Heng Swee Keat: Dealing with the implications of the crisis and
implementing policy reforms
Keynote address by Mr Heng Swee Keat, Managing Director of the Monetary Authority of
Singapore, at the Opening of EDHEC-Risk Institute, Asia, Singapore, 21 January 2011.
* * *
His Excellency Olivier Caron
Ambassador of France to Singapore
Mr Richard Simonin
Chairman, EDHEC International Advisory Board
Mr Olivier Oger
Dean, EDHEC Business School
Professor Noel Amenc
Director, EDHEC-Risk Institute
Associate Professor Frederic Ducoulombier
Director, EDHEC-Risk Institute, Asia
Ladies and gentlemen
Introduction
1. Good morning. I am very pleased to join you today at the grand opening of
EDHECRisk Institute's Asian centre in Singapore.
Key observations from the crisis
2. The financial crisis has fundamentally changed the way we perceive and manage
risks and uncertainty. Assumptions and models that had been taken for granted are being
challenged, and new developments are changing the risk landscape. Let me share three
observations about risks.
3. First, the growing complexity and interconnectedness within the financial system,
and between the financial and economic systems have multiplied risks significantly. There
are now many more potential sources of failures and the transmission of shocks from one
market to another have become faster and more unpredictable.
4. Prior to the crisis, financial and capital intermediation had increasingly shifted to
relatively unregulated non-bank financial institutions. Complex securitisation structures and
off-balance vehicles that were thought to disperse risks led instead to concentration of risks
and excessive leverage. The crisis highlighted the complex webs of inter-linkages between
financial institutions, financial instruments and financial markets. As liquidity and confidence
evaporated and the financial accelerator kicked in, credit markets and financial institutions
experienced severe stresses. This in turn dragged down the real economy, and world trade
collapsed. With globalisation, even though financial markets in emerging markets did not
suffer the same problems, the collapse of trade and investors' confidence, exacerbated by
credit cutbacks, brought most developed and developing countries across the world into a
deep and synchronous recession.
5. My second observation is that we should not underestimate how fast risks can build
up. In the years leading up to the crisis, many new financial products developed and grew
very swiftly. Credit default swaps for example, grew from just US$919 billion in 2001 to more
than $62 trillion within 8 years. In 2004, outstanding mortgages held in non-agency MBS in
the US were just US$670 billion. It tripled to over US$2 trillion within 2 years. It is a similar
story with the origination of subprime mortgages. In the same period, global CDO issuance
more than tripled from US$157 billion to about US$550 billion. These assets were held in
banks and non-banks globally. When the financial crisis struck, the world was shocked not
only by its severity, but also by the speed in the transmission of shocks throughout financial
markets. There is no better illustration of how new sources of systemic risk can build up
rapidly.
6. In a similar vein, the sharp deterioration of the fiscal positions of many governments
has also led to a re-assessment of sovereign risks. About 10 years ago, investors were
concerned that the strong budget surplus of the US Federal Government might lead to a
severe reduction in the supply of US Treasuries. Today, bond vigilantes are focusing
attention on not just the short term fiscal health of governments, but on the impact of
demographic changes, large entitlement benefits and unfunded pension liabilities on the
longer-term fiscal health of these governments.
7. My third observation is the speed of structural changes in emerging economies and
transformation in the patterns of global trade and investment. As these are superimposed on
cyclical changes, it is often difficult to disentangle the two. Emerging markets, especially
Asia, have weathered the crisis relatively well, and recovered quickly. This year, the IMF
expects emerging Asia to grow by nearly 7%, almost double the rate forecast for the global
economy as a whole. Many analysts expect the differential in growth rate to persist in the
coming decade. The global economy went through stagflation in the 1970s, disinflation in the
1980s, and a roaring decade in the 1990s. In 2000s, we had the dotcom bubble, and a
severe financial crisis. How the coming decade will turn out, especially for emerging
economies, will change many of the risks and return assumptions on a wide range of asset
classes.
Dealing with the implications
8. The growing complexity and interconnectedness in financial and economic systems,
the increasing speed of change, as well as the ongoing structural changes in emerging
markets will have profound impacts on all sectors of the global financial industry. These
driving forces will shape the evolution of the financial system and the economy, as well as
the risk-return profiles of a range of financial products. Financial institutions, investors,
regulators, policymakers and researchers will have to make significant changes to their
mental models, policies and practices. Let me touch briefly on some of these implications.
Implementing policy reforms
9. Given Asia's changing dynamics, Asian policymakers face some difficult balancing
acts in navigating the challenges. They need to grow the financial system to support
economic growth and promote the efficient intermediation of savings, but in ways which are
safe and stable. They need to deepen capital markets, and permit the growth of hedging
instruments and derivatives while keeping out instruments that are complex or opaque. They
need to reduce the opportunity for regulatory arbitrage across different sectors, and treat
similar risks in similar ways, without adopting a one-size-fits-all approach that reduces the
diversity of players in the industry which might in turn reduce the overall resilience of the
financial system. There is merit, for instance, in having diverse players such as pension
funds and insurance companies that have different investment horizons and requirements in
their asset-liability matching. Policymakers must support the global reform agenda, to help
build a more resilient global financial system, while taking into account local and regional
circumstances. In particular, as Asian economies undergo rapid transition, policymakers will
have to evolve their financial systems to meet the rapidly changing needs of their economies.
As the systems become more complex and more plugged into the global system, the risk to
financial stability will increase.
10. Indeed, post-crisis, central banks and regulators are focused on financial stability
and the need to be proactive with regards to the risk of asset bubbles. Many parts of Asia in
particular are vulnerable to property bubbles, not only because of current liquidity conditions,
but also because many investors believe that in a growing economy, the property market can
only move up. Many have forgotten how the property markets in the region slumped during
the 1997/98 Asian Financial Crisis.
11. As I mentioned earlier, risks can build up rapidly. Hence, not surprisingly, there has
been much debate on the types of policy tools to address potential asset bubbles. In my
view, there is no single tool that works best in all situations. We need a combination of tools
that addresses the different facets of the issue. These tools should be simple and easy to
understand. More importantly, for these tools to be effective, the intention of the authorities
has to be clearly communicated. Policymakers must leave no doubt of their resolve to tackle
the potential build-up of risks. This may mean, for instance, the willingness to take
progressively tougher measures where the situation warrants. This in essence is what the
MAS and other agencies in Singapore have done recently on the property cooling measures.
Let me add that these measures are not a substitute for banks' own risk assessment
processes. Banks should continue to maintain prudent lending practices. This includes taking
into account potentially higher interest rates in their credit assessments, and not assuming
that current low interest rates will last indefinitely. MAS will continue to monitor banks'
activities and practices closely.
Understanding Asia
12. Asia's growth prospects have attracted global interest and a surge of capital inflows.
Asia is now the second highest contributor to global trade, and is expected to overtake
Europe in a few years. China, India and Indonesia are growing rapidly, registering GDP
growths more than four times that of US and Europe. The prospect of greater Asian currency
appreciation has drawn greater fund flows into the region. In 2010, inflows into Asian local
bond markets reached record levels.
13. However, investing in Asia is not without risks. The huge capital inflows, if left
unchecked, have the potential to increase inflationary pressures and fuel asset-price
bubbles. In an informal survey by MAS of 30 major fund managers, almost half cited the
possibility of a hard landing of major emerging economies in Asia as a key risk. While inflows
have been swift, we must be prepared for a rapid outflow as well. Several years ago, most
major investors were investing in Asia but based thousands of miles away. Today, many
investors are realising that a ground presence in this time zone is necessary. The rapid
structural changes of economies in Asia, the differences in the stages of economic
development, in political systems, regulatory regimes and corporate governance standards
mean that investors must not only understand the differences within Asia, but they have to be
able to respond to swift changes in outlook, and to take into account ongoing structural
changes in their assessments. In short, the ability to distinguish noise from trend is essential.
Having the right risk mindset
14. Apart from responding to policy reforms and initiatives, investors and financial
institutions will do well to continuously rethink and challenge the fundamental tenets of their
investment and risk management tools and methodologies. To do so, it is imperative for
investors to have the right risk mindset.
15. We should put once-neglected risks, such as counterparty credit risk, model risk,
liquidity risk and technology risks, at the forefront of risk considerations. We have to be
mindful that falling back on historical experience may not necessarily provide the guidance
especially when developments are unprecedented. In this regard, boards of financial
institutions play a vital role in driving the level of risk consciousness in their institutions and
exercising effective risk management oversight. MAS will mandate all local banks and
significant insurers, following their Annual General Meetings this year, to have a dedicated
Risk Management Committee, and for members of this Committee to have the appropriate
balance of skills and expertise to discharge their responsibilities. Starting this year, we will
also be requiring mandatory training for all members of the Boards of local banks. At the
management level, MAS expects risk management units have to be sufficiently empowered
and adequately plugged in to the risk-taking activities of the firm.
Enhancing collaborative partnerships
16. Underlying these specific measures is a basic emphasis on having the requisite
knowledge, skills and expertise throughout the organisation's hierarchy in managing risks. In
this regard, research and executive education programmes help to increase the body of
knowledge and critical understanding of risks in the Asian financial industry.
17. One function of research is to explore unchartered territory and break new frontiers.
Many in academia do this important blue sky research. Another significant role of research is
in bridging the gap between theory and application. This form of research accelerates market
practices in a more immediate and direct way. Many research institutes here in Singapore,
including EDHEC-Risk, is focused on direct application. MAS welcomes this. Research
institutes can use their presence in Asia to work with the financial industry in the region and
help the region navigate the challenges ahead.
Conclusion
18. EDHEC-Risk is setting up its base in Singapore at a time of great transformation of
the economic and financial landscape in Asia. A deep understanding of risks provides the
foundation for stability and growth. The research and educational activities of EDHEC-Risk
Institute will help enhance our understanding of risks, and the development of talent. We
welcome EDHEC-Risk Institute to our research and financial community in Asia. Your
presence adds to another important strand in the deepening relationship between France
and Singapore. I congratulate EDHEC-Risk Institute on the opening of its Asian centre, and
wish Professor Amenc, Professor Ducoulombier and your colleagues every success.
19. Thank you.