Bandid Nijathaworn: Financial globalization and emerging market
economies
Speech by Dr Bandid Nijathaworn, Deputy Governor of the Bank of Thailand, at the Panel
Discussion, Bank of Thailand's International Symposium 2008, Bangkok, 8 November 2008.
* * *
First, let me thank the organizer for inviting me to take part in this panel. A lot has been said
in the last two days about financial globalization and emerging markets. We spoke about the
challenge for monetary policy, the challenge for financial regulation, and the implications for
capital flows management, and on this panel, we discuss the importance of having the right
international financial architecture to respond to the global challenge. But more important at
this time, I think the current global financial turmoil also offers a unique and important
perspective for us to look closely at financial globalization, in terms of the inherent risk, the
lessons that can be learned, and how emerging markets should go about managing the
process of financial globalization.
My remarks today will be on the practical challenge faced by emerging market economies
like Thailand in managing the process of financial globalization. On this, I will focus on the
financial sector and the implications that financial globalization has for the financial sector in
emerging markets.
A good starting point to discuss the issue is to look first at the lessons that can be learned so
far from the current turmoil. For all that can be said, the current turmoil is a powerful
manifestation of the risk and the complexities that could come with financial globalization. For
me, the turmoil points to three important observations.
First and foremost, it shows that financial turmoil can happen in any market regardless of
whether it is large or small, or whether it is emerging or developed. Once the imbalance is
allowed to occur, financial distress will likely happen and there is no exception to it.
Second, the turmoil highlights the central role that the financial sector plays in a boom-bust
cycle. First is the role that it plays as a mechanism that can contribute to and trigger a crisis.
This is because a bubble usually cannot happen without excessive credit growth. Therefore,
without proper regulation, a combination of strong capital inflows, easy credit, and the
procyclicality of the financial system can set the stage for a build-up of serious economic and
financial imbalances.
The financial sector also plays an important second role in that its strength and resilience can
significantly help cushion the real economy from the impact of external shock. The fact that a
majority of emerging markets in Asia at this time have been in a better position to weather
the first round impact of the turmoil, both the direct impact on banks and the impact on
financial markets from de-leveraging and capital flow reversals, is a clear testimony to the
importance of this second role. For emerging markets, both these roles are powerful, and
they put the financial sector at the center of any efforts to ensure economic and financial
stability in the long run.
The third observation is that the turmoil shows that the risk of systemic instability can be
greater with financial globalization, and this raises an important question about the
appropriate monetary policy framework for maintaining macroeconomic stability.
For central banks, price stability remains the first and foremost objective of monetary policy.
But in the context of today's financial globalization when the source of systemic danger is
clearly external, the idea that price stability in itself might not be enough to ensure
macroeconomic stability is now gaining more acceptance. One approach to deal with this is
to combine conventional monetary policy framework like inflation targeting with a
macroprudential framework. The latter is aimed at addressing the risk to financial stability by
implementing measures to counter excessive lending or the procyclical nature of the financial
system. This is the approach that we have taken at the Bank of Thailand, and I will speak
more on this later.
So, the current turmoil is a reminder of things that can go wrong with financial globalization,
and the three observations I cited point to the key challenge faced by policy makers in
emerging markets. In this context and in relation to the financial sector, the challenge for
policy is three-fold.
The first is how to ensure that we have a strong and resilient financial sector with disciplined
risk management so that it can help mitigate the risk of major imbalances in the economy.
The second is how to reduce the procyclicality of the financial sector so that the risk of a
credit-driven bubble can be avoided, especially at the time of strong and persistent capital
inflows. And the third is how to develop a deep and liquid financial market that can help
improve the ability of the economy to adjust to shocks.
In the context of financial regulation in emerging markets where the dominant part of the
system is typically the banking sector, the challenge for policy is to calibrate a regulatory
policy that fosters a strong and resilient banking sector with good and disciplined risk
management, that makes use of the necessary macroprudential measures when needed to
help reduce or counter the procyclicality in the financial system, and that provides
momentum for reform to strengthen financial infrastructure and governance. Thailand, like
most emerging markets, has also been struggling with this issue. And I want share with you
some of the policies that we have pursued in response to the challenge. It is a long journey,
and it is the journey that we are making.
On the issue of reducing risk from procyclicality of the financial sector, prevent
excessive lending, and ensure adequate capital. In our view, the key issue here is to
reduce a possible large swing in the availability and the price of credit stemming from the
tendency of banks to underestimate risks in good times, and then to overestimate them in
bad times. On this, our approach has been to ensure that banks' capital and
riskmanagement policy is forward-looking by using a combination of three instruments.
The first is stress testing to ensure that bank's own internal process for assessing the
adequacy of capital and overall risk management is alert to possible key risks. Thai banks
have begun conducting stress tests as part of the supervisory process since early last year
when we first underwent the FSAP assessment. From our experience, we find stress testing
to be a useful and effective instrument for helping banks in formulating strategy for capital
and risk management in a forward-looking manner. Also importantly, it provides a formal
process for a two-way dialogue between banks and supervisors on risk management and on
other financial stability issues.
The second instrument is the fair value accounting rules or IAS 39, which we have
adopted for non-performing loans and for structured products. In our view, these rules can
help strengthen market discipline over bank lending and investment. And because fair
valuation involves marking to market, its adoption also helps make provisioning for asset
impairment more forward-looking. The third instrument is prudential policy to limit excessive
procyclicality. In the past five years, when capital inflows were strong, we have put in place
prudential measures to stem the build-up of excessive credit growth on consumer spending
and on speculative housing demand. These include measures on credit card approval and
maximum loan-to-value ratio for luxury housing. As I noted earlier, in the context of monetary
policy framework, combining inflation targeting with macroprudential measure offers a
pragmatic approach to deal with concerns on financial stability and asset prices without
compromising the discipline of monetary policy with respect to its primary inflation objective.
So far, we have found this approach to be practical and useful.
On a final note, financial globalization is an important issue for emerging markets. It is the
development that is likely to continue given the strong momentum of globalization in trade
and in production that we are now seeing. But financial globalization is not without risk as the
current turmoil shows. For emerging markets, this risk can be quite potent because of the
smallness of the financial market and the limited abilities of economic agents to adjust to
shocks. How well we manage this risk will depend critically on how well we manage the
process of financial globalization.
In dealing with this, my view is that we should not resist it, but should manage it by adopting
a pragmatic approach to financial globalization. Being pragmatic means having the right
reservation about it, taking a careful step toward it, and be willing to take the needed action
to deal with the unintended consequence. This is not going to be easy, but it is probably the
best that we can do for now.
Thank you.