The small-world phenomenon
With the ongoing 31st Asean summit in Manila, it would be timely to share some thoughts on the importance of the Asean integration, particularly in the area of banking and finance.
Most of us, especially those who are into social network, such as Facebook, Instagram and Twitter, are familiar with the concept of “six degrees of separation.” This network theory suggests that, on average, anyone can be connected to anyone else in just six steps.
More than just a pop-culture mantra, the idea that everything is connected has also increasingly become an economic and financial reality. With the advent of globalization and rapid technological innovation, financial markets all over the world are now more interconnected than ever. While this development certainly has its benefits, greater connectedness also has its potential risks.
For instance, greater connectedness has led to more occurrence of financial spillovers or contagion, where a problem in one country can quickly become a problem elsewhere. The preliminary results of the Financial Connectedness Index for the global equity markets currently being developed by the Bangko Sentral ng Pilipinas would show that spillovers spike contemporaneously with economic and financial shocks (Chart 1). 1
This development, among others, has contributed to a volatile, uncertain, complex and ambiguous environment, or what is known as Vuca world. Under such an environment, the Asian region becomes more susceptible to risks emanating from the pace of monetary policy normalization, notably by the Federal Reserve and the European Central Bank (ECB); geopolitical risks, particularly on the Korean peninsula and in the Middle East; as well as the consequences of sustained low global inflation.
One market of limitless possibilities
Amid this Vuca world, it should make sense to enhance the scope for cooperation with our Asian neighbors and hold hands with “brothers” so to speak. But, what does Asean have as a region that is potent against Vuca? One might ask, why pursue integration during a period of heightened uncertainty where populism and prisoner’s dilemma type of outcomes are increasingly prevalent? We have seen the United Kingdom opt out of its membership with the European Union, and more recently we are witnessing the unfolding of a similar crisis in Catalonia.
In my view, the pursuit of stronger regional integration presents a viable opportunity as a natural hedge against the protracted difficulties from the global economy. The integration of the 10 economies of Asean into one market offers limitless benefits and opportunities (Table 1).
By integrating 10 economies into a single bloc, Asean provides members greater market access to a market of approximately 640 million people. This is roughly equivalent to 9 percent of the world population. More important, the region offers a market that is considered the third largest in Asia and the fifth largest in the world in terms of economic size, or GDP. Asean is fuelled by a vision of a single market and production base that is highly competitive and integrated into the global economy. This is slowly happening with free movement of goods, services, investment, skilled labor and freer flow of capital. Against other countries and economic blocks, Asean is stronger in the negotiating table as a block.
And what have we to show for this? Since the founding of the Asean in 1967, and with the implementation of the priority measures to establish an Asean Economic Community, the region has been transformed into an increasingly well-regulated, dynamic and creative platform for trade and commerce across what many regard as the world’s fastest-growing economic region (Charts 2 and 3).
The necessary backbone
Of course, achieving a fully integrated single Asean market requires financial integration that allows freer flow of financial services and capital. We should recognize that facilitating intra-Asean trade and investment will be implemented through increasing the role of Asean indigenous banks.
To do this, Asean central banks have crafted the Asean Banking Integration Framework (Abif). With the framework in place, well-capitalized banks will start to become more visible across the Asean region. But Asean is also mindful of the diversity across Asean members in terms of economic conditions, as well as legal and structural limitations. These realities make the task of integrating the banking sector more difficult and complex, and that is why the Abif was created to operate under the principles of readiness, reciprocity, bilateral negotiations, capacity building and financial stability. Reciprocity and bilateral negotiation in particular, should address the fear of some that big banks from the big Asean economies could impose undue dominance in the smaller jurisdictions. You do not ask for something that you are not ready to give. Thus, the framework seeks to guide and facilitate the entry and operation of qualified Asean banks (QABs) in Asean member countries to promote equal access and treatment among Asean banks.
QABs refer to high-quality banks that are strong and well-managed and meet specific qualifications, including the prudential requirements of both home and host countries. Under Abif, Asean members will aim at concluding reciprocal arrangements to create opportunities for establishing QABs in each jurisdiction and provide market access and operational flexibility. The extent of such concessions and flexibilities will depend on the bilateral negotiations of the concerned Asean members. While Abif facilitates banking integration, it fully respects domestic prudential requirements. Imposition of a template-approach is a no-no in the Asean.
Where do we stand
To fully support the Abif, the Philippines amended an existing law (Republic Act [RA] 7721) by enacting RA 10641 on July 15, 2014. This allowed foreign banks to operate in the Philippines through any one of the following modes of entry, subject to relevant licensing and other requirements prior to actual entry: 1) establishment of foreign bank branches with full banking authority; 2) acquisition of up to 100 percent of the voting stock of an existing domestic bank; or, 3) investing in up to 100 percent of the voting stock of a new locally incorporated banking subsidiary.
With this law, we are now on a par with the rest of the Asean-5 in terms of legal frameworks for access in the banking system. Moreover, this allowed the Bangko Sentral ng Pilipinas (BSP) to conclude negotiations with Bank Negara Malaysia (BNM) in April 2017. The BSP also initiated talks with Indonesia and Thailand. Last year OJK Indonesia and BNM also concluded bilateral negotiations. The concluded negotiations will become effective once the internal ratification processes of the negotiating countries are completed. The next steps include actual application, assessment and licensing of QAB candidates. The race is now on for the first QAB in Asean.
Embracing Vuca world
The region, including the Philippines, has everything to gain from banking integration. Foreign bank penetration results in improved financial services quality and availability following the increase in competitive forces. In addition, an increase in the depth and breadth of domestic financial market tends to enhance efficiency in the financial sector. Greater financial integration leads to increased foreign direct investments. Foreign investors tend to leverage on financial institutions from the same jurisdiction and therefore positive externalities can be reaped in the process of banking integration. This in turn helps facilitate transfer of technology and managerial know-how to a recipient country.
Additionally, financial integration enhances macroeconomic policy discipline and reduces frequency of policy mistakes. Financial openness signals a commitment to sound macroeconomic policies. Last, but not least, financial integration also reduces volatility through more efficient capital allocation. Financial integration expands the market, which can be accessed by regional players in the region, hence facilitating diversification. But, of course, it is recognized that, despite the benefits, interdependence of financial markets could increase the risks of spillovers and contagion.
Notwithstanding the risks and benefits, with the rapid pace at which globalization is proceeding, it can be expected that the world will grow more complex and connected in the future. This is the reality we need to face but, at the same time, we should be prepared to manage.
Hence, as countries in the region open and integrate their financial markets, it is important to establish the necessary capacities and pursue sound and consistent macroeconomic policies. In this way, Asian member-states will fully maximize the benefits and outweigh the risks of an increasingly integrated financial market. The task at hand may be challenging, but with greater cooperation, no challenge is insurmountable—after all it’s just a small world.
1 This index measures the average spillover in the global equities market consisting of 21 emerging and advance economies. See Fernandez, J. et al. “Measuring Philippine Financial Markets Connectedness: A Variance Decomposition Approach.” Forthcoming BSP paper.