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Financial Stability in Emerging Markets: Commentary--Damien White

Financial Stability in Emerging Markets:  Commentary
Damien White，Australian Treasury

? I would also like to thank the Secretary-General of the APEC Finance and Development Program for providing me with an opportunity to speak at the 2004 Annual Forum.  My area within the Australian Treasury has policy responsibility for prudential regulation and financial stability.  Today I will share with you some of the Australian reforms that have occurred in these areas over the last 15-20 years that can perhaps show up some of the lessons – both good and bad.
? First, I think that it is a useful reminder to put financial stability into its broad context.  Financial stability is not a goal in its own right but rather a means to an end.  Ultimately the objective of financial stability is to improve the welfare of people by encouraging sustainable growth. 
? As we all know, finance sectors play a very important part in facilitating growth, particularly through allocating savings to productive investments and providing means to manage risks.
? Developing a financial system that assists in managing the risks and macro?economic fluctuations that inevitably arise will assist in achieving this goal.  But as some of the previous speakers have noted, financial systems that cannot manage fluctuations impose large costs on countries.
? While recognizing that a reasonable level of stability is important, a balance needs to be struck between achieving stability and integrity in the financial system and promoting financial markets that are competitive, efficient and innovative.  This is just a way of saying that if regulators put too much focus on stability, the financial system may be curtailed to such an extent that it creates inefficiencies and inhibits growth.
– This trade off has been highlighted by developments in financial regulation in Australia.  The financial regulation framework in place up to the early 1980s relied heavily on the restriction of market forces to maintain financial market stability and security.  While this approach was successful in maintaining stability (at least for those regulated institutions), it also resulted in impediments to competition, reduced efficiencies and resulted in a lack of responsiveness to consumers - in short, it inhibited our growth.
– After Australia changed its regulatory framework in the mid-1980s, the finance and insurance sectors doubled as a proportion of GDP over the following 5 years.
Australian reforms over the last 15-20 years
? Australia reformed many parts of its economy and regulatory framework – tariffs/trade, floating currency, opening finance sector to international competition, reduced restrictions on finance sector, moved to national prudential regulation on functional basis, corporate governance reform, competition reform.
? Since the late 1990s we seem to have seen the benefits of that.  Australia has had consistent growth, even with external events – Asian financial crisis, growth slowdowns in US/Europe ? that would likely have caused deteriorations in economic circumstances previously.
? One thing that this shows is the long timeframes over which the benefits of reform might show up – only now are the benefits of what are old reforms becoming obvious.
? Shows that task is never complete.  We have had reforms building on other reforms – no big bang.
? Healthy balance sheets of banks and ability to manage currency risks.
Transitional issues
? Important to remember that when you change things, there will always be unanticipated consequences.  Pays to be vigilant to changing behaviour after reforms.  Essentially be watchful for transitional issues.
? In Australia’s case there are two examples that might show useful lessons.
– After initial opening of financial sector, had large increase in credit, reduction in credit checking standards.  Led to large losses in a number of banks – almost collapse of one of biggest banks.
– Changed prudential regulation framework in late 1990s.  Change of organisation and regulatory philosophy may have temporarily led to less vigilant regulation of insurers than was necessary.  Caused less than optimal regulatory responses to HIH insurance company, which failed.
? One interesting thing to note is that brought in foreign expertise after first crisis – knowledge transfer to our banks/insurers.
International integration
? With increasing global linkages there are challenges in achieving domestic financial stability
? Importance of rules assisting countries to get benefits of foreign entities while at some time not exposing to too much possible instability.
? Therefore importance of cooperation between regulators.  Common rules, MOUs, agreements on what to do in crises/difficulties etc
? Considerations of what you want you banking system to do.  Serve domestic market or be international player.