Financial markets, institutions and integration in East Asia

Abstract

This paper explores East Asian finance in two parts. The first part of the paper provides an overview of the state of regional financial markets in East Asia. It looks at recent trends in capital flows and cross-border banking, the state of financial market infrastructure, and at developments in financial markets – stocks, foreign exchange, bonds, and derivatives – in East Asia. The picture is not pretty. East Asian financial markets are tiered: the developed markets of the region (Japan, Singapore, Hong Kong SAR and Australia) perform well by international standards, most of the others (like Korea, Malaysia, Taiwan PoC and Thailand) are average, and a couple (like Indonesia and the Philippines) look dismal. Infrastructure and risk management in the region are, in general, at relatively low levels by international standards. Many countries face serious challenges. Institutions are generally weak. Developing ASEAN has to compete more and more with China for funds. Continued weakness in its financial institutions, market structure, and economy are diminishing the importance of Japan and impeding regional development. The second part of the paper explores in more detail four of the many issues that arise in looking at finance in East Asia. The first is refocussing on harmonising markets in East Asia, as a complement to institutional development. East Asian financial markets are fractured, and increasingly so relative to the Americas and Europe. The tiered nature of East Asia’s financial markets and institutions suggests that the way forward for integration is through the more developed markets and, through cooperation with them, the less well developed markets of the region. There is enormous scope for capacity building. There are special challenges for Japan in this whole process because its regulatory structure has different legal origins and its institutions and markets, while bigger, are structurally weaker and less efficient than the other developed markets in the region. This may mean that Japan is not the natural focus for financial integration in East Asia, especially in South-East Asia, even though it is of course a major player in the process. The third issue is the rise of regionalist sentiment and policymaking in East Asia. This has both potentially destructive and constructive elements. On the minus side, it can lead to insularity and a weakening of global rules and mechanisms. But these are unlikely eventualities in East Asia. Regionalist action in the finance domain is, on balance, more likely to provide benefits, like better policy dialogue, deeper cooperation, and financial development. It can also boost East Asia’s influence globally, although this largely depends on East Asia keeping its regional focus outward-looking. The final issue explored is the need for more market players in order to develop and deepen financial markets in East Asia. This entails expanding the range of financial institutions in markets, like institutional investors, to balance bank concentration in East Asian financial systems. And it means domestic systems accepting more foreigners and foreign institutions from within and without the region.