel III New
definition &calibration

4.5

2.5

7.0

Equivalent to about 2% of an
average international bank

6.0

8.5

8.0

1.0–2.5

10.5–15.5

52

Macroprudential policies can also help…..
• Macroprudential policies seek to mitigate risks
that could undermine the entire financial
system by imposing, for example, capitalrequirements and limits on foreign currency
borrowing that apply to all banks• They are designed to complement
microprudential regulation, which monitors
risks specific to individual institutions• Evidence indicates that macroprudential
policies can indeed manage and mitigate
macroeconomic risk in Asian economies
53Credit growth response to credit-related
macroprudential tightening in India
Credit growth response
U pper boundLower boundImpulse response
4

2

0

-2

-4

0

2

4

6

8

10
54

Leverage growth response to liquidity-related
macroprudential tightening in Indonesia
Leverage growth response
U pper boundLower boundImpulse response
4

0

-4

-8

0

2

4

6

8

10
55

Housing growth response to credit-related macroprudential
tightening in the Republic of Korea
H ousing growth response
U pper boundLower boundImpulse response
4

2

0

-2

-4

0

2

4

6

8

10
56

…as can FDI and diversified foreign funding• The literature offers ample evidence that ahigher share of foreign direct investment inforeign liabilities stabilizes financial markets• Empirical analysis across economies further
shows that those with more diversified
foreign funding when the taper tantrum
struck suffered less exchange rate
depreciation• When borrowing foreign currency, it isprudent to minimize currency mismatch
57

Diversification of external liability in short-term debt
and currency depreciation during QE taper tantrums
D eveloping Asia
O ther economies
Percentage change in nominal exchange rate
20
IN D

15

MON

10

TH A IN O
M AL
PH I
SRI

5

PAK
KO R

0
-5

0.0

KAZ
GEO BA N

0.2
0.4
0.6
D iversification of short-term liabilities
in short term debt, 20 12

0.8
58Share of foreign direct investment in the foreign
liabilities of selected economies, 2012
India
Malaysia

Developing
Asia

Philippines

ThailandIndonesia
Hong Kong, China
People's Republic of China

Other
economies

MexicoUnited States
Brazil
0

20

40

60
%

80

100
59

Outline• The case for financial sector deepening
in Asia• Financial development for growth• Financial access for inclusion• Financial stability to safeguard inclusive
growth• Financing Asia’s future growth: key
overall messages
60

Key overall messages• Financial sector development can foster
inclusive growth in Asia.
– Finance has a generally positive effect on growth.
– The benefits of growth will be even larger if financepromotes a more market-based allocation of resources.
• Experience in the PRC shows, for example, that the entry ofprivate foreign banks can enhance the efficiency of stateowned banks.

– But the impact of finance on equity is uncertain.
• To safeguard inclusive growth, further sector development
must be accompanied by steps to ensure broad access tofinance for households and firms.
61

Key overall messages• Regulators will be challenged, however, tofind the right balance– The region’s financial institutions are well placed tomeet the more stringent regulatory standards being
adopted globally, as many already surpass
requirements under Basel III.
– Yet regulators must act to strengthen financial
institution governance and clamp down on inefficientand inequitable practices like crony lending and insider
trading.

62

Key overall messages• Regulators will be challenged, however, tofind the right balance– They must appreciate how strong regulation protects
stability by preventing the accumulation of systemicrisks, but weigh it against the potential benefits offlexible regulation that promotes investment,
productivity, innovation, and economic growth• Reforms in other areas will magnify thebenefits of financial sector development– A benign investment climate strengthens the link
between finance, entrepreneurship, and investemt– Education reform that improves school equality will
increase the gain from borrowing for education

63