Tarisa Watanagase: Asian banking - coping with risks and seizing
opportunities
Luncheon talk by Dr Tarisa Watanagase, Governor of the Bank of Thailand, at the 27th Asian
Pacific Bankers Council (APBC) General Meeting and Conference, Bangkok, 31 October
2008.
* * *
Chairman of Asian Pacific Bankers Council,
Distinguished Speakers and Guests,
I would like to thank the Asian Pacific Bankers Council for inviting me to join this meeting
today. With great uncertainty ahead, actions of each and everyone - banks, regulators,
central bankers - can have significant impact at home and abroad. At this time, confidence
and trust forged by candid and opened communication between key stakeholders is of
paramount importance. Therefore, this meeting offers an immense opportunity for us to
foster this dialogue.
Just over a month ago, the global economic and financial market condition was at a much
different place from today. Since then, the magnitude of market adjustment, volatility, and
contagion across markets, types of institutions, and countries have proven that risk
diversification is easier said than done. This is especially as markets and institutions seem to
correlate in a crisis as a result of risk-aversion and fear of counterparty risk.
Nevertheless, the positive factor that has emerged is that governments of major economies
and financial centres are now addressing this with comprehensive package. The aims are
chiefly to restore "main street's" confidence by deposit guaranty; to shore up "Wall Street's"
confidence with adequate liquidity; and to mitigate counterparty risk through interbank
guaranty. The rescue package also spans injecting capital into systemically important
players, and neutralizing short-term market impact of valuation of toxic assets by
underwriting those risks themselves.
Ladies and Gentlemen,
Up to now, banks in Asia have been less affected by the direct impact of the global financial
turmoil. At this juncture, subprime-related losses have been lower in Asia than elsewhere.
The estimated write down and credit loss, as recoded by Bloomberg on 28th October, is
about 27 billion US dollars for Asia, compared with 430 billion US dollars in the U.S. and 221
billion US dollars in Europe.
While this may be the case, the impact on regional capital markets, including the prices of
bank stocks and widening credit spread, signals a much deeper concern. Events in the
recent weeks reflected market worries of the second round impact via expected slowdown in
the global economy, trade, and exports. Of course, the last leg to all of this is the currency
volatility experienced by regional currencies. In fact, we saw, for the first time in this past
decade, intervention by some regional central banks that would have been quite unthinkable
a year ago.
Looking ahead, significant downside risk to growth and upside risk to volatility remains. On
the growth side, the October IMF World Economic Outlook sees the world economy entering
a major downturn. Global growth is projected to slow substantially in 2008 and only a modest
recovery would begin later in 2009. Against this background, key concerns of Asian central
banks focus on the global economic slowdown, tightened global liquidity, and potential
capital outflow. Indeed, slower export growth to major advanced economies, and adverse
changes in equity market wealth on real consumption, investment, and income will certainly
affect export-dependent Asian economies.
As for financial market volatility going forward, some of the growth projections that came out
of various sources, including the degree of volatility in asset and currency markets, would
quite easily exceed even the most conservative stress-test scenario that most banks would
have carried out six months ago. However, if the experience of Asian crisis is anything to go
by, one should remain alert to the possibility of a long period of correction and adjustment.
Moreover, given the global contagion, economies and markets with less structural resiliency,
and lacking width and depth and thus liquidity, may eventually encounter dislocations in their
real sectors.
What does this combination of global slowdown and heightened market volatility
mean for banks and financial regulators?
Ladies and Gentlemen,
In this scenario, credit risk management would be the priority for banks and regulators, to
ensure that going forward, asset quality remains sound, and banks have adequate capital
and provision to absorb this risk. Indeed, the underlying cause of the present global financial
crisis is the lapse in credit culture and credit risk management, which has allowed excessive
leveraging and indebtedness. Moreover, raising new private capital in this environment is a
very tall order; while the option of public capital injection very costly for shareholders and tax
payers. Therefore, it is imperative that banks need to be even more vigilant in managing not
only their asset quality but also their internal capital, funding, expenditure including executive
pay, and dividend policy.
Looking at banks in the Asian region, such as Thailand, despite rapid development of capital
market in recent years, the core banking businesses remain traditional; largely deposit taking
and loan extension. Meanwhile, treasury operation remains relative small. Moreover, with the
financial market predominantly bank-based rather than market-based, there tends to be less
risk and complication arising from the originate-to-distribute models of securitisation.
Nevertheless, in the past few years, banks have expanded business scope, operating as
universal banks or financial conglomerate, with securities and insurance arms. Therefore,
organisational structure and risk profile, of even the more traditional banks, have become
much more complex. This, in turn, demands that bank's risk management, Board's oversight,
and supervisory framework can match the increasing complexity and ensure adequacy of
capital and risk management system on a consolidated basis.
On some banks in Asia and Pacific countries have been exposed to the
market risk,
subprime related assets such as CDOs as well as assets of failed institutions. The losses so
far have been limited to foreign assets and are addressed by private and government
assistance. On hindsight, this crisis highlights the fact that it is easy to overestimate one's
risk management ability. The same applies to banks, rating agencies, specialist players such
as bond insurers, hedge funds, and regulators. Mistakes brought down even highly
sophisticated market makers and specialist players such as Lehman, Bear Sterns, and AIG.
The CDOs and structured products were very complex, and their valuation and risk
management required sophisticated quantitative skill. When mark-to-market failed,
mark-tomodel becomes complicated by absence of in-house capacity. And, the option of turning to
external expert valuer such as arrangers is very expensive, due to the lack of liquidity and
captive nature of such market. Thus, the knowledge required to properly manage these risks
goes well beyond the quantitative skill and the usual front-office ability to value, price, and
trade in normal market period.
During abnormal periods, the Board must understand the context of each market, especially
its market structure, to be in a better position to gauge erratic market behaviour and liquidity.
Board members need to have a clear view, for example, whether the market would likely
become a captive one, and the degree of counterparty risk in such OTC derivatives market.
In the crisis environment, the strength of capacity of mid-and back-office becomes critical for
minimizing losses, such as by reducing counterparty risk, and dealing with settlement risks.
As this crisis develops, financial markets have witnessed, in an unprecedented manner, the
unwinding of many contracts, even those backed by standard agreements like ISDA.
On this note, I must stress that under-investment in human capacity and system of mid- and
back-offices, as opposed to fronts, could prove costly. Building the capacity of mid- and
back-offices may require in-house investment, as recruitment from market may not be as
easy as front-office, but possibly more important, a change in management culture, which
can only come from leadership of top management.
Ladies and gentlemen,
For those more conservative banks or financial markets, not affected in this first round hit, I
also say that they cannot afford to be complacent. As in risk rating framework, it is neither the
risk exposure nor risk management ability that determines bank's riskiness, but the danger
lies in the gap between the two. Therefore, banks, though engaged in less complex products
would still be at risk if their ability to manage such risk is lagging behind their products.
Indeed, the gap between risk exposure and management capacity becomes more important
in a very volatile macroeconomic and financial environment. This is since such a gap may
possibly emerge or expand undetected, given the dynamics of market events. Even with
plain vanilla products, the exposure can become complex due to the number of positions
used for different hedges and at different strikes. This is not to mention the complex layers of
counterparty, with counterparty risk and concentration risk.
At such time as this, caution is vital, because even conservative banks could be exposed to
market risk from domestic assets as well as currency risk. Even if not directly, risks could
come indirectly via the exposure of their clients, especially in the case of interlinked market
and credit risks.
The present environment also raises concerns of the close link between financial and
reputation risks. Banks or their affiliates, be they fund management or insurance arms, may
have sold inappropriate products to clients without doing proper due customer diligence or
education. As a result, clients' losses could lead to either bad assets and credit risk,
counterparty risk, or reputation risk for banks if dissatisfied customers generate queue and
protest in front of the banks, or even legal risk. In this environment of tight liquidity, and
depositors have bargaining power, reputation risk and customer queue and loss of
confidence could translate into liquidity risk.
This brings me to the third risk implication from this global crisis, which is the liquidity risk.
Indeed, tightened global liquidity will be more pronounced for economies that rely on external
short-term debt. For other economies, the shift of external funding toward domestic sources
and the effect on trading partners' economies could cause a widespread contraction in credit
supply. Furthermore, re-pricing of risks by investors and deleveraging has increased the risks
and volatilities in global financial markets, which could in turn lead to greater risk-aversion in
emerging markets. As a consequence, there could potentially be more reversals of capital
flows from emerging markets, including Asia, thereby denting growth in countries heavily
dependent on capital inflows.
Having said this, there is a sense of comfort that the capital base of banks in this region
remains relatively sound. But going forward, banks, regulators, and central banks would
benefit from undergoing stress-test and crisis management exercise to assess their strategy
and make necessary adjustment to their risk management and capital policy. The close
dialogue forged by such an exercise will be very useful in helping to instigate coordinated
actions including information sharing.
In terms of financial stability surveillance, candid on-going dialogue and market
communication between key stakeholders is at the heart of an early identification of
emerging trends and risk in the system. We all know that most indicators, risk models, and
early warning models are built based on the structure of the past crisis, but no two crises are
identical. For the Thai banks, you are already familiar with the stress-test, both top-down and
bottom-up, that has started last year when we successfully completed the assessment of the
Financial Sector Assessment Programme of the IMF and the World Bank, or the FSAP.
Ladies and Gentlemen,
The present global financial crisis highlights the importance of supervisory coordination.
While this has been especially critical for crisis management in affected countries, a step-up
in coordination would also be critical for currently unaffected countries as well. Importantly,
this coordination should include both domestic and cross-border dimensions. And, it should
encompass key regulators and central banks, for information sharing and elimination of
regulatory arbitrage, which has been one of the underlying causes of this crisis.
While the crisis management may lead to rapid changes in regulatory framework, such as
the much discussed mark-to-market rule, it is important to remember two things. First,
investors would form their own opinion of valuation. Second, differences in such treatment
could, if not carefully managed, cause regulatory arbitrage, moral hazard, deterioration in risk
management culture, and difficulty in exit-policy.
There is of course no simple rulebook on how to deal with a crisis. Each country has to take
into account its own institutional context. But, the mantra of a good and sensible risk
management, especially at its core principle level, should not be violated. Again, I cannot
overemphasize that the internal risk management system of banks should match its risk
profile, as deemed appropriate by the Board. Simply observing minimum regulatory
standards or international standards may not be adequate. Should the nature of its
underlying risk indicate otherwise, attempts to ignore it would likely be tested by markets,
and with real consequences. For this reason, the key principle of Basel II makes a very good
sense, and even more so with the dynamic changes in risk emerging from the current crisis.
On the issue of cooperation, I am pleased to say that central banks and regulators of the
Asia Pacific region have forged a very close cooperation over the years, under fora including
ASEAN, EMEAP, SEACEN, and SEANZA. These fora, where finance ministers, central bank
governors, and financial regulators meet regularly with each other and with their private
sector counterparts, have achieved an important voice in the global financial community in
recent years.
In the area of banking supervision, EMEAP - comprising ASEAN 5, China, Japan, Korea,
Hong Kong, plus Australia and New Zealand - has representatives in the various BIS
committees and working group, which set the international standards for financial
regulations. In fact, Thailand currently represents the EMEAP group in the Accord
Implementation Group. Through such avenues, the authorities in Asia Pacific region have
and will continue to influence the evolution of the global standards. The goal is to ensure that
these standards are suitable to the context of our economies and financial systems, based
on feedbacks and dialogues with our regional banks.
Ladies and Gentlemen,
We all agree that the challenges for Asian economies and Asian banks are higher going
forward. To ensure financial and economic stability to support long-term growth, the
authorities need to foster closer policy coordination among regulators, domestically and
internationally, as well as having continuous dialogue with market participants. Where
possible, closer regional cooperation in the areas of surveillance and financing should be
promoted further. Domestically, greater macroeconomic policy flexibility hinges on
augmenting monetary and fiscal policies with financial policies that mitigate contagion risks in
financial markets. In any case, a policy should be implemented carefully, avoiding
overreaction that could increase distortion and instability in the economic and financial
systems.
Given that the current turmoil will bring about changes in the financial landscape, both the
policymakers and private sector have to adapt themselves in an effective manner. To
increase financial system resiliency, including by improving the credit information system,
regulatory reform could possibly mean more stringent prudential guidelines during the upturn
to help financial institutions achieve bigger cushions during the downturn period.
In this challenging time, the private sector has to be alert, yet prudent with the new
opportunities available. The board of directors and senior management has to oversee the
operations and risk profile of their organization closely and regularly.
Ladies and gentlemen,
Just before ending note, allow me to touch on the situation in Thailand and the impact of the
global crisis.
The latest assessment of Monetary Policy Committee projected that growth is expected to
moderate, to a range of 4.3 to 5 percent this year, and 3.8 to 5 percent next year. Inflation
should subside next year, with headline CPI at around 3 to 4 percent. External position will
remain strong with current account surplus for this year and next year, international reserves
currently at around 104 billion US dollars, while external debt is 65 billion US dollars as of
August, of which just over one-third is short-term. Overall, the economy does not have
imbalances that could pose as vulnerability.
The Thai banking system remains resilient and profitable, due to strengthened risk
management of banks as well as the continued stable macroeconomic conditions at home,
and credit growth remains supportive of the economy. BIS capital ratio stood at 15.7 percent
at end-September. NPL has continued to decline in third quarter by another 15.7 billion,
gross ratio to total loans down to 6 percent, and Net NPL ratio down to 3.3 percent. NPL is
fully provisioned for in according to IAS 39 since the end of last year. We will continue to
encourage banks to focus on bringing this down further to strengthen the sector outlook.
Liquidity conditions in the banking system remains normal as Thai banks rely on local
funding in the form of deposit with some small portion of bill of exchange, or B/E, for 86
percent of the total liability. Thus, the Thai baking system is quite unaffected by direct impact
from global credit crunch. Overall, the liquidity indicator, the ratio of loan to deposit plus B/E,
is stable at around 90 percent throughout the third quarter, with slight tightening at the end of
second quarter as loan growth accelerated, reaching 13.2 percent in September.
The direct impact of the turmoil so far on the Thai banking sector has been limited. This is
because the Thai banking sector has low direct exposure to CDOs and other problem assets.
Thai banks' exposure to CDOs including sub-prime CDOs is now less than 0.1 percent of
total asset. Banks with CDO exposure have already made full provisioning and recognized
losses in line with IAS 39, and presently all sub-prime related CDOs have been unwound.
Thai banks also have very low exposure to investment banks like Lehman Brothers and have
no investment in US GSE securities. In all, total exposure of Thai banks to foreign investment
is about 1.2 percent of total assets, about half of which are sovereign assets.
Having said this, we are very mindful of the risk from second round effect of slowdown in
global growth and domestic growth, which can affect credit, market, as well as liquidity risk.
To handle this, the Bank of Thailand has been holding dialogue with top managements of
banks to discuss financial stability outlook, and have conducted stress-test to ensure that
banks are alert to these risks and are able to manage them to ensure adequate capital and
liquidity. We will continue to hold candid and two-ways dialogues with all the banks operating
here to ensure that we can manage these challenges and dynamics of the global turmoil.
Ladies and gentlemen,
I would like to conclude with some lessons learned so far to increase our immune system
going forward. First, growth must be based on strong macroeconomic foundation, with
prudent fiscal and monetary policy, flexible policy options, and strong external positions.
Second, sound system of financial institutions, with adequate capital fund, good risk
management, corporate governance, and systematic and effective system of financial and
market information disclosure that promotes market discipline is important for economic
stability. Finally, the private sector should increase competitiveness and the ability to adapt,
with emphasis on human resource development and key infrastructure.
Ladies and Gentlemen,
With increased globalisation and financial integration, emerging market economies has
become more synchronized with advanced countries. As the turmoil is unfolding, we must
work even more closely together to ensure smooth adjustment and safeguard economic and
financial stability.
Thank you for your attention.