Lee Hsien Loong: Post crisis Asia - the way forward
William Taylor Memorial Lecture by Mr Lee Hsien Loong, Deputy Prime Minister of Singapore and
Chairman of the Monetary Authority of Singapore, before the Eleventh International Conference of
Banking Supervisors, held in Basel, 20-21 September 2000.
* * *
Introduction
Three years have passed since the Asian crisis struck in 1997. The crisis showed how unstable the
international financial system could be, and how vulnerable apparently strong Asian economies were
to a sudden shock. It has caused a searching reappraisal of the benefits and risks of globalisation, as
well as the strengths and weaknesses of the Asian economies. I propose to discuss how attitudes
towards globalisation have shifted, and what challenges Asian economies face in remedying the
weaknesses uncovered.
When Mr Paul Volcker, Chairman of the G30, invited me to deliver the William Taylor Lecture to this
distinguished gathering of banking supervisors, he asked me to share Singapore's experience in
dealing with the financial turbulence. I will also explain how we are reforming and liberalising our
financial sector, to benefit from globalisation while protecting ourselves against mishaps. Not all the
lessons Singapore has drawn will apply to other economies because of differing circumstances. But I
hope Singapore's case will illustrate the importance of basing financial reforms on a realistic
appreciation of the risks and difficulties.
In analysing the Asian crisis, and in describing the Singapore experience, I will be underlining the
importance of sound banking systems and strong supervisory oversight. I am particularly pleased to be
doing this at a Lecture held in honour of a man who dedicated his life to these goals.
Pre-crisis wisdom
For a decade before the crisis, the conventional belief was that globalisation was an unmitigated good.
The dramatic success of the Asian tigers had shown that openness to trade and foreign investments
was a key source of economic growth. A 1992 World Bank study on the "East Asian Miracle" credited
their success chiefly to market friendly and outward oriented policies.
There was broad intellectual consensus, including in the multilateral institutions, in favour of free
markets: put simply, deregulation, privatisation, and trade and financial liberalisation were always
good, and the faster the better. This was what John Williamson called the "Washington consensus",
but the view went beyond the US Treasury, the IMF and World Bank.
One important element of this intellectual consensus was the liberalisation of capital accounts. Free
trade in goods and services had enabled countries to exploit comparative advantage and international
division of labour, and produced half a century of unprecedented global prosperity. It was argued that
in the same way, free flows of capital would open new avenues for deploying savings and funding
investments, and promote more efficient allocation of resources. Financial markets were globalising,
driven by technology and deregulation. The faster countries plugged into the global network, the more
they would benefit.
The pre-crisis consensus did acknowledge the risks associated with open capital markets. But it
stressed the virtue of market discipline more than the possibility of market failure. Financial crises
were the fault of inappropriate policies. The remedy was more liberalisation, deregulation and
privatisation. Markets would work, if only they had access to timely and accurate information. So the
emphasis was on policy transparency and data disclosure, to enable the private sector to make
"correct" decisions. So steadfast was the faith in open capital markets that, as late as September 1997,
after Thailand had run into trouble, the IMF and G7 countries were still lobbying member states to
amend the IMF's Articles of Agreement to give the Fund the mandate to promote capital account
liberalisation.
Crisis shock
Given this worldview, the Asian crisis came as a tremendous shock. Financial markets proved highly
susceptible to contagion and herd behaviour. Problems in one country triggered a loss of confidence in
its neighbours. Manias, panics and crashes occurred on a titanic scale, shaking seemingly sound
economies to their roots.
Structural flaws in the Asian economies undoubtedly contributed to the crisis. So did policy errors by
governments and international institutions in responding to the problems when they emerged. The
most serious flaws were in the financial and corporate sectors. Balance sheets were weakened by
currency and maturity mismatches. Banks were lax in their credit practices. They borrowed short-term
from abroad and lent long-term at home, often to related companies without proper assessment.
Companies borrowed excessively, especially in foreign currencies without hedging their exposures,
encouraged by implicitly pegged exchange rates.
But lenders in the developed economies could not escape blame either. They were only too eager to
extend credit, based on the political connections of the borrowers, or on faith in an Asian miracle.
Banks stampeded into the region. When sentiments turned, they stampeded out again, equally
indiscriminately. The sudden massive outflow of funds, especially through banking lines, left countries in a
severe liquidity crunch, and was an immediate cause of the crisis.
The punishment meted out by the markets was out of proportion to the crime. The damage was not just
the 9% shrinkage in the GDP of the crisis countries, but the social dislocation and political turbulence
that followed.
Indonesia suffered the worst, even though the IMF made a pre-emptive house call early in the crisis,
and pronounced Indonesia's fundamentals to be basically sound.1 The Indonesian government had
pursued prudent macro policies and maintained steady economic growth. But companies had
borrowed large sums from abroad, and the banking sector was afflicted by related party lending, poor
credits, and weak provisioning. This, together with concerns about KKN - corruption, collusion and
nepotism - was enough to turn an initial loss of confidence into a full-blown crisis of the body politic,
forcing President Suharto to resign and pushing the country to the brink of chaos.
The origins of the Asian crisis thus lay in institutional weaknesses and inefficiencies. These grew more
serious in the 1990s, but they continued to be masked by generally sound macroeconomic conditions
and investor confidence in a sustained Asian boom. However, the sudden onset of the crisis cannot be
explained without appreciating the panic-prone and panic-inducing behaviour of international financial
markets.
Fortunately for most of Asia, the crisis, though severe, was short. The Russian default and LTCM
debacle in the fall of 1998 were a turning point. The G7 countries, led by the US Federal Reserve,
lowered interest rates promptly and decisively. While this lowering was motivated by domestic
considerations, there was also a collective sense of concern over the weak state of the global economy.
In the event, it helped restore liquidity and confidence to global financial markets. Now nearly all the
Asian countries are recovering, though in different ways and to varying degrees.
Post-crisis caution
After this near-death experience, it is not surprising that countries are re-examining their belief in the
global economic system. What lessons have countries learnt?
Firstly, unlike previous crises, the crisis was due mainly to a run on the capital accounts. Thus, there
was no reason to rethink the merits of free international trade and investments. These fuelled the last
Asian boom, and are crucial if countries are to get their economies growing again. The most open of
the Asian economies - Hong Kong and Singapore - were among the least badly affected by the crisis.
The devastating demonstration of the downside risk of globalisation could easily have triggered a
nationalist and protectionist backlash. Such sentiments have surfaced to varying degrees. No country
likes to be told what to do by the IMF, or be forced to sell off distressed banks and companies to
foreign buyers, especially at fire sale prices.
But no country is opting out of the global system. All continue to court foreign investments and
promote exports. Most Asian governments remain convinced that despite the attendant risks,
globalisation is still the best way to achieve progress and economic development. On this most basic article
of faith, there has been no change.
Secondly, the crisis has highlighted the problems of capital account liberalisation. The IMF has
acknowledged that capital flows can be highly volatile and a potential source of crisis.2 Countries are
now acutely aware that they must sequence capital account liberalisation judiciously, and to strengthen
financial supervision and prudential safeguards as they liberalise. But there is still broad consensus
that provided countries take these precautions, they can benefit from international capital flows. No
Asian country has imposed exchange controls as a result of the crisis, except Malaysia. And even
Malaysia continues to welcome foreign portfolio investments in its asset markets.
Thirdly, all the affected countries have recognised the dangers of over reliance on
bank-based
In most Asian countries, capital markets were undeveloped. Bond markets especially were
financing.
illiquid or non-existent. This led Asian firms to rely on short-term bank financing to fund longer-term
projects, thus exposing themselves to maturity mismatches. Further, when the banks got into trouble,
the firms were left with no alternative avenues to raise working capital. Thin capital markets
accentuated price movements when investor preferences shifted. As a result, the economies' ability to
absorb shocks was severely impaired. So across the region, steps are now being taken to develop
capital markets.
Fourthly, there is now greater recognition that effective prudential oversight and corporate
are critical to maintaining a sound financial system. Many Asian countries fell short in these
governance
areas, and are now striving to remedy the weaknesses. They need to establish rigorous supervisory
regimes, foster a sound credit culture in banks, and apply international standards of accounting,
disclosure, and loan classification.
In this respect, the Basel-based committees, BIS, OECD, and other standard setting bodies have done
valuable work, promulgating standards on banking supervision, risk management, corporate
governance and public disclosure. Few would claim that these standards are Western cultural
impositions, and that Asian banks and companies need different norms more suited to their societies
and stage of development.
Fifthly, there have been stronger calls to improve the workings of
the international financial system,
rather than adopt a hands-off approach. No plausible alternative to the existing market-based system
has emerged. But the consensus view is that the robustness of the system can be improved, in
particular through better monitoring, and greater transparency among market participants. This is work
in progress. The Financial Stability Forum and other groups and agencies have made many proposals
to this end. These proposals should help to reduce the risk and severity of future crises, though they
will not eliminate them.
Managing the change
While the fundamentals for sound financial systems are universal, specific policies to attain them must
recognise the unique socio-political context of each country. To succeed, countries must change, or at
least modify, deeply embedded social structures and cultural practices. As the experience of the former
Soviet republics and the former East European economies shows, such a far-reaching change can only
be an evolutionary process; it cannot happen overnight.
The in each country will dictate the pace and texture of financial and economic reform. In
politics
Malaysia, Prime Minister Dr Mahathir Mohamed has made clear that in reforming and restructuring
the corporate and financial sectors, his government's social and political objectives come first. In
Indonesia, monetary and banking reforms, important as they are, are subordinate to more fundamental
issues of political transition, security, and national cohesion.
The will constrain what is possible. In many Asian countries, laws are incomplete,
legal framework
and enforcement is weak. For example, not all Asian countries have adequate insolvency laws.
Without these, borrowers have an incentive to become "strategic" debtors, deliberately defaulting on
interest and loan payments. Creditors have no incentive to accept realistic write-downs, preferring
instead to reschedule loans and reflect them as performing loans in their books. So supply of fresh
credit remains weak.
After the crisis some Asian countries have passed new bankruptcy laws, and even established new
courts to administer them. But enforcement continues to be difficult. As Acting Governor of Bank
Indonesia Anwar Nasution said, in explaining the slow pace of corporate restructuring (this was when
he was the Senior Deputy Governor): "it will take a while, partly because we have a very rotten legal
and accounting system ... the most important thing is that we have very weak bankruptcy
procedures."3
The of each country underpin the formal structure of laws and institutions. A
social values
relationship-based approach towards doing business is part of the culture of most Asian societies. Few
Asian societies have the "contract-based" commercial culture of the West, particularly the US, with its
robust emphasis on legal and impersonal obligations. Few have made a practice of separating the
ownership of firms from their management.
In some countries, there are close ties between the state, the banks and industry, e.g. the state-owned
enterprises in China, and the chaebols in Korea. All over the region, family-based firms and
conglomerates are the norm, especially in banking. Companies in the same group would do business
with one another, maintaining trust on the basis of family ties and shared ownership. Even in Japan,
where ownership of large corporations is not in the hands of families, long-term corporate
relationships and cross-shareholdings have dictated business.
This was how entrepreneurship evolved in East Asian societies, and among the overseas Chinese in
South East Asia. Many of these family firms were hugely successful, driven by the business acumen
and entrepreneurial drive of the founding patriarchs, and supported by a web of networks, or guanxi.
But the world has changed. Family relationships may be an adequate basis for running a medium sized
company, but not for an MNC employing tens of thousands of people. To be world-class, companies
need to be led by the best man for the job, and this person is not likely to come from the same family,
generation after generation. And business based on relationships rather than hard-headed commercial
calculations is prone to abuse and under-performance, as was shown in the Asian crisis.
It will not be easy for the families to relinquish control. The instinct to hand an heirloom down the
generations is still strong. There are also real practical difficulties. If the families sell out, who will the
buyers be? Who will take charge of the companies? Most Asian countries lack a group of institutional
shareholders who can exert market discipline and defend minority shareholder interests, like the
mutual and pension funds in the US. Nor have they developed a class of professional
entrepreneurmanagers, like those who drive MNCs in the West and Japan.
Changing these institutional features of Asian economies will be an arduous task. But over time the
countries can, and must, change discredited practices. State-owned or family-run enterprises can be
transformed into firms run along meritocratic lines by professional managers. Greater public
ownership can strengthen market discipline and the incentive to improve returns for all shareholders.
Companies that are not profitable have to be closed or restructured.
Asian leaders understand this. For example, the governor of the Bank of Thailand Mr Chatu Mongol
Sonakul said, describing efforts to promote corporate governance in financial institutions and
companies:4 "What we are doing is a very long process. We're not talking of months or years. We are
talking in, maybe, decades or generations. We're not changing our way of working; we actually try to
change our way of life."
Governments play a key role in fostering and managing this process of change. They have to make the
political judgment on how fast to go, how to sell the changes to the people, and what compromises are
necessary. Only they have the mandate to decide, and only they can take responsibility for the
outcomes. South Korea under President Kim Dae Jung is a good example of how this can work, as
well as of how difficult the process can be.
External institutions like the IMF and the World Bank are also important, providing advice and
applying pressure to do what is painful but necessary. This means that IMF and World Bank loans and
assistance have to come with strict conditionality. But the line between essential conditionality and
excessive intervention is a fine one.
In Indonesia, the IMF pushed the Suharto government hard, not just to deal with the immediate crisis,
but to implement sweeping structural reforms. President Suharto interpreted this as a threat to his own
position, and treated the IMF as an opponent rather than an ally. This contributed to a collapse of
confidence, political turbulence, and finally Suharto's resignation in May 1998. Whether or not the
IMF intended this outcome, it helped to precipitate a decisive and momentous change in Indonesia, the
consequences of which are still unfolding.
Singapore's approach
Let me now turn to Singapore's experience in navigating through the crisis and preparing itself to meet
the challenges of globalisation, especially in the financial sector.
Singapore is not entirely typical of the region. We are a small, open economy, about half the size of
the Swiss economy, and heavily reliant on foreign trade. We are also a financial centre in Asia, and
therefore highly exposed to disturbances in the international financial system. So it is not surprising
that Singapore was affected by the Asian crisis. Our GDP growth plunged from 8.4% in 1997 to 0.4%
in 1998. Retrenchments went up sharply. Our stock market fell, in line with regional markets.
Navigating the crisis
But overall Singapore was less affected than most of the region. The banks were unshaken, and
Singapore companies did not keel over. Why was this the case?
Firstly our economic fundamentals were sound. We had pursued pro-business and pro-development
economic policies for many years, and maintained consistently low inflation.5 We had kept our
economy open, and had taken a market-oriented approach towards economic development. So
investments did not go into industries in which we lack competitive advantage, and Singapore
companies were generally efficient.
Secondly, the Government had a strong Indeed it continued to register a budget
financial position.
surplus throughout the crisis. We had no foreign debt, much less short-term debt. Foreign exchange
reserves were comfortable.
Thirdly, to the crisis was to reduce business costs directly, to help businesses stay viable
our response
and so preserve jobs. No company was bailed out by the Government; no creditor was prevailed upon
to maintain a loan to a failing borrower. Instead we granted rebates in taxes and government charges
across the board, and reduced employers' monthly contributions to employees' retirement fund -
effectively a wage cut. Fortunately union leaders understood the gravity of the crisis, and helped to
persuade workers to accept this unpalatable prescription. Overall these measures amounted to 7% of
GDP. The measures, and the population's positive response to them, instilled confidence among
Singaporeans and foreign investors.
Fourthly, our banks were sound. Even during the boom years, our banks had been generally prudent
and conservative in their lending policies. Also MAS had supervised the banks strictly, requiring high
capital and liquidity standards, insisting on prompt and adequate provisions for non-performing loans,
and frowning upon excessive expansion of bank loans. So when the crisis struck, the banks stayed on
an even keel,6 even as MAS required them to make large general provisions in anticipation of future
NPLs.
Fifthly, we were lucky with our timing as we had deflated a early. Like several other
property bubble
Asian countries, Singapore had experienced a property boom. It started in 1993, and in just 3 years
property prices had doubled. By early 1996, the property market was becoming dangerously
overheated. The Government decided to prick the bubble. We restricted bank credit by capping
housing loans at 80% of valuation, and imposed other anti-speculation measures. So by the time the
Asian crisis struck a year later, property prices were already declining. The froth had been skimmed
off. Had we not acted in 1996, the adjustment would have been more painful, and the banks would
have had more serious problems with their loans.
Managing financial sector reforms
Although the crisis is past, we are not back to the status quo ante. While Asia was preoccupied with its
problems, globalisation of financial markets proceeded apace, spurred on by deregulation and
technology. With the internet, markets are becoming borderless. Banks, insurance firms, and now
securities exchanges are facing cut-throat competition, and going through a worldwide wave of
mergers and consolidation.
Singapore has to keep up with these global trends to remain a sound yet dynamic financial centre. For
many years, we had regulated our financial sector tightly. We insisted on high standards of integrity
and competence. We sought to protect investors, especially retail investors, by circumscribing what
they could be allowed to invest in. We protected local banks and stockbrokers from foreign
competition, in order to build up dependable Singaporean players. We sought to minimise risk
wherever possible, and accepted the trade off for a less vibrant and innovative industry.
This approach had worked, and proved its worth in the crisis. But going forward, it no longer suffices.
In the new environment, we need to take a bolder, less dirigiste approach. We should regulate with a
lighter touch, accept more calculated risks, and give the industry more room to innovate. We need to
liberalise and allow greater competition.
We will not abandon the high standards of integrity and sound financial management which we have
built up. But our attitude to supervising risk must change.
We should focus more on systemic risk rather than protecting individual firms, or preventing risky
products from reaching the market. We should allow investors to judge and take business risks for
themselves. We should rely more on market discipline and full information disclosure to protect
investors, rather than extensive formal and informal regulation. We need to shift emphasis from
regulation to supervision, and from one-size-fits-all rules to oversight tailored to the characteristics of
individual institutions.
We decided on these fundamental changes in our policy framework for the financial sector in 1997.
We went ahead to launch it, just as the storm clouds were gathering, because we saw it as an essential
strategic shift, independent of short-term ups and downs of economic fortunes. We felt confident of
weathering the storm, although we did not know it would turn out to be a super hurricane.
We decided to make a phased transition over several years, rather than have a single big bang. We had
seen how big bangs in some other countries had led to excesses and problems later down the road. We
could not afford this risk, unlike the more established financial centres like London. Our regulators,
financial institutions, and investors all needed time to develop new expectations of one another, and
understand the new way things worked. We needed to manage the reform process in an environment
made difficult by the Asian crisis, and keep the system on an even keel.
Over the last three years, we have systematically reviewed every part of the financial industry. We
have freed up the use of compulsory savings in the state retirement fund scheme, demutualised and
merged the stock and futures exchanges, deregulated brokerage commissions, opened up all areas of
the financial industry to new entrants, and taken steps to develop the bond market.
I will focus on two specific changes, to illustrate the trade-offs and considerations in designing our
liberalisation programme. The first is the review of our policy of not encouraging the
internationalisation of the Singapore dollar. The second is our decision to open up the domestic market
to foreign banks, while giving impetus to local banks to strengthen themselves.
Singapore dollar non-internationalisation policy
We have long maintained an explicit policy not to encourage the internationalisation of the Singapore
Dollar. Being small and vulnerable, we are especially wary of large and volatile capital flows
distorting our exchange rate, and thus damaging our real economy. Our international trade is 3 times
our GDP, higher than any other country in the world. If our exchange rate moved up and down like the
Japanese Yen against the US dollar, we would be in deep trouble.
Singapore has no capital or exchange controls. Anyone can move funds freely into and out of
Singapore, whether in S$ or foreign currencies. The non-internationalisation policy does not try to
prevent currency speculation per se, or to limit the flow of capital into and out of Singapore. It
imposes only one restriction: non-residents may not borrow S$ for activities unrelated to the Singapore
economy, though they may buy and sell as much S$ as they wish. This restriction on borrowing S$ is
to make it harder for non-residents to accumulate ammunition through borrowing for a speculative
attack on the S$.
Despite the non-internationalisation policy, there is virtually complete capital mobility in Singapore.
Empirical studies have shown that domestic S$ interest rates are almost entirely determined by parity
with offshore US Dollar interest rates, adjusted for future exchange rate expectations. In economist's
jargon, the "interest parity condition" holds.
The role of hedge funds in the Asian crisis is controversial. There is evidence that the hedge funds
were active in a number of the regional currencies before and during the crisis. Although some
observers are convinced that hedge funds were the main culprits in bringing currencies down, the
evidence is not conclusive. Nevertheless, we believe that our policy of non-internationalisation helped
to protect the S$ against excessive volatility during this unstable period. Of course the policy could not
have been effective if Singapore's economic fundamentals had not been sound, and if we had not had
a floating exchange rate which could be managed flexibly in line with these fundamentals. We had an
easier ride than Hong Kong, which also had a sound economy, but whose currency was, for good
reasons, pegged to the US dollar.
Going forward, we intend to maintain the non-internationalisation policy, but to periodically review its
scope and implementation. In the early phase of our development as a financial centre, international
and regional business serviced out of Singapore could be conducted in US dollars. But as our financial
centre matured, and our capital markets became more comprehensive and integrated, foreign players
increasingly wanted to issue S$ debt and equity, and to hedge their positions using S$ swaps and
repurchase agreements. At the same time, the Singapore economy and our foreign reserves have
grown, and so has our confidence in withstanding pressures on our exchange rate.
Our policy needed to adapt to these changed circumstances while preserving its basic objective. As
part of our financial reforms, we have progressively relaxed the S$ restrictions. Notably we have made
an exception to the restriction on borrowing S$, to allow foreign entities to issue S$ denominated
bonds and equity, provided they swap or convert the proceeds into foreign currency for use outside
Singapore.
We will continue to evolve the non-internationalisation policy, as we gain experience and confidence
with the liberalised rules. The policy will not compensate for unsound economic fundamentals, nor is
it a foolproof protection against exchange volatility. But it would be unwise to discard a useful
deterrent against would-be speculators who might otherwise be tempted to try their luck.
Banking liberalisation
The second example of our measured liberalisation approach is the opening of our retail banking
sector, with simultaneous steps to help strengthen local Singapore banks.
Our starting position was different from most countries. Foreign banks (mostly British) dominated the
Singapore banking system when we gained independence. For three decades, the Government has
protected the local banks, especially in the retail business, to enable them to expand their market share.
We believed that strong and well-managed local banks, with a significant share of the home market,
were critical to the resilience and stability of our financial system. We wanted to be sure that in a
crisis, we could count on major institutions whose long term interests were aligned with the Singapore
economy. We still hold this view.
Like banks in other Asian countries, most of our local banks started as family banks, and are still run
by their controlling shareholders. But strict supervision enabled them to grow into sound,
wellcapitalised institutions, free of the problems of improper and imprudent lending to related companies.
By Asian standards, the local banks were exceptionally well run. But compared to the best
international banks, they lagged in many areas: size, technology, expertise, range and quality of
service, and shareholders' returns.
We could not afford to let Singapore banks fall behind, or deprive the rest of our economy of
worldclass financial services. In any case, because of globalisation and cross-border competition, a
protectionist policy was becoming less and less tenable.
Therefore we moved last year to open up the Singapore market further to foreign banks. We hoped
that this would spur efficiency and innovation among the local banks, and push well-run banks to seek
scale and expand at home and abroad. We were convinced that unless we opened up, this
transformation would never take place. There is no substitute for real competition.
We did not want the liberalisation to weaken our banks and destabilise the financial system. So we are
not taking a big bang, laissez faire approach. Instead, we are phasing the liberalisation over five years,
and opening the market to financially strong, committed foreign players.
At the same time, we are motivating the local banks to strengthen themselves. We have raised
disclosure standards to international norms, and we now require banks to publish details of their
nonperforming loans and inner reserves, which were previously closely guarded secrets.
We are also raising corporate governance standards, which lie at the heart of the improvements
required in Asian banking systems. We instituted nominating committees on bank boards, comprising
a majority of independent directors. Their remit is to ensure that persons appointed to the boards and
to key executive positions are selected for their expertise, and their ability to contribute to the bank
and to the interest of all shareholders.
Most important of all, we are requiring the banking groups to make a clear separation between their
financial and non-financial businesses. The banks will have to divest all control of non-financial
activities, and remove all cross-shareholdings. This will help ensure that all transactions with
nonfinancial entities remain at arms length, that the interests of the bank are not confused with the other
interests of the controlling shareholder, and that management attention stays focussed on the
increasingly complex business of banking.
If this programme works, we hope a few Singapore banks will grow to become strong regional
players. Of course, success cannot be guaranteed. If the local banks lose too much ground, some of our
anchor players may end up marginalised, or being taken over. Still we have resolved to proceed,
knowing tha