Assessing the Financial Landscape for the Association of Southeast Asian Nations Economic Community, 2015

bs_bs_banner Asia & the Pacific Policy Studies, vol. 2, no. 1, pp. 116 129 doi: 10.1002/app5.61 Original Article Assessing the Financial Landscape for the Association of Southeast Asian Nations Economic Community, 2015 Choong Lyol Lee and Shinji Takagi* Abstract The article assesses Association of Southeast Asian Nations (ASEAN) s financial landscape and considers issues related to regional financial cooperation. Although the ASEAN Economic Community is expected to come into force by the end of 2015, given the large disparity between the more and the less advanced member countries, regional financial integration in ASEAN can only be an evolutionary process. Regional cooperation is needed not only to help integrate the region financially but also to manage the attendant risks. Areas of cooperation must include, among others, establishing common licensing standards for financial institutions and creating region-wide systems for deposit insurance, credit rating, financial market supervision, payment and settlement, and consumer protection. Key words: ASEAN Economic Community, ASEAN economic integration, ASEAN financial markets and institutions * Lee: Department of Economics, Korea University, Sejong 339-770, Korea; Takagi: Graduate School of Economics, Osaka University, Osaka 560-0043, Japan. Corresponding author: Takagi, email takagi@econ.osaka-u.ac.jp. The article draws on their background work (Lee & Takagi 2013) for ASEAN 2030: Toward a Borderless Economic Community, Tokyo: Asian Development Bank Institute (ADBI) 2014. The views expressed in the article are their own and should not be attributed to any institution with which they are or may have been affiliated. 1. Introduction The article assesses the financial landscape for the Association of Southeast Asian Nations (ASEAN) and considers issues related to regional financial cooperation. 1 The ASEAN leaders, meeting at the 12th Summit in 2007, affirmed their commitment to the creation of an ASEAN Economic Community (AEC) by the end of 2015 and to transforming ASEAN into a region with free movement of goods, services, investment, skilled labour, and freer flow of capital. The AEC is meant to transform ASEAN into a single market and production base by: (i) accelerating regional integration in the priority sectors; (ii) facilitating the movement of business personnel, skilled labour and talents; and (iii) strengthening its institutional mechanisms. The prospect that the economic rise of China and India might marginalise individual ASEAN member countries as a destination for direct and portfolio investment flows from outside the region is said to have played a role in the leaders decision to accelerate regional integration efforts (Chia 2013; Das et al. 2013). Regional financial integration, involving capital account liberalisation, financial services liberalisation, and capital market development, is a critical 1. ASEAN includes 10 member countries: Brunei Darussalam, Cambodia, Indonesia, the Lao People s Democratic Republic (PDR), Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam. The original, more advanced member countries are sometimes referred to as ASEAN 5: Indonesia, Malaysia, the Philippines, Singapore, and Thailand.. This is an open access article under the terms of the Creative Commons Attribution-NonCommercial License, which permits use, distribution and reproduction in any medium, provided the original work is properly cited and is not used for commercial purposes.

Lee and Takagi: Assessing the Financial Landscape 117 component of the process, not only as a means of solidifying and further facilitating real integration but also to create a market with the size, depth, and liquidity attractive to foreign investors. Financial integration, however, is arguably among the last segments of the AEC to be completed. Imperfect information characterises the nature of financial transactions, so that financial integration requires far more sophisticated institutions than would be needed in other spheres of economic activity. Unlike the movement of goods, services and people, moreover, distance matters little in finance. Thus, advanced members of ASEAN with more developed markets and infrastructures may find it easier to integrate with developed countries outside the region than with less advanced ASEAN members. While regional economic integration would not be complete without financial integration, regional financial integration must therefore proceed as part of global financial integration. Given the current absence of a formal mechanism to place the integration process on a concrete path, however, it would not be an easy task to make ASEAN a financially integrated region anytime soon. Latest expert commentary on the AEC is almost unanimous in concluding that the goal of creating a single market and production base will not be fully achieved by the end of 2015 (Economic Research Institute for ASEAN and East Asia (ERIA) 2012; Chia 2013; Das et al. 2013; Asian Development Bank Institute (ADBI) 2014). As Chia (2011) notes, while commitments on paper are impressive, the devil is in the various exclusions and exceptions and in the implementation record (p. 44). The author then attributes ASEAN s poor implementation record to (i) weak commitments; (ii) slow decisionmaking; (iii) time-consuming national legislative processes; (iv) lack of technical capacity; (v) insufficient private sector consultations; and (vi) inadequate financial resources. The ASEAN Secretariat estimates that less than 70 per cent of AEC Blueprint commitments were met between 2008 and 2011; the Chairman s Statement issued at the 23rd ASEAN Summit suggests that an estimate as of September 2013 was about 80 per cent (Asian Development Bank Institute (ADBI) 2014). These estimates of compliance refer to the implementation of the agreed targeted measures, not how many of the universe of all required measures have been delivered. Given the complex AEC undertaking involving trade and investment promotion and facilitation in priority areas, it is understandable that financial integration should take a back seat for the moment. 2 This is not to say that no steps have been taken, 3 but it is almost certain that financial integration will not be a core element of the AEC when it comes into force at the end of 2015. In fact, the AEC Blueprint itself is vague and ambiguous about what is to be expected. For financial services, the blueprint notes the need to allow members to ensure orderly financial sector development and maintenance of financial and socioeconomic stability, stipulating the so-called ASEAN minus X formula. 4 Likewise, for capital movements, it calls for (i) ensuring an orderly capital account liberalisation consistent with member countries national agenda and readiness of the economy; (ii) allowing adequate safeguard against potential macro- 2. Finance is not among the 12 priority sectors targeted for accelerated integration by the ASEAN High Level Task Force. 3. Several ASEAN-wide forums exist to discuss and follow up on financial integration issues, including the ASEAN Finance Ministers Meeting and the ASEAN Central Bank Governors Meeting, which are supported at the technical level by the ASEAN Capital Markets Forum and various working groups of ASEAN central banks. In April 2011, Central Bank Governors agreed that multilateral liberalisation in the banking sector would be achieved by 2020 for ASEAN commercial banks; in May of the same year, Finance Ministers agreed to the fifth package of commitments on financial services under the ASEAN Framework Agreement on Services. A perusal of these documents, however, gives the impression that many commitments lack specificity and the number of exemptions are large as they are left to member countries to claim unilaterally. See Nikomborirak and Jitdumrong (2013) for a broader discussion of why progress in ASEAN trade liberalisation in services, including financial services, has been slow. 4. Under the ASEAN minus X formula, countries that are ready to liberalise can proceed first and be joined by others later.

118 Asia & the Pacific Policy Studies January 2015 Figure 1 Total Financial Assets in ASEAN Countries, 2012 (In Per Cent of Gross Domestic Product) 1 Note: 1 Bank assets are total bank claims on the nonfinancial sector; 2010 for Lao PDR and 2011 for the OECD. Sources: Authors estimates based on International Monetary Fund, International Financial Statistics; World Bank, http://data.worldbank.org ; and Asian Development Bank, Asian Bond Online, http://asianbondsonline.adb.org/ index.php. economic instability and systemic risk that may arise from the liberalisation process; and (iii) ensuring the benefits of liberalisation to be shared by all ASEAN countries. No clear end goal is suggested. 5 These provisions imply that each member country has ample flexibility to choose its own pace of reform, and that regional financial integration will therefore be an evolutionary process not bound by a definitive target date. In what follows, we attempt to give specificity to the ASEAN financial integration process, which lags progress in other areas. For this purpose, we first assess where ASEAN s financial markets and institutions stand today and, on this basis, highlight the need for regional cooperation measures to help accelerate the process. Some of these measures are also desirable from the point of view of managing the risks that will likely arise from greater financial integration. The experience of the recent past has taught that financial development, while beneficial, could also raise the risk of financial crisis (Easterly et al. 2000; Rajan 2005). Likewise, financial integration could increase the vulnerability of a country to shocks that originate elsewhere in the region. 5. In terms of capital account liberalisation, the goal is freer, not free, movement of capital. The rest of the article is organised as follows. Section 2 assesses ASEAN s domestic financial landscape by reviewing the features of capital markets and financial institutions in individual countries. Section 3 discusses the regional aspect of the financial landscape, including the extent of intraregional capital flows. Section 4, in providing specific examples of regional cooperation modality, highlights six areas where cooperation is needed both to deepen integration and to manage the greater attendant risks. Finally, Section 5 presents a conclusion. 2. The Financial Landscape in Individual Countries Diversity is the most distinguishing characteristic of the ASEAN financial landscape. In terms of total financial assets as a share of gross domestic product (GDP), Malaysia and Singapore compare favourably to the average for the member countries of the Organisation for Economic Cooperation and Development (OECD), while Lao PDR and Myanmar are at the other end of the spectrum (Figure 1). In fact, the latter two countries GDP shares, at 25 and 20 per cent, respectively, are among the lowest in the world. According to the

Lee and Takagi: Assessing the Financial Landscape 119 Table 1 Domestic Capital Markets in Advanced ASEAN Countries (In Billions of US Dollars) Debt securities outstanding (end 2013) All issues Of which, government debt only Principal stock exchanges Market capitalisation (end 2013) Share trading (2013) Indonesia 153.9 81.7 346.7 125.1 Malaysia 364.1 150.8 500.4 159.7 Philippines 134.7 86.4 217.3 57.4 Singapore 330.7 98.6 744.4 278.7 Thailand 285.2 93.9 354.4 360.6 Global total a 91,538.0 N.A. 61,420.5 74,199.1 Note: (a) WFE total for the stock exchange data; N.A. indicates data not available. Source: Authors estimates based on Bank for International Settlements, Quarterly Review, June 2014; and World Federation of Exchanges (WFE), http://www.world-exchange.org/statistics. same metric, the financial development of Brunei Darussalam and Cambodia is not much higher. The generally limited financial development of the region largely reflects the small size of capital markets, despite the recent overall growth in some countries. In terms of bonds outstanding, for example, even the largest of the ASEAN markets (Malaysia) constitutes only about 0.4 per cent of global total; the value of all ASEAN bond markets combined is barely 1.4 per cent, less than half the share of world GDP (Table 1). 6 Although equity markets are more developed, none of the ASEAN exchanges are among the world s 20 largest markets in terms of capitalisation or trading value; the combined share was 3.5 and 1.3 per cent of global total, respectively, for capitalisation and trading in 2013. These markets therefore offer limited depth and liquidity to large global investors, making them excessively subject to global capital flow volatility. Given the underdevelopment of a variety of financial products, banks offer virtually the only reliable products in most countries and claim an overwhelming share of total financial institution assets; in 2012, the share of bank assets was about 80 per cent in ASEAN as a 6. According to the April 2014 World Economic Outlook database of the International Monetary Fund, ASEAN s combined GDP in 2013 was 3.3 per cent of world GDP, when converted at market exchange rates. whole (Table 2). 7 Even so, accessibility to banking services is limited in some lowincome members. According to the latest available data (for 2012 in most cases), the number of deposit accounts per 1,000 adults was 145.6 in Cambodia, 44.3 in Lao PDR, and 144.3 in Myanmar. The average number of bank branches per 100,000 adults was 4.4, 2.7, and 1.9, respectively, while the number of automated teller machines (ATMs) per 100,000 adults was 6.7, 12.9, and 0.1 (Table 3). The International Monetary Fund (IMF) s financial access survey ranks these countries among the lowest in the world. ASEAN s national commercial banking sectors are small on an absolute scale, even in Singapore (see Table 3). The combined total commercial bank assets in ASEAN, at $2.6 trillion, were about a fourth of the balance in France ($9.5 trillion) or Germany ($10.6 trillion). These numbers imply that the (simple) average size of individual banks in ASEAN was only $6.9 billion in 2012, about the size of the 813th largest bank in the world. Insurance companies, though the only type of non-bank financial institutions found across ASEAN, are not as well developed, especially in low-income member countries. In terms of 7. Besides insurance companies, there are several other types of non-bank financial institutions, such as leasing and finance companies, credit card companies, and export import banks. In less developed countries (such as Cambodia and Lao PDR), microfinance institutions are popular with low-income households.

120 Asia & the Pacific Policy Studies January 2015 Table 2 Total Assets of ASEAN Financial Institutions (In Billions of US Dollars; End 2012) a Banks b Insurance companies Other institutions c Total Brunei Darussalam 15.7 (85.3) 1.0 (5.4) 1.7 (9.2) 18.4 Cambodia 10.8 (90.8) 0.1 (0.8) 1.0 (8.4) 11.9 Indonesia 482.1 (83.3) 33.7 (5.8) 62.9 (10.9) 578.7 Lao PDR 6.3 (100.0) 6.3 Malaysia 658.2 (88.0) 65.1 (8.7) 25.0 (3.3) 748.3 Myanmar 13.0 (100.0) 13.0 Philippines 190.6 (65.0) 36.1 (12.3) 66.6 (22.7) 293.3 Singapore 728.8 (76.0) 143.6 (15.0) 85.9 (9.0) 958.3 Thailand d 748.8 (75.5) 75.4 (7.6) 167.1 (16.9) 991.3 Vietnam 236.0 (94.6) 5.5 (2.2) 8.1 (3.2) 249.6 ASEAN total 3,090.3 (79.9) 360.5 (9.3) 418.3 (10.8) 3,869.1 Notes: (a) Per cent of total in parentheses; indicates amount negligible. (b) Depository institutions except for the central bank. (c) Other financial institutions include finance companies, export-import banks, leasing companies, and development finance and microfinance institutions. (d) September 2013 for Thailand only. Source: Authors estimates based on official websites and annual reports of ASEAN central banks and financial supervisory agencies. Table 3 Features of the Commercial Banking Sector in ASEAN (End 2012) a Accounts per 1,000 adults Deposits Accessibility Assets Amount (In per cent of gross domestic product) Bank branches per 100,000 adults Automated teller machines per 100,000 adults Total (In billions of US dollars) Brunei Darussalam 2,188.5 77.4 22.2 90.5 9.6 1.2 Cambodia 145.6 35.9 4.4 6.7 10.8 0.3 Indonesia 708.1 39.1 9.6 36.5 454.1 4.2 Lao PDR b 44.3 29.2 2.7 12.9 6.3 0.4 Malaysia 2,305.3 146.9 19.9 52.9 477.9 17.7 Myanmar 144.3 19.4 1.9 0.1 13.0 0.6 Philippines 497.6 38.2 8.2 19.3 170.3 4.6 Singapore 2,180.6 150.1 9.8 58.2 728.8 22.1 Thailand 1,468.1 77.6 11.8 84.2 475.4 13.2 Vietnam N.A. 119.7 3.2 21.2 236.0 4.8 ASEAN total or average N.A. N.A. N.A. N.A. 2,582.2 6.9 Average size (In billions of US dollars) Notes: (a) N.A. indicates data not available. (b) End 2010 for Lao PDR. Source: Authors estimates based on International Monetary Fund, Financial Access Survey Database, http:// fas.imf.org/ ; and official websites and annual reports of ASEAN central banks and financial supervisory agencies. total assets, insurance companies on average accounted for 9.3 per cent of total financial institution assets at the end of 2012 (see Table 2). Likewise, in 2012, the average annual value of insurance premiums paid as a share of GDP (known as the insurance penetration ratio) was 3.48 per cent in seven advanced ASEAN member countries (ASEAN 5 plus Brunei Darussalam and Vietnam). It turns out that this ratio was far smaller than the OECD average of 8.06 per cent. 8 Accessibility to life insurance is particularly limited in low-income member countries (Table 4). While Singapore 8. The Philippines overall penetration ratio of 2.43 in 2012 appears comparable to the average of 2.38 among lower middle-income countries in 2011. See Beck et al. (2000), as updated in November 2013.

Lee and Takagi: Assessing the Financial Landscape 121 Table 4 Structure of the ASEAN Insurance Industry (End 2012, Unless Otherwise Noted) a Number of companies Assets (In billions of US dollars) Insurance penetration ratios (In per cent) Life Non-life Others b Total Life Non-life Total Life Non-life Total Brunei Darussalam 5 8 0 13 0.7 0.3 1.0 0.82 1.46 2.28 Cambodia 2 6 1 9 0.0 0.1 0.1 N.A. N.A. N.A. Indonesia 47 84 9 140 26.2 7.5 33.7 1.31 1.69 3.0 Lao PDR c 0 5 5 10 0.0 0.0 0.0 N.A. N.A. N.A. Malaysia 9 20 13 42 55.0 10.1 65.1 2.80 1.30 4.1 Myanmar 0 1 0 1 0.0 0.0 0.0 N.A. N.A. N.A. Philippines 29 76 6 111 32.4 3.8 36.1 1.85 0.58 2.43 Singapore 15 110 34 159 117.6 26.0 143.6 4.87 1.05 5.92 Thailand 24 64 2 90 56.0 19.4 75.4 3.44 1.65 5.09 Vietnam 14 29 2 45 3.8 1.7 5.5 0.69 0.86 1.55 ASEAN total or average 145 403 72 620 291.9 68.7 360.6 2.25 1.23 3.48 Notes: (a) N.A. indicates data not available. (b) Others include composite, reinsurance and state-owned companies. (c) End 2009 for Lao PDR. Source: Authors estimates based on ASEAN Insurance Database, 2012. had as many as 159 insurance companies of various types in 2012, Cambodia had only nine, Lao PDR only 10, and Myanmar only 1; neither Lao PDR nor Myanmar had a single life insurance company. 3. The Regional Landscape The extent of financial services integration, measured by the cross-border activities within ASEAN of financial institutions based in member countries, has been limited. For example, no ASEAN-based bank has either a branch or a subsidiary in all ASEAN countries. Three of ASEAN s most internationally active banks, Malaysia s Maybank, Singapore s United Overseas Bank, and Thailand s Bangkok Bank, each have subsidiaries in 6 out of the 10 ASEAN countries and a branch in 1 country. In contrast, global institutions, such as Standard Chartered, HSBC and Citibank, are active throughout the ASEAN banking market. The lack of significant regional integration in the banking market in part reflects the fact that many ASEAN countries not only strictly control the entry of foreign banks but also impose discriminatory restrictions on the operations of foreign banks within their domestic markets. This has often worked against the regional activities of ASEAN-based banks in favour of large global institutions. 9 In contrast, the insurance sector is more open to foreign ownership. Especially, in the low-income countries of Cambodia, Lao PDR and Vietnam, foreign-owned and foreigncontrolled insurance companies dominate the insurance market. This reflects the fact that the insurance industry is at an early stage of development, so that the expertise brought by foreign firms is highly valued. However, a foreign entrant in ASEAN domestic markets is typically not an ASEAN-based company but a company from outside the region. For example, out of the three foreign life insurance companies in Malaysia, two are the subsidiaries of companies based in Germany and Japan (the other from Singapore). Except for Myanmar, ASEAN countries have been active sources and recipients of international capital flows. On the inflow side, foreign direct investment (FDI) has been the dominant type, while the share of portfolio inflows has been small except in more recent years. This is consistent with the absence of large and liquid domestic capital markets, 9. For example, countries often impose size requirements (e.g. among the world s top 200 in asset size) or advanced technology requirements.

122 Asia & the Pacific Policy Studies January 2015 Table 5 External Assets and Liabilities in ASEAN, 1990 2012 (In Per Cent of Gross Domestic Product; End-of-Year Data) a 1990 2000 2012 Cambodia N.A. 176.8 199.6 Indonesia 80.6 136.8 80.3 Lao PDR 215.3 198.7 N.A. Malaysia 121.6 185.5 264.2 Philippines 95.0 143.3 109.3 Singapore 361.3 809.5 1,610.5 Thailand 68.8 142.7 196.9 Vietnam N.A. 110.7 N.A. Note: (a) N.A. indicates data not available. Source: Authors estimates based on Lane and Milesi-Ferretti (2006) for 1990 and 2000; for 2012, International Monetary Fund, International Financial Statistics. especially in debt securities. Even so, international capital flows have become increasingly two way, with the balance of external assets and liabilities exceeding 100 per cent of GDP in 2012 in all ASEAN countries for which we have data, except in Indonesia (Table 5). This means that ASEAN s de facto capital account openness is relatively high (though not in Myanmar). Intra-regional portfolio investment, while rising over time in absolute value, is more limited than extra-regional investment and has no indication that the share in total crossborder investment is on a rising trend (Figure 2). Restricting our attention to investment flows between the ASEAN 5 countries and the other ASEAN countries, the share in total cross-border flows only amounted to 9.9 per cent for outflows and 11.6 per cent for inflows in 2013. Among the five countries, Singapore, at $66.7 billion (or 74.5 per cent of total intra-regional flows), was the single largest source country. It is likely that much of this represented capital inflows from outside the region that were intermediated through Singapore s regional financial centre. If so, even the small intraregional portfolio flows overestimate the actual magnitude. Capital account policy in part explains the limited extent of intra-regional (as opposed to overall cross-border) financial flows. Singapore is the only country with a virtually fully open capital account (Chinn & Ito 2013; International Monetary Fund (IMF) 2013). While most other ASEAN countries substantially allow direct investment inflows and portfolio inflows through purchases by nonresidents of domestic securities, they maintain controls on the ability of residents to invest abroad; the controls are generally tighter on outflows than on inflows, even for the advanced members of ASEAN. The region s bias against outflows has had the effect of discouraging capital inflows from within ASEAN. Importantly, many countries place restrictions on external borrowing and lending through the banking sector (see also Park & Takagi 2012). 4. Regional Institutions and Cooperation Initiatives Integrating the region s financial markets requires more than rhetoric. Given the nature of finance, where transactions are characterised by asymmetric information between lender and borrower, financial integration requires a number of institutions and initiatives designed and implemented at the regional level to minimise informational costs. The need for regional cooperation in six areas is highlighted below. Given ASEAN s bank-dominated financial system, many of the areas involve banking sector issues, but cooperation is desirable in many more areas, including capital market development and capital account liberalisation. 4.1 Common Licensing Standards for Financial Institutions Promotion of banking integration requires the establishment of common, transparent licensing standards to be applied to all foreign banks, which must cover, among others: (i) capital adequacy; (ii) consolidation requirements; (iii) restrictions on large exposure; and (iv) accounting and transparency requirements (Barth et al. 2006); 10 any discrimination against foreign entrants including ASEAN- 10. Barth et al. (2006) provide a systematic approach to, as well as a comprehensive survey of, banking regulation.

Lee and Takagi: Assessing the Financial Landscape 123 Figure 2 Portfolio Investment by ASEAN Five Countries 1 Note: 1 ASEAN 5 includes Indonesia, Malaysia, the Philippines, Singapore and Thailand; end of June for 2013. Source: Authors estimates based on International Monetary Fund, Coordinated Portfolio Investment Survey (CPIS), 2014. based subsidiaries should be eliminated. These would be necessary to guarantee equal footing for competition with domestic banks in compliance with the World Trade Organisation (WTO) rules. Also, there must be a consistent, if not uniform, regulatory environment across Asian Development Bank (ADB) and ASEAN Secretariat (2013) assess the existing regulatory barriers to foreign bank entry in ASEAN member countries in terms of equal access, equal treatment, and equal environment. the region, regarding accounting standards and disclosure requirements, minimum capital requirements, prompt corrective action and methodologies for the resolution of failed banks, restrictions on large exposure, and antimoney laundering and consumer protection regulations. These regulatory harmonisation efforts, however, would take a long time to complete in any region. For this reason, the European

124 Asia & the Pacific Policy Studies January 2015 Union (EU) has relied on mutual recognition (with home country supervision) as an additional tool of promoting banking and other financial services integration (see Pasadilla 2008 for a review of financial services integration in the EU). Mutual recognition sidesteps political and bureaucratic obstacles to harmonisation, as it allows each member state to maintain its own rules on the condition that it accepts the entry of banks licensed by other jurisdictions (Davies 2006). In the context of ASEAN, however, liberal application of the mutual recognition principle would be difficult because some countries are reluctant to allow financial firms from less advanced countries to operate in their jurisdictions, considering that they lack adequate risk management capability. Thus, a high degree of initial regulatory harmonisation will be required. In this context, Asian Development Bank (ADB) and ASEAN Secretariat (2013) proposed, as a limited form of mutual recognition, what they call the ASEAN Banking Framework, under which a small number of highquality banks that meet specific qualifications are given access to the banking markets in all member states. In the proposed ASEAN Banking Framework, minimum standards are imposed on banks aspiring to operate freely across the region. 4.2 Region-Wide Deposit Insurance Deposit insurance protects bank depositors, in full or in part, from losses caused by a bank s inability to pay its debts when due. While its merits continue to be debated by economists who point to its moral hazard aspects, it has been widely adopted by most countries of the world as a tool of preventing a bank run and thereby to promote financial stability (Demirgüc-Kunt et al. 2005). Instability could arise in a financially integrated region if countries have different schemes in terms of coverage, type, funding and payouts and incentives are thereby created to shift funds from one country to another. The end goal of building an ASEAN-wide deposit insurance system (or systems) is therefore not only to secure the stability of the regional financial system but also to prevent arbitrage between countries offering different terms. With such a system, bank depositors in ASEAN could be assured greater safety for their deposits held by the region s financial institutions regardless of where they are located. At present, explicit deposit insurance is provided to depositors in eight member countries, but not in Cambodia or Myanmar (where it is understood that the insurance is implicit). 11 The rate and the coverage of insurance, where available, differ widely, especially the maximum payout. For example, the statutory limit is THB 50 million (about $1.5 million, converted at the end-2013 exchange rate) in Thailand, RM 250,000 ($76,000) in Malaysia, and KIP 20,000,000 ($2,500) in Lao PDR (Demirgüc-Kunt et al. 2014). 12 This disparity must be narrowed if banking market integration is to proceed smoothly. Otherwise, deposits could be withdrawn from institutions located in a country with a less favourable insurance system. The EU too was characterised by a variety of national schemes existing side by side, with the process of harmonisation starting only in 1994 (Laeven 2014). The impetus for harmonisation strengthened following the failure of Lehman Brothers in the fall of 2008, with the primary objective of creating a level playing field in terms of minimum levels of insurance coverage and maximum payout periods. Further steps to harmonise national schemes are in progress. Likewise, within ASEAN, some harmonisation will be necessary not only to create a level playing field for the region s financial institutions but also to help better integrate the regional banking market. ASEAN could either build an ASEAN-wide single deposit insurance institution to cover the deposits of all ASEAN banks, or allow each country to maintain its own deposit insurance agency but based on harmonised standards. 11. Where there is no explicit deposit insurance, governments are pressed to step in to provide a deposit guarantee of one type or another in the event of a systemic banking distress (Demirgüc-Kunt et al. 2005). 12. The limits are all per depositor per institution.

Lee and Takagi: Assessing the Financial Landscape 125 4.3 A Regional Credit Rating Scheme Credit rating agencies play an important role in facilitating financial transactions by providing an assessment of the credit risk of those who issue fixed-income securities. Although the use of private credit rating for regulatory and supervisory purposes is a topic of intense discussion (Gavras 2012), no debt markets can develop without a credit rating agency providing potential investors with credit information that is otherwise costly to obtain. Because established global agencies are unlikely to provide credit risk assessments on (often smaller) domestic and regional borrowers, ASEAN member countries must develop domestic and regional credit ranting schemes if they are to enhance the process and outcome of regional financial integration. The end goal of building a region-wide credit rating scheme is to allow any ASEAN investor easy access to credit rating and other credit-relevant information on uniform and transparent criteria. At the end of 2013, seven member countries (ASEAN 5 plus Brunei Darussalam and Vietnam) had local rating agencies. Given the diverse needs and different stages of market development in each country, credit rating agencies may have different methodologies and criteria to use in rating a company or bond. This suggests that, at least initially, each country should have its own local credit rating agencies, although the standards and rating methodologies must become increasingly uniform. This should not prevent region-wide agencies, including globally active ones, from rating the region s large issuers. Nor does it preclude the possibility of local agencies collaborating or associating with regional and global firms in developing skills and techniques. 4.4 Regional Financial Market Supervision Elliott (2014) argues that the EU s failure to establish regionally integrated banking supervision as the provision of banking services became increasingly regional aggravated the impact of the 2010 euro area debt crisis. A lesson from the European experience is that as financial markets become more interconnected, a regionally coordinated financial supervisory service is required to secure the stability of the regional market as a whole. ASEAN may thus need to build a cooperative mechanism for ASEAN-wide financial market supervisory harmonisation. Such a mechanism would include greater cooperation in the sharing of information on regional financial institutions that engage in cross-border activities. At present, no formal region-wide mechanism exists to facilitate regular communication and information sharing among the supervisory agencies. Each country has its own system of supervision (often with an agency unique to itself), with an almost exclusive focus on its own financial markets and institutions. Examples of new regulatory frameworks include a Financial Stability Board and a College of Supervisors. The Financial Stability Board (FSB) was established in 2009 to coordinate at the international level the work of national financial authorities and international standard setting bodies in order to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies. Likewise, in collaboration with international financial institutions, an ASEAN FSB could address vulnerabilities affecting the financial systems of the member countries in the interest of ASEAN financial stability. It could also promote coordination and information exchange among the authorities, and monitor and advise on market developments and their implications for regulatory policy. A college of supervisors is a permanent, although flexible, structure for cooperation and coordination among the supervisors responsible for and involved in supervision over the different components of a cross-border financial group. It aims to facilitate the exchange of information, views and assessments among the supervisors in order to allow for a more efficient and effective supervision and timely action, on both the consolidated and nonconsolidated basis. The college is expected to assist the supervisors of individual countries to monitor the current status and future movements of the business activity of an ASEAN-

126 Asia & the Pacific Policy Studies January 2015 wide banking group. It would enable the supervisors to develop a common understanding of the risk profile of the banking group as the starting point for risk-based supervision. Finally, it could coordinate decisions taken by individual authorities and contribute to a consistent implementation of regionally coordinated policy. Membership of the college may consist of the directors for banking supervision in ASEAN countries. 4.5 Region-Wide Payment and Settlement A good payment system would be essential to the smooth functioning of an integrated ASEAN financial market (see Rambure & Nacamuli 2008 for a comprehensive review of issues related to payment systems). As the volume of cross-border payments within ASEAN increases, a well-developed, wellconnected region-wide payment and settlement system, covering a large-value payment system, a retail payment system, and a foreign exchange (FX) payment and settlement system, becomes important. Ultimately, ASEAN should have a riskless and costefficient region-wide payment and settlement system combined with a single (or at least harmonised) real-time gross settlement (RTGS) platform, a retail payment system, and an FX transactions system. At present, six ASEAN countries (ASEAN 5 plus Vietnam) have RTGS systems operated by their own central banks, while the other four countries do not. As to retail payment systems, a number of parallel systems exist. These are primarily electronic bank fund transfer or card-based payment systems, such as credit and debit card systems and electronicfunds-transfer-at-point-of-sale systems. The same six ASEAN countries that have RTGS systems make active use of electronic payment systems, while the other four member countries do not. The long-term goal in terms of developing a retail payment system is to achieve a single payment area like the EU s Single Euro Payments Area, such that any economic agent can use a connected payment network across the region. Finally, as to foreign exchange payment systems, three are currently in use: (i) a correspondent bank system; (ii) a local payment vs payment (PVP) system; 13 and (iii) the Continuous Linked Settlement (CLS) system, the most common system for global FX transactions. 14 Within ASEAN, most foreign exchange payments and settlements are currently executed through the correspondent bank system. Because most ASEAN countries are still at earlier stages of financial development, it is understandable that many of them do not have an advanced electronic system, like RTGS, among financial institutions (with the notable exception of Singapore). Though local PVP FX payment and settlement has become more widely used in foreign exchange transactions in recent years, it is evident that there is a long way to go before an efficient CLS system is fully developed in all ASEAN countries. 4.6 Consumer Protection Consumer protection laws are designed to ensure fair competition and the free flow of truthful information in the marketplace. In the financial industry, consumer protection helps not only to raise the welfare of the consumer but also to improve the system s efficiency by mitigating information asymmetries and power imbalances between providers and users 13. PVP is a mechanism to ensure that a final transfer of one currency occurs if and only if a final transfer of the other currency or currencies takes place. At present, there are three local PVP systems in ASEAN: the ringgit and US dollar trading system by way of Hong Kong s Clearing House Automated Transfer System (CHATS), the rupiah and US dollar trading system by way of Hong Kong CHATS, and the peso and US dollar trading system. 14. CLS is a process by which a number of the world s largest banks manage the settlement of foreign exchange among themselves (and their customers and other third parties). It provides the largest multi-currency cash settlement system, which is managed by CLS Group Holdings AG and its subsidiary companies, and includes a settlement bank regulated by the Federal Reserve Bank of New York. The group was formed in 1997, and the settlement system has been operational since 2002. The CLS system is currently the most advanced and widely used foreign exchange system, delivering greater operational efficiency without settlement risk when settling payment instructions related to trades executed in six traded instruments and in 17 major currencies.

Lee and Takagi: Assessing the Financial Landscape 127 Figure 3 Consumer Protection in Selected Country Groups (In Per Cent of Total) 1 Note: 1 Numbers represent the share of countries with a relevant law or system in each category. Source: Authors estimates based on World Bank (2010). of financial services. At present, consumer protection systems for financial services are not well developed in ASEAN. According to the World Bank (2010), East Asia and the Pacific, which includes ASEAN, ranks lower than the neighbouring regions of South Asia and the Middle East, let alone the OECD countries, in terms of legal, institutional and dispute resolution mechanisms (Figure 3). The end goal is to provide users of financial services with access to consumer protection services that are as good as those available in advanced countries. For this long-term goal, a high level of harmonisation must be achieved in the consumer protection regulations. 5. Conclusion ASEAN capital markets and financial institutions are small on an absolute scale and in some countries underdeveloped. Neither are they well integrated regionally. Scale economy and narrowing down of the gap between the more and the less advanced members would be two obvious benefits of regional financial integration, but it is neither feasible nor realistic for the AEC goal of a financially integrated region to be created quickly certainly not by the end of 2015. Given the large disparity in the financial landscape across ASEAN, financial integration can only be an evolutionary process sustained over a long period of time. The practice of allowing each member to proceed as its domestic considerations permit has created a divergent pattern of financial development, and the situation is not likely to change. The pace of integration may even slow down, given the heightened stress on the region s emerging market economies created by the (actual or prospective) tapering of monetary stimulus in the United States, which may cause the authorities to become more cautious towards further capital account and financial liberalisation. The absence of a formal mechanism of creating a roadmap and enforcing national commitments also does not bode well for promoting financial integration. Aside from these concerns, this article has highlighted the medium-term need for regional cooperation to promote regional financial integration, as the AEC seeks to achieve. In particular, the article has highlighted six areas where regional cooperation is needed to place ASEAN financial integration on a concrete

128 Asia & the Pacific Policy Studies January 2015 path. They include, but are not limited to, the establishment of common licensing standards for banks, a region-wide deposit insurance system, a regional credit rating scheme, a regional Financial Stability Board or College of Supervisors, a region-wide payment and settlement system, and a system for consumer protection. These measures are necessary not only to facilitate the process of financial integration, but also to enhance the capacity of the region s policy-makers to manage the risks that will likely arise as the region becomes more financially integrated. If financial integration proves successful, there will inevitably be a region-wide consolidation of the financial landscape. As seen in the EU, this is unlikely to mean that many of the existing domestic institutions and markets will disappear altogether. More likely, there will be a two or three-tier market structure in which some domestic institutions serve strictly local needs and others compete with their global or regional peers across national borders; likewise, the boundary between national markets may increasingly blur for regionally or globally known institutions, but national markets may still remain viable for local institutions. The process of integration and consolidation will continue to be an inescapable reality as long as ASEAN wishes to remain part of the global economy. This article has argued that, especially for financial transactions, achieving the AEC goal of a single market cannot be left to market forces alone. Serious regional efforts are essential in creating the appropriate framework for facilitating and managing the process of integration. November 2014. References Asian Development Bank (ADB) and ASEAN Secretariat (2013) The Road to ASEAN Financial Integration: A Combined Study on Assessing the Financial Landscape and Formulating Milestones for Monetary and Financial Integration in ASEAN. Asian Development Bank, Manila. Asian Development Bank Institute (ADBI) (2014) ASEAN 2030: Toward a Borderless Economic Community. Asian Development Bank Institute, Tokyo. Barth JR, Caprio G, Levine R (2006) Rethinking Bank Regulation: Till Angels Govern. Cambridge University Press, New York. Beck T, Demirgüç-Kunt A, Levine R (2000) A New Database on Financial Development and Structure. World Bank Economic Review 14, 597 605. With an update in November 2013. Chia SY (2011) Association of Southeast Asian Nations Economic Integration: Developments and Challenges. Asian Economic Policy Review 6, 43 63. Chia SY (2013) The ASEAN Economic Community: Progress, Challenges, and Prospects. Working Paper No. 440. Asian Development Bank Institute, Tokyo. Chinn MD, Ito H (2013) The Chinn Ito Index: A De Jure Measure of Financial Openness. http://web.pdx.edu/ ito/chinn -Ito_website.htm. An update to 2011 of: Chinn MD, Ito H (2008) A New Measure of Financial Openness. Journal of Comparative Policy Analysis 10, 309 22. Das SB, Menon J, Severino R, Shrestha OL (eds) (2013) The ASEAN Economic Community: A Work in Progress. Asian Development Bank and Institute of Southeast Asian Studies, Manila and Singapore. Davies G (2006) Is Mutual Recognition an Alternative to Harmonisation? Lessons on Trade and Tolerance of Diversity from the EU. In: Bartels L, Ortino F (eds) Regional Trade Agreements and the WTO Legal System, pp. 265 80. Oxford University Press, Oxford. Demirgüc-Kunt A, Karacaovali B, Laeven L (2005) Deposit Insurance around the World: A Comprehensive Database. Policy Research Working Paper No. 3628. World Bank, Washington. Demirgüc-Kunt A, Kane E, Laeven L (2014) Deposit Insurance Database. Working Paper No. 14/118. International Monetary Fund, Washington. Easterly W, Ritzen J, Woolcock M (2000) On Good Politicians and Bad Policies:

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