The State of Finance in Asia and the Pacific

ESCAP is the regional development arm of the United Nations and serves as the main economic and social development centre for the United Nations in Asia and the Pacific. Its mandate is to foster cooperation between its 53 members and 9 associate members. ESCAP provides the strategic link between global and country-level programmes and issues. It supports Governments of countries in the region in consolidating regional positions and advocates regional approach to meeting the region’s unique socioeconomic chanllenges in a globalizing world. The ESCAP office is located in Bangkok, Thailand. Please visit the ESCAP website at www.unescap.org for further information.

ACKNOWLEDGEMENTS

The darker area of the map represents the members and associate members of ESCAP.

This paper has been prepared by Alper Aras, Regional Advisor, Macroeconomic Policy and Financing for Development Division, ESCAP, with support of Alper Hekimoglu, Financial Mathematics Phd candidate at Middle East Technical University. This paper benefited from comments by Hamza Ali Malik, Tientip Subhanij and Shuvojit Banerjee. This paper is presented as a background document for the 4th High-Level Dialogue on Financing for Development in Asia and the Pacific (April 2017). The paper describes research in progress by the author(s) and are published to elicit comments and debate. The views expressed in this paper are those of the author(s) and should not necessarily be considered as reflecting the views or carrying the endorsement of the United Nations.

Cover credit: Shutterstock (filmlandscape)

This paper has been issued without formal editing.

ABSTRACT

A healthy and dynamic financial sector that considers demographic shifts, rapid urbanization, large infrastructure needs, and the evolving structure of economic activity in Asia itself is needed to mobilize large savings into the most productive activities. However, financial sectors in the region are ill-suited to respond to these needs of the region. In this context, this paper examines why despite having abundant domestic savings that can be used to finance their needs, the region is excessively dependent on volatile capital inflows for its economic development. The paper analyzes the demand of funds by companies and individuals through financial markets and institutions and the supply of funds by domestic institutional investors in selected Asian countries. The paper shows that Asia has a diverse set of financial systems that vary not only in depth (size and liquidity of markets) but also in access (ability of individuals and companies to access financial services) and in efficiency (ability of financial institutions to provide financial services at low cost and with sustainable revenues, and at the level of activity of capital markets). The paper also introduces a new broad-based financial development index including depth, access and efficiency of the financial system and provides a comprehensive understanding of the level of financial development in Asia and the Pacific. Finally, the last section of the paper examines whether there is a threshold beyond which financial development can be detrimental to economic growth and whether this threshold effect is relevant for the region.

CONTENTS

Introduction

Section 1

The Asia and the Pacific Funding and Investment Structure

1. Funding Structure

i. Equity Funding

ii. Corporate Bond Funding

iii. Bank Funding

2. Investment Structure i. Financial System Deposit

ii. Mutual Funds

iii. Insurance and Pension Fund

iv. Key impediments facing foreign investors

Section 2

Measuring Multifaceted Financial Development

1. A Snapshot Comparison across Peer Groups

2. Trend of Financial Development Index

Section 3

Financial Development and Growth

Conclusion

Appendix I- Construction of the Index

References

Appendix II- Econometric Methodology, estimation and results

Appendix III- Financial Development Index of Countries

1

INTRODUCTION

Asia increased its share of global GDP from 23.2% to 38.8% between 1990 and 2014, much larger than the shares of the United States and European Union1. However since 2012, a sluggish global economy has led to a slowdown of exports, which exhibits the limits of such an export-driven growth model. This situation forces countries in the region to shift from their current export-driven growth model towards a new model that is focused on domestic consumption. The region’s growing and vibrant middle class can be the backbone of this new model. Estimates show that by 2030, two-thirds of the world’s middle class will be in Asia.2

In addition, rapid urbanization and the growth of the middle class in the region requires improved infrastructure in urban communities, including amenities, utilities, and links between production locations and centers of domestic consumption3. In this respect, countries in the region face huge needs for infrastructure development. However, although the region has an abundance of domestic savings that can be used to finance these infrastructure needs, it is ironic that it is excessively dependent on volatile capital inflows for its development.

A healthy and dynamic financial sector therefore will be needed to smooth this transformation and to mobilize large savings to finance large infrastructure needs. A well-developed financial sector reduces volatility of the economy by providing a variety of instruments and information to help households and firms cope with adverse shocks through consumption and investment smoothing. However, the financial sectors in the region are ill-suited to facilitate this transformation and to mobilize large savings. The Asian financial sector is dominated by short-term bank lending. The short duration of banks’ liabilities limits their capacity to finance long-term investments such as home loans and infrastructure investments. The bank-centered financial systems also lead to a supply-demand gap in lending of small and medium-sized enterprise (SMEs) which are a backbone of a resilient national economy in every country due to their nature of stimulating domestic demand through job creation, innovation, and competition4. This dominance has come at the cost of underdeveloped equity and bond markets in most countries. Underdeveloped equity and bond markets prevent institutional investors from supporting financial deepening, including through improved market efficiency and liquidity. The region therefore suffers from a supply-demand gap between funding (bank, equity and corporate bond funding) and investment (financial deposits, mutual, pension and insurance funds) which leads to a rise the cost of capital and to depending on foreign investment to finance local funding needs. Therefore, the diversification of financing modalities beyond conventional bank lending is better to serve the various financing needs of the region. In this context, economies must continue their efforts to develop financial markets. These efforts must be expended along multiple dimensions, including depth, access and efficiency.

In this context, the first section of this report analyzes the supply-demand gap in selected countries and provides policy implications for Asian policy makers. The following section then introduces a broad-based financial development index and presents a comprehensive overview of financial development in Asia and the Pacific. The last section examines whether there is a threshold beyond which financial development is detrimental to growth and whether this threshold effect is relevant for the region.

1https://dupress.deloitte.com/dup-us-en/economy/asia-pacific-economic-outlook/2016/q1-asia-economic-growth-continues.html?

2 Ratna Sahay, Jerald Schiff, Cheng Hoon Lim, Chikahisa Sumi, and James P. Walsh,2015. “The Future Of Asian Finance”.

International Monetary Fund 3 Over the next 30 years, it is estimated that over 1.8 billion people will move into cities and that Asia-Pacific will contribute almost

half of this urban shift. Price Waterhouse Coopers, 2015. Asian Passports, the coming of age. An overview and its demand. 4 Ratna Sahay, Jerald Schiff, Cheng Hoon Lim, Chikahisa Sumi, and James P. Walsh, 2015. “The Future of Asian Finance”.

International Monetary Fund.

2

SECTION 1 - THE ASIA AND THE PACIFIC FUNDING AND INVESTMENT STRUCTURE

While many Asian economies typically run a current account surplus, they also receive large amounts of foreign direct investment (FDI) at the same time (Figure 1 and 2). This leads to the question that although there is an abundance of domestic savings (current account surplus), why is it that the region relies so much on foreign savings (inward FDI).

Figure 1. Current Account Balance , 20155

Figure 2. Inward FDI Stock as a percentage of gross domestic product6

According to table 1, a large proportion of domestic savings flow out of Asia in the form of foreign portfolio investment (FPI), and is thus invested in foreign financial assets such as stocks and bonds. Popular destinations for portfolio investment are the United States and Europe7.

5http://data.worldbank.org/indicator/BN.CAB.XOKA.CD?locations=SG-MY-PH

6 http://www.brinknews.com/asia/the-missing-link-financial-development-and-technology-in-southeast-asia/

7 Ibid

-100 -50 0 50 100 150 200 250 300 350 400

China

Japan

Republic of Korea

Signapore

Thailand

Hong Kong China

Malaysia

Philippines

Indonesia

India

Avustralia

3

Table 18 FPI net outflow as a percentage

of current account balance

2005 2010 2015

Indonesia 389% 49% -5%

Malaysia 4% 28% 31%

Philippines 83% 20% 42%

Singapore 26% 67% 83%

Thailand -20% 25% 12%

While the constant inflow of FDI into Asia indicates abundant investment opportunities and growth potential, a current account surplus combined with an FPI outflow reflects a lack of domestic investment opportunities in financial assets. This paradox can be explained by the underdeveloped financial markets and institutional investor base in the region. Asia is home to a diverse set of financial systems that vary in depth and sophistication, including a number of emerging market and low-income economies. While Hong Kong China and Singapore dominate the scene as regional financial hubs, growing giants have relatively small equity and bond markets and institutional investors relative to their GDP level. Companies and individuals use financial markets to meet their funding needs. To meet the demand of funding needs of companies and individuals, domestic institutional investors should channel their savings into the demand of funding needs through financial markets. However, since excess savings of the region cannot currently be channeled by underdeveloped financial markets and institutional investors, these excess savings are absorbed by developed markets such as the United States and Europe. In this respect, the demand of funds by companies and individuals through financial markets (bank credits, equity and bond markets) is larger than the supply of funds through domestic institutional investors in selected Asian countries, except Japan and Singapore, whereas the supply side (domestic institutional investors) is larger than the demand side (bank credits, equity and bond markets) in advanced economies. This gap in Asian countries can lead to a rise in the cost of capital, and leads to these countries depending on foreign investment to finance their local funding needs (Figure3). Financial markets and the institutional investor base therefore need to be deepened further to lower the cost of capital and mitigate capital flow volatility to meet the large infrastructure needs of the region. The following section details the demand of funds by companies and individuals through financial markets in Asia and the Pacific, referred to as funding structure, and supply of funds through domestic institutional investors in Asia and the Pacific, referred to as investment structure.

8 Ibid

4

Figure 39

1. Funding Structure The size of funding structure signifies the demand of funding needs of companies and individuals. This is because if companies or individuals need money for their investments, they need to find these sources from banks, equity and bond markets. Though not widely known, equity funding in many Asian countries is comparable in size to that of their bank funding. While the size of equity funding is larger than bank funding in financial hubs, India and most of the emerging markets, bank funding is larger than equity funding in mature markets. On the other hand, the corporate bond market is still at an early stage of development in many Asian emerging markets when compared to alternative channels of funding, including bank and equity funding. Furthermore, bank funding is dominant in mature markets and growing giants. However, emerging markets present a mixed picture (Figure 4). Financial markets in Asia should be developed further to provide adequate stable funding for long-term investment and risk capital for innovation and entrepreneurship. However, bank dominance comes at the cost of underdeveloped equity and bond markets in many countries. The short duration of banks’ liabilities limits their capacity to finance long-term investments.

9 World Bank, 2015 and 2016, Global Financial Database, BIS, IMF database and http://www.sifma.org/research/statistics.aspx,

Total funding consists of banking funding, equity funding and bond funding. Bank funding refers to credit to private sector by banks and other financial institutions . Equity funding includes stock market capitilization. Bond funding includes corporate bond issuance by private companies other than finance companies. Investment side consists of demand , time and saving deposits in banks and other financial institutions, mutual and pension funds and insurance assets.

0 200 400 600 800 1000 1200 1400

United States of America

Germany

Hong Kong China

Singapore

Japan

Republic of Korea

Australia

China

India

Indonesia

Thailand

Malaysia

Philippines

Ad

van

ced

Eco

no

mie

sH

ub

sM

atu

re M

arke

tsG

row

ing

Gia

nts

Emer

gin

g C

ou

ntr

ies

Asian Total Funding and Investment As Percentage of GDP, 2014

Total Funding (Demand)

Investment (Supply)

5

Figure 410

i. Equity Funding Five of the 10 largest stock markets by capitalization in the world are located in Asia, including three in mature markets (Australia, Japan, and Hong Kong China) and two in growing giants (China and India). They are an important source of financing for local companies. However, equity funding of growing giants is small relative to their GDP level. Almost 23,490 companies were listed in Asia’s stock markets as of end-2014, compared with 4,369 in the USA and 8,681 in European Union. New capital raised by stock issuance in East Asia and the Pacific and South Asia amounted to about $2.5 trillion in 2014, compared with $2.3 trillion in the United States. Furthermore, of 53 nations in the region, 18 countries have no stock exchanges as of March 2016 (Table 2).

10

Ibid

0 200 400 600 800 1000 1200

United States of America

Germany

Hong Kong China

Singapore

Japan

Republic of Korea

Australia

China

India

Indonesia

Thailand

Malaysia

Philippines

Ad

van

ced

Eco

no

mie

sH

ub

sM

atu

re M

arke

tsG

row

ing

Gia

nts

Eme

rgin

g C

ou

ntr

ies

Total Funding Structure As Percentage of GDP, 2014

Bank Funding

Equity Funding

Bond Funding

6

Table 2

With the exception of a few countries, market capitalization is relatively limited in the region (Figure5). The liquidity in the Asian equity markets tends to be low (Table 3), which reduces their attractiveness for investors concerned about the possibility of rapid exit at a stable price.

While Japan, Republic of Korea and China have high level market liquidity, other emerging markets have low levels of market liquidity that prevents the development of secondary markets and high levels of corporate listings (Table 3). Equity markets in the region also tend to be highly volatile. The asynchronous monetary policy in advanced economies and uncertainty regarding the timing and pace of further monetary policy tightening by the Federal Reserve led to large declines in major regional stock markets in 2015 and early 2016. China and Singapore`s stock markets declined by 21%, and 18.2% respectively11. This situation also discourages institutional investors from investing in stock markets, which adversely affects the liquidity of equity markets. In liquid markets, investors can easily convert their stocks to cash without causing drastic change in the asset's price. Liquid stock markets allow for the rapid exit from a stock when the share price falls. In this respect, liquid markets are seen as more attractive than illiquid stock markets by institutional investors. In this context, the following measures can be considered for stock markets having low level of liquidity to improve their liquidity. First of all, many companies can be encouraged to list on the stock exchange so as to facilitate liquidity on the market by regulators of the various industries. This can be achieved through persuasion, dialogue, collaboration, policy setting and mutual consent. For example, the requirements for raising equity on the market determined by regulators should not discourage firms from listing on stock markets. In the same way, transaction fees can be reduced to attract more people to trade on the Stock Exchange.

11

Ibid

Countries That Have No Stock Markets

1- Afghanistan

2- Brunei Darussalam

3- French Polynesia

4- Kiribati

5- Korea, Dem. Rep.

6- Macao China

7- Marshall Islands

8- Micronesia, Fed. Sts.

9- New Caledonia

10- Palau

11- Samoa

12- Solomon Islands

13- Tajikistan

14- Timor-Leste

15- Tonga

16- Turkmenistan

17- Tuvalu

18- Vanuatu

7

Figure 5-Stock Market Capitalization of Listed Domestic Companies to GDP-201412 Table 3-

Stock Market Turnover Ratio13

Second, education and training can be intensified to increase investor knowledge of the role of the stock exchange in the country’s development. For example, Securities and Exchange Commissions can persuade all firms within their jurisdictions to include education of the public as a license renewal requirement. Third, liquidity could be improved by privatization of state-owned enterprises through stock exchanges. Fourth, while regulators in countries should consider the impact of new financial products on financial stability these considerations should not lead investment banking firms to avoid developing more products that can be traded on the Stock Exchange.

ii. Corporate Bond Funding It is well known that bond markets help reduce excessive reliance on short-term funding provided by banks and mitigate currency and maturity mismatches14 that some Asian economies suffered during the Asian financial crisis. This, in turn, has big potential to increase the resilience of Asian economies. However, regarding the size of corporate bonds, Asia is behind other regions. The United States and European markets have respectively $22 trillion and $18 trillion outstanding corporate bond issues compared to $3 trillion in Asia (as of 2014).15 In the region, only a limited number of countries have a

12

http://data.worldbank.org/indicator 13

World Bank, 2016, Global Financial Database 14

Definition of maturity mismatch: It occurs when a bank has substantial long-term assets (such as fixed rate mortgages) funded by the short-term liabilities (such as deposits). Definition of currency mismatch: Having assets that are denominated in a different currency than liabilities, so that a change in exchange rate between those currencies can have a large positive or negative effect on balance sheet. 15

Decisions at the crossroads. Capital market trends and their implications on Asia, Deloitte, 2015

0 50 100 150 200

Malaysia

United States of America

Philippines

Republic of Korea

Thailand

China

India

Euro Area

New Zealand

Indonesia

Russian Federation

Turkey

Viet Nam

Sri Lanka

Pakistan (2011)

Kazakhstan

Bangladesh (2011)

Mongolia (2012)

Countries Stock Market

Turnover Ratio (2014)

Kazakhstan 3.77

Sri Lanka 12.21

Philippines 17.89

Indonesia 25.32

Malaysia 30.28

Viet Nam 50.6

India 54.29

Republic of Korea

102.2

Japan 112.41

8

developed local currency bond market such as the Republic of Korea, Singapore and Malaysia (Figure 6). Significant progress has nevertheless been achieved in recent years in other markets such as China, Thailand and to a lesser extent the Philippines.

Figure 616

Furthermore, Asian corporate bond markets have low levels of market liquidity, measured as the ratio of total turnover to the average outstanding amount of debt securities (Figure 7). Interestingly, although most of the government bond markets are liquid markets, corporate bond markets’ liquidity is very low17. In this context, it seems likely that some issuers may have been deterred by unfavorable conditions, or the lack of depth in corporate bond markets, in particular at longer maturities.

Figure 718

The average maturity of corporate bonds is also shorter in Asia and the Pacific than the average maturity of corporate bonds issued in other regions. While the average maturity of issued corporate bonds is around 11.41 and 7.99 in the United States and Germany respectively, its average is about 7 years in Asia and the Pacific. The average maturity has shortened somewhat in some markets, such as China, Thailand and Indonesia. However, it noticeably lengthened in Malaysia, Australia and the Philippines (Table 4). Overall, this suggests that the conditions of issuance in Asia are not as good as in the United States or Germany.

16

https://asianbondsonline.adb.org/ 17

Ibid 18 Ibid

0 20 40 60 80

Republic of Korea

Singapore

Hong Kong China

Malaysia

China

Thailand

Japan

Philippines

Indonesia

Viet Nam

The Size of Local Currency Bond Market As Percentage of GDP

2008

2014

0 0.2 0.4 0.6 0.8 1 1.2 1.4

China

Hong Kong China

Indonesia

Japan

Republic of Korea

Malaysia

Thailand

Bonds Turnover Ratio, 2014

Corporate bonds

Government bonds

9

Table 4. Average Maturity Of Corporate Bonds (in years)19

2000 2005 2009 2010 2011 2012 2013 2014

Advanced Economies United States 7.89 11.92 9.51 10.26 10.44 10.57 11.11 11.41

Germany 5.14 12.33 5.42 5.8 6.06 6.93 6.94 7.99

Financial Hubs Hong Kong China 4.1 7.9 9.6 5.9 8.6 9.2 6.1 6.47

Singapore 4.6 4.2 5.1 5.8 4.7 7.4 4.8 5.25

Mature Markets

Japan 6.97 8.05 7.31 6.97 6.75 5.99 6.87 7.89

Rep of Korea 3.1 2.9 2.9 3.4 3.8 4.1 5 5.63

Australia 6.06 9.18 6.78 11.9 11.32 10.73 8.62 10.2

Growing Giants China 4.7 4.7 3.8 2.9 2.9 3.4 2.9 3.83

India 6.7 6.6 6 6 5.8 5.5 6 6.92

Emerging Countries

Indonesia 5.5 3.9 4.3 4.4 2.9 4.3 4.8 …

Thailand 6 4.7 4.7 4.6 3.9 5.8 4.6 5.13

Malaysia 4.1 2.7 1.1 3.8 3.9 6.6 7.1 7.7

Philippines … 5.8 5.4 6.4 6.7 7.6 8.3 8.7

Another challenge is the concentration in corporate bond markets, where the top 10 issuers accounted for 60−90% of an individual country’s total corporate bond issuance in 2013 (Figure 8). This implies that access to bond market funding is primarily available to large and well-established corporations. However, China is an exception, with only 24% of corporate bond issuance attributed to the 10 largest issuers.

Figure 820

As a result, corporate bond markets in many Asian countries are relatively underdeveloped in terms of size, liquidity and maturity, which impede the channeling of long-term savings to long term investments. In particular few countries have a developed corporate bond market as illustrated in Figure 9. Liquidity and maturity are also restraining the possibility of using bonds for long-term infrastructure projects. Therefore deepening of local capital markets is needed. However, these are not developed overnight but through an incremental process as described in Box 1.21 Such a process has been observed in the region where countries such as Viet Nam, Indonesia and the Philippines have first established a government bond market before the corporate one. This incremental process means that each country should follow a strategy based on its current market development stage.

19

Ratna Sahay, Jerald Schiff, Cheng Hoon Lim, Chikahisa Sumi, and James P. Walsh. 2015. “The Future Of Asian Finance”.

International Monetary Fund Φ 20

Hannah Levinger and Chen Li, 2014. “What’s behind recent trends in Asian corporate bond markets?” 21

Cem Karacadag and others, 2003 , “Managing risk in financial market development: The role of sequencing”

0 10 20 30 40 50 60 70 80 90 100

China

Hong Kong China

India

Indonesia

Republic of Korea

Malaysia

Philippines

Singapore

Thailand

Top 10 Share of Total Corporate Bond Issuance, percentage, 2013

10

Figure 922

22

https://asianbondsonline.adb.org/

0

50

100

150

200

250

Size of Government and Local Corporate Bonds as percentage of GDP, 2014

Corporate Bond

Government Bond

Box 1. The Hierarchical Order of Financial Markets

Financial market development follows a sequencing approach. Typically, the money market (i.e. very short term debt securities usually issued by governments and financial institutions) precedes the other segments because of its central role in price discovery and interest setting. Money markets are the medium through which central banks intervene and where financial institutions manage their liquidity by lending and borrowing to and from each other. Money market and treasury bills and foreign exchange markets affect each other in terms of their liquidity and depth. In this respect, depth in money market and depth of treasury bills and foreign exchange markets are highly interdependent. For non-resident investors, the foreign exchange market is a must and can accelerate the deepening of government bond markets. A well-developed government bond market is also necessary as it works as a catalyst for establishing and improving an appropriate bond market infrastructure, and broadening and deepening the fixed income markets. In this way, liquid and deep government bond market yield curves serve as a price reference for corporate bonds. Finally, well-developed bond and equity markets, which underlie derivative instruments, are prerequisites for the development of derivative markets.

11

In particular, a developed government bond market is a prerequisite for corporate bond and equity markets. However, the government bond market in the region did not record significant growth between 2004 and 2014 in many countries in the region (Figure 10). This can be one of the reasons why corporate bond market development in Asia and the Pacific is not quite successful so far. Figure 1023

However, a government bond market sometimes does not lead automatically to the development of a corporate bond market. For example, although Japan has the largest government bond market in the region, reaching $8,292 billion as of 2014, its corporate bond market is very small relative to its government bond market, amounting to $680 billion (Figure 9). A reason for an underdeveloped corporate bond market can be the higher cost of issuing corporate bonds due to the higher volume of documentation required in comparison to bank lending. Regulators should investigate ways to lessen such costs without compromising the need of investors for transparency and security. Regardless of this reason, this example illustrates that a reliable benchmark yield curve provided by the government bond market is necessary but not enough to improve efficiency and transparency in the pricing of corporate bonds. On the other hand, it can be irrational to establish corporate bond or stock markets for some small countries because the low volume of transactions makes these markets unprofitable. Therefore, small economies in the region can create a trading link among themselves which connects their capital markets. This link makes it easy for investors to trade in other countries’ bond markets. However, before creating this trading link, small countries should harmonize their regulations, corporate governance and financial products for mutual recognition of their trading transactions. The ASEAN Trading Link launched in 2012 can be a good example for creating such links among small countries in the region. Furthermore, well developed corporate bond markets require well operated infrastructure, standardized credit rating systems, risk management products and a functioning legal and regulatory framework. In this respect, in 2002, the ASEAN+3 countries (includes China, Japan, and the Republic of Korea) launched the Asian Bond Market Initiative, which was aimed at strengthening the regulatory frameworks and necessary

23

https://asianbondsonline.adb.org/

0 50 100 150 200 250

Viet Nam

Singapore

Philippines

Thailand

Japan

Malaysia

Indonesia

Hong Kong China

Republic of Korea

China

The Size of Government Bond Market As Percentage of GDP

2004

2014

12

market infrastructures, as well as promoting the issuance of local currency bonds. In 2010, the Credit Guarantee and Investment Facility was established in collaboration with the Asian Development Bank to provide credit guarantees for investment-grade, local-currency bonds24. Hong Kong China and Malaysia also launched a pilot platform for cross-border clearing and settlement of debt securities in 2012, aimed at promoting standardization and dissemination of corporate announcements across Asian markets. Although these attempts to develop bond markets in the region are a positive development, such markets still have a very large room to develop in many Asian economies in which outstanding amounts of corporate bonds tend to be small relative to GDP levels.

iii. Bank Funding Asian banks focus on commercial lending. Banks’ contractually long-term funding in emerging markets in Asia amounts to only 4% of GDP, while it is about 10% in the United States and 27% in the Euro area25. However, credit growth has accelerated significantly in some developed and developing countries since 2008 compared with the period before the global financial crisis (Figure 11). In particular, China, Hong Kong China, Malaysia, Singapore, and Thailand have progressed to strong credit growth from moderate credit growth after the global financial crisis. In general, this strong credit growth reflects financial deepening. On average, a 10 percentage point increase in developing Asia’s average ratio of private credit to GDP is associated with higher growth in GDP per capita by about 0.3 percentage points per year26. However, subdued global growth and low interest rates are resulting in a more challenging operating environment for Asia Pacific banking systems. The prolonged period of easy monetary policies and low interest rates in advanced economies has spurred a search for yield which has led to a return to high leverage for firms and a surge of capital inflows into emerging markets. If the credit cycle turns, it can lead to higher corporate problem loans which can adversely affect the health of banking sectors and stock and bond markets in the region. While the share of debt owed to banks is highest in the Republic of Korea and China, high household debt levels are a concern for banks in Thailand, Malaysia and Hong Kong China27.

24

Ratna Sahay, Jerald Schiff, Cheng Hoon Lim, Chikahisa Sumi, and James P. Walsh. 2015. “The Future Of Asian Finance”. International Monetary Fund 25

International Monetary Fund, 2013. Global Financial Stability Report. 26

Asian Development Bank. 2015. Financing Asia`s Future Growth 27

https://www.moodys.com/research/Moodys-2016-Outlook-for-Asia-Pacific-Banks-stable-but-headwinds--PR_341160

13

Figure 1128

In this respect, the acceleration in credit growth for some countries in the region over the recent past could

pose asset quality issues in following years. For example, McKinsey analysis indicates banks in Asia need to

raise $400 billion to $600 billion in additional capital by 2020 to cover losses from non-performing loans

while maintaining capital adequacy ratios. Furthermore, the Basel Committee on Banking and Supervision

(BCBS) highlights that the credit to GDP gap, pointing to risks arising from strong credit growth, is a useful

early warning indicator of financial crises. This measure is expected to be between 2 and 10. BCBS also

states that two-thirds of all readings above the threshold of 10 were followed by serious banking strains in

the subsequent three years. As of September 2016, while this ratio was over 10 for Hong Kong China,

Singapore and Thailand, China had an extremely high credit-to GDP gap of 30.1. Despite the pressures on

asset quality, strong loss absorbing buffers and strong loss reserves make Asia-Pacific banks stable (Table

5). However, profitability is expected to weaken due to global slow growth and low interest rates, which

can result in weaker capitalization for the following years.

28

World Bank, 2016, Global Financial Database.

0 50 100 150 200 250

United States of America

Germany

Hong Kong China

Singapore

Japan

Republic of Korea

Australia

China

India

Indonesia

Thailand

Malaysia

Philippines

Ad

van

ced

Co

un

trie

sH

ub

sM

atu

reM

arke

tsG

row

ing

Gia

nts

Eme

rgin

g C

ou

ntr

ies

Private credit by deposit money banks to GDP (%), 2014

2008

2014

14

Table 5: Capital Buffers and Reserve Coverage of Problem Loans, 201429

Countries Capital

Adequacy Ratio Provisions to NPLs

Hong Kong China 16.8 85*

Singapore 16.4 34.8

Japan 15.2 24.4

Republic of Korea 18.2 30.1

Australia 11.8 26.4

China 12.2 282.7

India 12.5 48.7

Indonesia 18.7 50.8

Thailand 15.5 52.4

Malaysia 15.4 28.4

Philippines 16.1 73.5 Although some countries have large credit growth in the region, it is questionable whether less developed and some developing countries have sufficient credit to GDP ratios to fully satisfy the funding needs of the private sector. While the private credit to GDP ratio is over 100% in developed and some developing countries, it is about 50% for many of the developing and less developed countries30. This shows the great growth opportunities in the banking sector when this ratio is compared with developed countries. However, to deepen only banking sectors without strengthening capital markets or other financial institutions increases the risk of an overexposed banking system through maturity or currency mismatches. The Asian financial crisis clearly shows that heavy reliance on banking systems distorts structural resilience and system stability. Furthermore, firms do not have an opportunity to diversify their funding, which make them more vulnerable to financial shocks in banking dominant systems. In this respect, to raise the amount of credit extended to private sectors that are in need, countries can develop policies and regulations to establish financial institutions from outside the banking sector such as FinTech companies, like Alibaba, which are start-up technology companies offering financial products such as payment systems and lending platforms. The other concern is the government ownership of banks that is fairly common in Asia. Governments control about 23% of the aggregate assets of financial institutions, with 16% in commercial banks and 7% in policy banks31. The dominance of state banks is markedly higher in emerging Asia, especially China, India, Indonesia, and Malaysia, but such banks also have an important presence in the Republic of Korea, the Philippines, and Thailand. This situation leads to a close relationship between the banking system and the state that can negatively affect both financial sector supervision and development. Since the state plays both a direct and an indirect role in the allocation of credit, this adversely affects independent supervision and often results in concentration of exposure and an excessive reliance on rules-based approaches. Reducing the role of the state, particularly in countries in which public banks dominate the financial system, would facilitate the growth of more responsive and competitive financial systems32.

29

Capital Adequacy Ratio: It is a ratio of total regulatory capital to its assets held, weighted according to risk of those assets. Provisions to NPLS (Non Performing Loans): Nonperforming loans are loans for which the contractual payments are delinquent, usually defined as being overdue for more than a certain number of days (e.g., usually more than 90 days). Hong Kong`s NPLS value is for 2010 year. 30

World Bank, 2016, Global Financial Database 31

Asia-Pacific group consists of Australia, Hong Kong China, Japan, Republic of Korea, New Zealand, and Singapore for advanced Asia; and China, India, Indonesia, Malaysia, the Philippines, and Thailand for emerging Asia. 32

Ratna Sahay, Jerald Schiff, Cheng Hoon Lim, Chikahisa Sumi, and James P. Walsh. 2015. “The Future of Asian Finance”. International Monetary Fund.

15

2. Investment Structure

The presence of investment structures (domestic institutional investors and financial system deposits) in many countries is not sufficient to channel more funds to capital markets to meet the needs of companies and individuals. Furthermore, while advanced economies and, to some degree, financial hubs and mature markets have a diverse investment structure, growing giants and emerging markets have uniform structures, except Malaysia (Figure 11). This uniform structure makes these countries more vulnerable to external shocks and increases the cost of their financial instruments. More diverse structures provide greater opportunities for financial innovations to meet the requirements of different types of investors, thereby leading to higher market efficiency. In this respect, to lower the cost of financial instruments and market volatility, policymakers need to stimulate a diverse investor base that removes the threat of an issuer being held hostage by a particular group of investors.

Figure 1133

There is a high correlation between the size of the institutional investor base (mutual funds, insurance and pension funds) and the size of capital markets (equity and bond funding). This indicates the importance of developing a critical mass of long-term institutional investors to support financial deepening, including improved market efficiency and liquidity. These investors are therefore instrumental to the development of domestic bond and stock markets.

Domestic institutional investors also have liabilities in local currency, providing them with a natural currency hedge. This means that they are ready to provide long-term financing in local currency, which is critical to avoid currency mismatch34.

33

World Bank, 2016, Global Financial Database, BIS, IMF database and http://www.sifma.org/research/statistics.aspx . 34

Currency mismatch: Having assets that are denominated in a different currency than liabilities, so that a change in exchange rate between those currencies can have a large positive or negative effect on the balance sheet.

0 200 400 600 800 1000

United States of America

Germany

Hong Kong China

Singapore

Japan

Repuclic of Korea

Australia

China

India

Indonesia

Thailand

Malaysia

Philippines

Ad

van

ced

Eco

no

mie

sH

ub

sM

atu

re M

arke

tsG

row

ing

Gia

nts

Emer

gin

g C

ou

ntr

ies

Total Investment Structure as percentage of GDP, 2014

Financial System Deposit

Mutual Funds

Insurance

Pension Funds

16

Figure 12. Asia: Institutional Investors and Capital Markets, percentage of GDP, 201235

Unfortunately, the size of domestic institutional investors is relatively limited in the region despite the presence of sizeable social security and public pension schemes in some countries.36 For example, the OECD estimated that the largest Asian funded pensions systems are well below the OECD average of 84% of GDP, with developing Asia at less than 5%.37 Additional efforts should thus be made to support the emergence of a larger base of domestic investors. The rising urbanization trend and the growing middle class in the region have the potential to drive the demand for mutual fund, pension and insurance assets that would lead to increased size of these institutional investors in following years for the region38

.

i. Financial System Deposit Financial system deposits is the dominant source of funding in all countries in Asia, except Hong Kong

China, Singapore and Australia. This situation is consistent with the bank dominant funding structure of the

region. However, this leads to an underdeveloped local institutional investor base (mutual and pension

funds, insurance). Households in Asia hold a high percentage of what they do have in bank deposits: 49%

compared to 14% for North America, as of 2014 (Figure 13). Moreover, most people in emerging Asia still

depend on “traditional” retirement support – that is, their children – rather than institutionally funded

support from insurance companies or pension funds.

35

Heedon Kang, Phakawa, and Cheng Hoon Lim, 2014. “A Bird’s-Eye View of Finance in Asia” International Monetary Fund. IDN: Indonesia, NZL: New Zealand, CHN: China, IND: India, PHL: Philippines, THA: Thailand, SGP: Singapore, MYS: Malaysia, JPN: Japan, KOR: Republic of Korea, AUS: Australia. 36

Japan’s Government Pension Investment Fund (about $1.2 trillion), Republic of Korea’s National Pension Service ($400 billion), China’s National Social Security Fund ($200 billion), Singapore’s Central Provident Fund ($190 billion), Malaysia’s Employees Provident Fund ($180 billion), India’s Employee Provident Fund ($116 billion). OECD, 2014. Annual Survey of Large Pension Funds and Public Pension Reserve Funds. 37

OECD, 2014. Pension Markets in Focus. 38

Over the next 30 years, it is estimated that over 1.8 billion people will move into cities and Asia-Pacific will contribute almost half of this urban shift. Price Waterhouse Coopers, 2015. Asian Passports, the coming of age An overview and its demand.

0

50

100

150

200

250

300

350

0 50 100 150 200

Size

of

cap

ital

mar

kets

Size of institutional base

Size of capital markets versus Sizeof Institutional base

JPN

MYS

SGP

KOR

AUS

THA

PHL

IND

CHN

NZL IDN

17

Figure 1339

Asian banks are funded primarily by retail deposits rather than wholesale funding. The large pool of retail

deposits helped Asian banks weather liquidity shortages during the global financial crisis. It also plays an

important role in putting Asian banks in a favorable position to meet the Basel III liquidity requirements,

compared with peers in Europe and North America40.

In some Asian economies, credit-to-deposit ratios41 were under 100% at end-2014 (Table 6). The exceptions

were Republic of Korea, China and New Zealand. Particularly, in the Republic of Korea and New Zealand,

banking sectors saw a marked increase in net foreign liabilities during 2001−0842. As a result, they

introduced macroprudential measures, including the macroprudential stability levy (Republic of Korea,

August 2011) and the Core Funding Ratio (New Zealand, April 2010), to discourage excess reliance on

international wholesale funding and thus contain systemic liquidity risk. However, although retail deposits

are seen as a superior and reliable source of funding because they are behaviorally long-dated, the reliance

on contractually short-term current account/saving account deposits can limit banks’ ability to provide

long-term funding to the real economy because deposit maturities shorten dramatically during crises43.

Institutional investor bases therefore should be diversified to provide alternative funding sources to banks

besides deposits.

In this respect, although the dominance of financial system deposits is one of the important barriers in the

development of institutional investor bases, policy makers should consider the importance of retail

deposits for banks in countries with less developed capital markets when they create strategies for

diversifying investment structures of their countries.

39

Allianz, 2015. “Allianz Global Wealth Report” 40

Ötker-Robe and Pazarbasioglu, 2010. “Impact of Regulatory Reforms on Large and Complex Financial Institutions”. 41

Credit deposit ratio is one of the tools to determine whether banks use additional sources beyond deposits to fund their credits 42

Ratna Sahay, Jerald Schiff, Cheng Hoon Lim, Chikahisa Sumi, and James P. Walsh, 2015. “The Future of Asian Finance”. International Monetary Fund 43

Andrew Sheng, Chow Soon Ng and Christian Edelmann, 2013. “Asia Finance 2020. Framing A New Asian Financial Architecture”

49

22

53

14 30

35

45

18

52 27

15

30 26 32 40

1 2 3 2 3

0

20

40

60

80

100

120

Asia-ex Japan Latin America Japan North America Wester Europe

Asset classes as % of gross financial assets, 2014

Other

Insurance and pensions

Securities

Bank Deposit

18

Table 6. Credit to Deposit Ratio, 2014 (percentage)44

Countries

Hong Kong China 66.13

Myanmar 49.22

Micronesia, Fed. Sts. 38.19

Japan 47.8

Philippines 59.77

Maldives 65.55

Macao China 65.5

India 77.49

Brunei Darussalam 52.74

Pakistan 49.9

Timor Leste 33.62

Sri Lanka 78.95

China 299.79

New Zealand 159.31

Republic of Korea 108.61

ii. Mutual Funds Mutual funds bring additional liquidity to local markets by easily trading their securities in response to

changes in market conditions. In this way, households can hold local currency bonds in more liquid and

easily tradable units through mutual funds. However, the concentration of the investor base in many

countries has resulted in a sizable portion of local currency bonds being held in “buy-and-hold” portfolios.

This, in turn, has had an adverse effect on market liquidity, constraining trading by the market’s largest

investors. For this reason, mutual funds are particularly important in those markets that would otherwise

be dominated by local buy-and-hold investors45.

Although over the past two decades the global mutual fund industry has blossomed in the world, the

growth rate of mutual funds in region has been lower than other regions (Figure 14). Mutual fund assets

rose from $4.0 trillion in 1993 to $28.9 trillion in 2013:Q3 in the world. In this period, the European and

United States mutual funds rose 620% to almost $9.0 trillion and nearly 600% to $14.3 trillion, respectively,

whereas mutual fund assets in the Asia-Pacific region expanded only 463% to $3.3 trillion.46

Hong Kong China and Singapore lead this industry in the region because of their roles as regional financial

hubs, with more than 50% of their assets derived from foreign capital inflows. The other economy with

rapid growth in mutual funds is Malaysia. However, mutual funds are comparatively underdeveloped in

other mature and emerging markets.

44

World Bank, 2016, Global Financial Database. 45

Philip Turner, 2009. “Weathering financial crisis: domestic bond markets in EMEs”. 46

ICI, 2014. “ICI Global Research Perspective”.

19

Figure 14. Growth of mutual fund assets, 2011 to 201347

Growth in the mutual fund industry throughout Asia has been largely dependent on domestic factors, including rising incomes and the broadening of the domestic investor base48. The other important barriers that the mutual fund industry faces can be summarized as follows:

a) Lack of strong and appropriate regulation of funds and financial markets b) The scarcity of large common markets where mutual funds can be traded c) Volatile returns on stocks and bonds markets in the region d) Weak investor education and safeguards. e) The nonexistence of a defined contribution plan system in some countries that allows participant-

directed investments, including in mutual funds. As a result, the mutual fund industry is still blocked by an embryonic investment culture in emerging Asia, the regulatory structure, a lack of independent pricing and valuation, and weak investor education and

iii. Insurance and Pension Fund Insurance companies and pension funds are a major source of long-term risk capital for companies and infrastructure projects. They provide liquidity to secondary markets, and facilitate the formation of spot prices in the capital markets. They have longer-term liabilities and greater diversification of assets than banks. Their interconnection with the rest of the financial system is also less than banks, which decreases the contagion effect of financial crises. The size of pension and insurance assets in Asia is lagging other regions. While insurance and pension assets are about 2.5 times the size of bank assets in the United States, they account for only 43% of bank assets in Asia in 201449. Furthermore, total insurance and pension fund penetration, measured by assets under management as a percentage of GDP, is less than 20% for most emerging Asian countries. By contrast, they are 64% in the Euro area, 130% in Australia and 152% in the United States, as of end of

47

Compounded annual growth rate 48

Ratna Sahay, Jerald Schiff, Cheng Hoon Lim, Chikahisa Sumi, and James P. Walsh. 2015. “The Future of Asian Finance”. International Monetary Fund. 49

Asia is represented by Hong Kong China, Singapore, Japan, Republic of Korea, Thailand, India, China, Indonesia, Malaysia, Philippines and Australia

$0.00 $5.00 $10.00 $15.00 $20.00

United States

Eurpoe

Asia-Pacific

Other Americas

Three year growth of mutual fund assets (3Q11-3Q13)

2013

2010

11.2%

4.4%

4.5%

8.2%

20

2012.50 These funds often exhibit significant home bias in Asia, with many investing more than 80% of their assets in domestic markets. However, this home bias is not evident in Hong Kong China and Singapore.51

Challenges to Insurance Growth While insurance companies are more prominent in mature economies, their size is relatively small in growing giants and emerging countries (Figure 11). However, although the size of the insurance sector is relatively small in Asia when compared with banking sector, Asia is the driver of world growth in insurance. Between 2009 and 2014, the global life insurance market rose from $698 billion to $891 billion, and 54% of this growth came from Asia. Strong demand largely stemmed from emerging markets, such as China and India. Also, nonlife insurance, especially auto insurance, continues to expand significantly since 2010. The global market for auto insurance rose to $33 billion in 2013. While emerging markets captured 64% of this growth, 38% came from emerging Asian markets. In emerging markets, growth was driven by a continuing surge in car ownership. This pattern is expected to continue while China`s economy shifts to a consumer base economy from an investment base economy, which leads to increased car sales. Credit ratings agency Moody’s expects that nonlife insurance will grow by more than 5% in developing countries in coming years, which is the highest expected growth rate in the world. In this respect, insurance firms can develop new strategies to expand their non-life operations in developing countries by using technology to reach customers in emerging markets in the region52. However, the low interest rates and adaptation of new technology are two areas that pose big challenges to the high growth of the sector in the region. The prolonged period of easy monetary policies and low interest rates in advanced economies have caused insurance firms to widen their search for additional sources of yield and returns. This is because most of the savings products which constitute most of such firms’ investment portfolios are linked to interest rates. Lower interest rates therefore make insurance products less attractive to either customers or shareholders. In this respect, some large insurers have tried to access Asian emerging markets which have high growth and interest rates compared to advanced countries. However, there are not many diverse assets to invest in in developing Asian markets because of the lack of developed capital markets. Many large insurance firms from other regions therefore have ended their operations in these markets, such as Axa, Prudential and Manulife which had heavily invested in Asia. In low interest and growth rate environments, insurers should take on significantly more risk compared to the past while they broaden their search for additional sources of yield. In this respect, they should look for alternative assets other than sovereign assets which are invested traditionally and have no capital charge but offer low yield. For example, alternative assets to sovereign assets can be infrastructure financial instruments that combine relatively attractive returns with low capital charges. However, growing competition may also lead to increasing cost of these instruments. Another alternative asset could be private equity. Since the banks have short-term liabilities they could not invest in private equity, which involves tying their cash for many years. In this investment area, insurers have more competitive advantage than other financial institutions with short term liabilities. Such an investment shift can support the development of private equity market in the region. While insurers struggle with low interest rates, many of the latest technological developments are beginning to threaten them. In the short term, start ups that focus on peer-peer insurers or robo-adviser and telematics specialists used in insurance industry can compete with insurers for the market, which can lead insurers to lose their current customers. To tap new sales and service channels, insurers should also

50

Andrew Sheng, Chow Soon Ng and Christian Edelmann, 2013. “Asia Finance 2020. Framing A New Asian Financial Architecture”. 51

Ratna Sahay, Jerald Schiff, Cheng Hoon Lim, Chikahisa Sumi, and James P. Walsh. 2015. “The Future of Asian Finance”. International Monetary Fund 52

Financial Times, 28 June 2016. “Special Report: The Future of Insurance”.

21

extend their digital presence and move from the traditional agency–based style of distribution to a more complex model, involving direct and telemarketing and the use of the internet. Further, in the low interest rate environment, insurance firms should explore how data analytics and technology can enable to correctly price products and mitigate risk in real time, given the region inherent risks. In this respect, it can be better strategy for insurance companies to form strategic partnership with start ups to expand in markets. For example, Alibaba Health will begin to sale CPIC Allianz’s health insurance products through the internet. 53

Challenges to Pension Funds Growth While the share of pension funds is relatively more prominent in the share of investment structure in Australia and Malaysia, their share is comparatively small in other countries (Figure 11). There are three important reasons why share of pension assets are relatively small in the share of investment structure of the countries. The first reason is the low coverage of formal pension systems. The second one is the very common practice of withdrawing of savings before retirement. The last one is the rigid regulations that dictate pension funds` asset allocation. The gap of coverage of formal pension systems between developed and developing countries is huge in the region (Table 7). While it ranges from 69.7% in Australia to only 6.4% in India, for the population aged 15 to 64, it ranges from 90.7% in Australia to 10.3% in India. This gap arises from the diverse structure of economies in the region. Small-scale agriculture with large rural populations which have high degrees of absolute poverty makes it more difficult to cover the labour force or population with formal social security systems. Furthermore, the network of family support in the region still substitutes the role of formal pension systems. Low coverage of formal pension systems, as networks of family support weaken, may lead to growing levels of old-age poverty.

Table 7-Membership of mandatory pension schemes by population and labour force54

Country Year Members Percentage of population

aged 15 to 65

Percentage of

labour force

Advanced Economies

Germany 2005 36,156,000 65.6% 86.9%

United Kingdom 2005 28,402,200 71.5% 93.2%

Financial Hubs

Singapore 2012 1,790,000 64.0% 84.0%

Hong Kong, China 2009 2,921,815 55.4% 78.9%

Mature Markets

Australia 2005 9,578,000 69.7% 90.7%

Growing Giants

China 2010 268,200,000 27.7% 33.5%

India 2006 44,404,000 6.4% 10.3%

Emerging Markets

Indonesia 2010 12,979,473 8.0% 11.0%

Malaysia 2010 6,400,000 28.1% 53.5%

Thailand 2009 8,537,000 17.7% 22.5%

Philippines 2011 10,163,000 17.5% 26.3%

53

Ernst and Young, 2016.”EY Asia-Pacific insurance outlook”. 54

OECD. 2013. “Pensions at a glance Asia/Pacific”.

22

Another concern is that people can withdraw benefits early, leaving little money for retirement. Although, workers receive their benefits in the form of “annuities55” in most of the countries in the world, the pension schemes of many Asian economies do not provide regular payments. For example, while the pensions are paid as a lump sum at the time of retirement in Malaysia, they are paid as a mix of a single lump sum or an annual payment over five years in Indonesia. Workers in Hong Kong China also have a lump-sum option56. Moreover, many less developed countries in the region do not have a welfare system that meets important needs, such as a sudden medical emergency. This condition gives an incentive to older people to withdraw their benefits early. Some people also want to bequeath money to their families. But in an annuity system, benefits are ended when people die. This is another incentive for people not to convert their lump sum benefits into annuities.

Another hurdle is the dictation of rigid criteria by regulation of pension funds’ asset allocations that leads to concentration in government securities in their asset allocation. The resulting concentration of exposures in a particular segment of the market has had a negative effect on market liquidity. For example, investment restrictions on Indian pension funds that are captive sources of finance for government securities have held back participation of these funds in the corporate bond market. In contrast, pension funds in Malaysia is a good example where actively managed publicly mandated or related funs provide an important source of retirement savings and liquidity to debt markets. In Thailand, contractual savings institutions have also become the dominant investors in local currency bonds57. In this respect, it ways should be explored to gradually ease restrictions on pension funds by balancing the risk posed by pension funds’ asset allocations.

iv. Key impediments facing foreign investors As mentioned above, the gap between demand of fund (bank, corporate bond and equity funding) and

supply of fund (financial system deposits, mutual funds, insurance and pension funds) implies that some

countries depend on foreign investment to finance their local funding needs (Figure 3). This makes foreign

participation in Asia’s capital markets more important. However, as of end-2012, foreign participation was

less than 25% in most Asian markets, except Australia, Indonesia, and New Zealand. Foreign participation

was much higher in advanced Europe and North America58. Opening domestic capital markets to foreign

investors and removing restrictions on outward financial investments by domestic residents lead to greater

risk diversification and increased competition and liquidity in the domestic market, thereby supporting

economic development. At the same time, however, greater international financial openness may make the

economy vulnerable to volatile international capital flows that may threaten domestic financial stability. It

is therefore important that policymakers should also consider financial stability issues when they open their

capital market to foreign investors.

In this context, the key impediments facing foreign investors in the region are summarized as poor legal

and regulatory system and market infrastructure, capital controls, taxation and availability of foreign

exchange hedging instruments.

55

Regular payments until the death of individual members or of their survivors. 56

OECD, 2013. “Pensions at a Glance Asia/Pacific”. 57

Ratna Sahay, Jerald Schiff, Cheng Hoon Lim, Chikahisa Sumi, and James P. Walsh. 2015. “The Future Of Asian Finance”. International Monetary Fund 58

Ibid

23

Legal and Regulatory Systems Legal and regulatory systems are essential for expanding the foreign institutional base. These have two key roles. First, they should reflect the need to protect the rights to investments in countries. Second, they would allow an investor to more accurately predict cash flows from a project, which is a key step in any valuation. Investors need to be able to rely on a destination country’s adherence to the rule of law in the jurisdiction. Its track record of treating foreign investors is important. For example, ownership positions in investments must be legally protected. Furthermore, there must also be an ability to have the terms of contracts enforced. The rule of law in the region is a mixed picture (Table 8). While there are only 2 countries in the first ten of global ranking among 113 countries, there are four countries in the last ten.

Table 8

Country Score Global Ranking

Denmark 0.89 1

New Zealand 0.83 8

Singapore 0.82 9

Australia 0.81 11

Japan 0.78 15

Rep of Korea 0.73 19

Georgia 0.65 34

Malaysia 0.54 56

Nepal 0.52 63

Philippines 0.51 70

China 0.48 80

Myanmar 0.43 98

Bangladesh 0.41 103

Pakistan 0.38 106

Afghanistan 0.35 111

Cambodia 0.33 112

Another concern for foreign institutional investors is the uncertainty of what might constitute the regulatory framework in the future. Since consistent application of a regulatory framework provides more certainty in forecasting cash flows, which reduces the return required to compensate for risk, governments should reduce regulatory uncertainty which adversely affects long term investment. In this respect, they can establish protocols assuring investors that rules affecting such projects will not be arbitrarily changed following a change in government. For instance, corporate-debt default in China in 2014 shows that the default could be resolved more predictably via bankruptcy proceedings rather than be treated as idiosyncratic events to be dealt with through a sharing of losses among stakeholders largely independent of their position in the capital structure of the borrower.59 The presence of inflation also makes it more difficult to accurately forecast cash flows in a long term investment, thus controlling inflation enhances the security of real returns. Inflation was between –1% and 3% as of 2015 in the major economies in the region, except in India and Indonesia, because of the downward pressures from lower global food and fuel prices60. A greater number of inflation indexed bonds

59

ibid 60

IMF. 2016. “Regional Economic Outlook: Asia and Pacific”.

24

signals to investors that government commits to controlling inflation. For example, The Reserve Bank of India allowed inflation indexed bonds in 2013 and 2014, a financial instrument which can act as a hedge against inflation61. In this way, foreign investors had an opportunity to maintain their investment value against inflation.

Market Infrastructure

The existence of key market infrastructure for securities, including payment systems, cross-border clearing and settlement systems, central securities depositories and custodians are needed to attract foreign investors in local markets. For example, most of the local central securities do not have links with international central securities, except Malaysia and Singapore. Furthermore, currently, there are no cross-border infrastructure linkages for trading, clearing, custody, or settlement across countries in the region. On the other hand, since most foreign exchange deals in the region are transacted against the United States dollar, a key problem for foreign investors is the timing difference between the securities and cash movements which settle after Asian business hours. Thus, there would likely be a major benefit for Asia and the Pacific countries from a cross-country clearing and settlement arrangement. However, this is an area of challenge for most of the emerging markets. In this respect, strengthening the financial ties with the regional and global financial markets could help diversify the sources of financing by attracting foreign institutional investors and reducing the cost of funding in emerging Asia.

Capital Controls

Market access has eased for foreign investors through progressive capital account liberalization. Despite some capital account liberalization measures, there are limits placed on nonresidents to hold and trade domestic securities in countries such as China, India and Thailand. Furthermore, most of the countries, except Hong Kong China, Japan, Singapore and Republic of Korea, have foreign exchange restrictions, which adversely affect the decision of foreign institutional investors.

While foreign-exchange-related restrictions help mitigate vulnerabilities from short term foreign borrowings, it should also be recognized that such restriction policies also entail costs, mainly arising from low level amount of investments by nonresident institutional investors and higher intermediation charges and their effect on long-term output. In this respect, countries in the region should follow an approach which balances the negative and positive effects of such restriction policies on investments and stability.

Taxation

Governments consider the use of tax incentives to lure foreign institutional investors. But it is important to determine the optimal point of the tax treatment on foreign income, one which does not adversely affect the decision of investors and the tax revenue of the countries. In Asia and the Pacific, with the exception of Malaysia and Singapore, most Asian emerging markets impose withholding taxes on interest earned from local bonds by foreign investors. India also levies taxes on capital gains of nonresidents. These tax applications are one of the important reasons for the existence of shallow local corporate bond markets in the region.

Foreign exchange hedging instruments

While international allocations are growing among institutional investors, the need to remove currency exposure via hedges through derivative instruments is getting more important for institutional investors. Generally, interest swaps and currency swaps are used by foreign institutional investors. However, the value of the derivatives market is significantly smaller when compared to other global markets. The United States and Asia derivative markets constituted 35% and 15% of the total market, whereas European and other derivative markets accounted for 50% as of 2012. Since the corporate bond market which is less prone to currency and maturity mismatches and less vulnerable to volatile capital flows is underdeveloped

61

http://capitalmind.in/2013/05/inflation-indexed-bonds-in-india/

25

in most of the Asian countries, most of the investment projects are being funded through short-term, foreign-currency borrowing by banks.

To overcome the effect of shallow derivative markets on nonresident institutional investors, some special programs can be developed that provide some advantages to these investors in managing their currency risk. For example, the Reserve Bank of India established a program in 2014 to help nonresident institutional investors in Indian debt instruments to hedge coupon receipts against currency risks62. In this respect, the RBI has proposed working with the Securities and Exchange Board of India (SEBI) to allow nonresident institutional investors to hedge currency risk with exchange-traded currency futures63.

Foreign institutional investors can also utilize a special purpose fund that provides OTC derivatives to hedge the currency and interest rate mismatch that is created in cross-border investments between international investors and local borrowers in frontier and less liquid emerging markets. For example, the Currency Exchange Fund (TCX) provides this service covering 70 currencies in Sub-Saharan Africa, Eastern Europe, the Middle East & North Africa, Central Asia, South East Asia, and Latin America64. Since TCX does not cover all currencies in the region, the service is not sufficient to meet the demands of nonresident institutional investors related to hedging currency risk.

In this respect, countries lacking derivative markets should develop their derivative markets for institutional investors to hedge their currency risks for their long term investments. However, the following factors have hindered the development of comprehensive derivatives markets in the region65:

• Deficiencies in prudential regulation and supervisory oversight (for example, capital rules, disclosure requirements, and accounting rules)

Operational infrastructure (for example, market trading, clearing, and settlement systems; and sound risk management)

• Limited market participation by domestic and foreign institutional investors, as well as banks

SECTION 2 - MEASURING MULTIFACETED FINANCIAL DEVELOPMENT In the previous section, funding (bank, equity and bond funding) and investment structure (financial deposits, mutual, insurance and pension funds) of the region was analysed and some policy actions were recommended on how to deepen and broaden these structures. However, Asia has a diverse set of financial systems that vary not only in depth (size and liquidity of markets) but also in access (ability of individuals and companies to access financial services) and efficiency (ability of financial institutions to provide financial services at low cost and with sustainable revenues, and at the level of activity of capital markets). Therefore, looking only at only depth of the financial system would not offer a comprehensive understanding of the level of financial development. Furthermore, without making trend analyses which is a powerful tool used for creating detailed pictures of what the future might look like, it is impossible to understand the current and future situation of the Asian financial system. A financial development index can address these two issues. But the main question is how to measure financial development to identify weaknesses and strengths of financial institutions and markets. There are two different studies in the existing literature for the measurement of financial development. The first group of research measures financial development by considering the observed outcomes of

62

http://www.investopedia.com/ask/answers/061015/how-does-foreign-institutional-investor-fii-manage-currency-risk-when-investing-abroad.asp 63

Currency futures specifies the price at which a currency can be bought or sold at a future date. 64

https://www.tcxfund.com/about-tcx 65

Hannah Levinger and Chen Li , 2014. “What’s behind recent trends in Asian corporate bond markets?”

26

financial development. These studies cover efficiency, access and depth of financial systems as a measure of financial development. The second group measures financial development on the basis of the characteristics of institutional business and political environment. It considers proxies of a country's legal, business, and political conditions as well as the stability of financial systems. However, measuring financial development by using the second group’s approach is very difficult because of the lack of a sufficient time variant data set. Thus, here a financial development index is created to help paint a more comprehensive measure of financial development by using the first group approach (Box 2).

1. A Snapshot Comparison across Peer Groups In particular, the “gap” in financial development among developed, developing and countries in special needs (CSNs)66 differs across the various dimensions of financial development highlighted in Figure 15. However, the most prominent gap is between FI and FM in the region. While FM of CSNs is around 0.01, it is around 0.58 and 0.27 for developed and developing countries, respectively. Further, banks having the largest weight in FID suggests the dominance of the banking sector in the region (see appendix 1 for ratio weights). This makes CSNs and to some degree developing countries more susceptible to financial crises. This is because if banking sectors have any trouble, it adversely affects companies because of the lack of alternative funding sources, such as stock and bond markets, that can channel savings to the real sector. The larger gap in FID and FMD between CSNs and other developed and developing countries also suggest that financial institutions and markets in CSNs do not fully satisfy the funding needs of the private sector. The credit to deposit ratio of some of these countries also support this argument. There can be two important reasons that prevent financial institutions to extend credit in these countries. First is the lack of appropriate finance infrastructure that prevents banks from lending money to customers who are unknown

66

Developed, developing and CSNs countries are classified in accordance with UNESCAP`s classification.

Box: 2 Measuring Financial Development The financial development index combines sub indices on financial institutions and markets along the dimensions of financial depth, access, and efficiency. The list of indicators below highlights which dimensions of development and inclusion enter into the index. Financial Institutions Index (FI)

Depth (FID): Private sector credit to GDP, pension fund assets to GDP, mutual fund assets to GDP, and life and non-life insurance premiums to GDP.

Access (FIA): Commercial bank branches per 100,000 adults, and ATMs per 100,000 adults.

Efficiency (FIE): Net interest margin, lending-deposit spread, non-interest income to total income, overhead costs to total assets, return on assets, and return on equity.

Financial markets Index (FM)

Depth (FMD): In percent of GDP: Stock market capitalization, stock market turnover, international debt securities outstanding, and corporate bond issuance.

Access (FMA): Percent of stock market capitalization outside of top 10 largest companies, Value traded excluding top 10 traded companies to total value traded, Number of listed companies per 1.000.000 people

Efficiency (FME): Stock market turnover ratio (stock market turnover/capitalization). The underlying series and sub indices are combined in a linear manner, with weights being determined by PCA with Gaussian mixture methodology. (For more information see Appendix 1)

27

by banks, such as lack of credit bureaus. Second, is the effect of having rigid regulations that lead to regulation arbitrage. Regulation arbitrage occurs when foreign and local banks move to another country with relatively soft regulation.

Figure 15. Financial Development Index: Peer Group Averages, 2014

Although it is widely known that increasing financial access deepens markets, this does not work for CSNs. For example, while FIA was significantly increasing between 2006 and 2013 for CSNs, its effects on FID is very small (Box 3). It can therefore be better that countries whose financial inclusion strategies are mainly based on increasing the number of bank branches and ATMs to shift this strategy to a new financial inclusion strategy positively affecting FID, such as increasing SMEs access to finance through mobile banking. A similar situation is also valid for the relationship between FMD and FMA for developed and developing countries (Box 3). The reason for this can be the low liquidity of the stock markets, which resulted from buy-and-hold investors. In this respect, to increase the effect of FMA on FMD, policy makers should create strategies leading to increased institutional investors` access, particularly mutual funds` access, to capital markets, which bring additional liquidity to local markets by easily trading their securities in response to changes in market conditions. Moreover, while FIE plays a dominant role in creation of FI, FME captures a small share in the construction of FM. A bank centric system leads to increased FIE due to lack of rival financial markets. However, this system without appropriate competition laws can bring about a rise in the cost of credit adversely affecting the development of countries. For example, although credit-to-deposit ratios were under 100% in some Asian economies at the end of 2014 (Table 6), banks` efficiency ratios performed very well. Moreover, bank interest margin has a weight of 0.21 within the efficiency subcomponent of FI, which comes in second among 6 ratios (see appendix 1). These imply that banks sold credit to the private sector more expensively than it should be. On the other hand, many capital markets in the region have low volume of transactions that makes these markets inefficient. Therefore the best policy option to increase efficiency of financial markets is to create a trading link within the region, which connects the capital markets of economies. As mentioned in Section I, creating this trading link requires countries to harmonize their regulations, corporate governance and financial products for mutual recognition of their trading transactions. ASEAN Trading Link can be the first step to create this link for the whole region.

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

FID FIA FIE FI FMD FMA FME FM FD (Overall)

Developed

Developing

CSN

28

There is not much variation in financial development across the income group (Figure 16). However, countries have different sub indices that show their strengths and weaknesses in their financial development. For example, although Hong Kong China has a high FID and FMD, its FIA is relatively low compared to its other sub indices. In the same way, while Samoa has a high level FIE, its other sub indices are relatively too low compared to other countries` sub indices.

Box 3. The progress of Financial Access and Depth In FI And FM over time

0

0.05

0.1

0.15

0.2

0.25

0.3

2004 2006 2008 2010 2012 2014

FID And FIA Thorough Time-CSN Countries

FID

FIA

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

FMD And FMA Through Time-Developing Countries

FMD

FMA

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

FMD And FMA Through Time-Developed Countries

FMD

FMA

29

Figure 16. FD index: Selected Countries-201467

2. Trend of Financial Development Index Financial development has progressed quite noticeably in developed countries, but to a lesser extent in both developing and CSN. The gap between developed and other groups widened significantly between 1980s and 1990s, reflecting the Japanese asset bubble price between 1986 to 1991.

Figure 17. Financial Development over Time

67

See Appendix 3 for all countries` FD.

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9

Japan

Avustralia

New Zealand

Hong Kong China

Singapore

Republic of Korea

China

India

Indonesia

Thailand

Malaysia

Phillippines

Bangladesh

Nepal

Mongolia

Fiji

Samoa

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Developed

Developing

CSN

30

Developed Countries Real estate and stock markets were greatly inflated in Japan between 1986 and 1991. FD of Japan rose from 0.56 to 0.65 in this period. Especially in this period, banks aggressively extended loans to small and medium-sized enterprises against real estate collateral as well as real estate related loans at low interest rates. Consistent with this situation, FID and FMD significantly rose. Then, a sharp decrease was seen in FMD between 1990 and 1991, which reflects that stock markets correctly priced the consequences of this asset bubble. FMA and FME were also adversely affected at the end of this crisis between 1989 and 1991. However, it is seen that FIE maintain its trend throughout this period. This suggests that banks managed this crisis well in terms of efficiency by increasing their interest margins or return on assets. The second jump for developed countries took place between 2003 and 2007. This increase mostly stemmed from financial markets (stock and bond markets) reflecting the positive effects of excess liquidity in the world. In this period, FID rose very smoothly implying that banks were more prudent than financial market investors. Although FID fell in 2007, it began to rise after 2008. However, the adverse effects of global financial crisis clearly showed in FMD and FME in 2007 and 2008 respectively. FMD had not still reached its 2007 level by 2014. In sum, the effect of the global financial crisis on financial markets is more than the effect on financial institutions. On the other hand, the large gap between FID and FMD implies the dominance of financial institutions, especially of banks, over financial markets in developed countries.

31

Figure 18. Developed Countries Sub-indices

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

19

86

19

88

19

90

19

92

19

94

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

FID

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0.5

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

FMD

0.76

0.78

0.8

0.82

0.84

0.86

0.88

FIA

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

FMA

0

0.2

0.4

0.6

0.8

1

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

FIE

0

0.05

0.1

0.15

0.2

0.25

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

FME

32

Developing Countries The most prominent jump for developing countries realized between 1992 and 1994. In some degree, Asian crisis can be reason for this trend. Before the Asian Crisis happened in between 1997 and 1998, large quantities of credit stemming from hot money policy led to push up asset prices to an unsustainable level between about 1992 and 1997. These asset prices eventually began to slump, causing individuals and companies to default on debt obligations which adversely affect the financial tables of financial institutions. These effects are clearly seen on FID of these countries that significantly rose from 1992 to 1997. Further, in consistent with the increase of FID, FIE also increased through this period. After 1997, the growth of FID slightly declined reflecting deleverage the banking system in effected countries. However, FIE continued to increase until 2000, then became stable. However, although the growth of FMA became stable after this period, FMD continued to increase until 2007. This means that capital markets did not clearly show the adverse effects of this crisis. But on the other hand, the growth of FMD in these countries that were the most adversely affected by this crisis decreased sharply through this period. For example, the trend of FMD`s of Indonesia and Malaysia is consistent with the adverse effects of Asian crisis (Figure 19). This implies that the impacts of crisis on capital markets are different across developing countries through this period. This situation therefore prevent us to clearly see the adverse effect of this crisis on these markets through these indices. Figure 19

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

FMD

Indonesia

Malaysia

33

Figure 20. Developing Countries Sub-indices

On the other hand, sub-indices show that the 2007-2009 global financial crisis did not greatly affect the financial institutions and markets of these countries. The less complex financial sectors in these countries can be the number one reason for this limited effect. Finally, the size of FME is relatively very low compared to other sub-indices. This implies the illiquid and volatile markets that prevent the development of secondary markets and high levels of corporate listings also causes unfavorable conditions or the lack of depth in corporate bond markets.

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

FID

0

0.05

0.1

0.15

0.2

0.25

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

FMD

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

FIA

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

FMA

0

0.2

0.4

0.6

0.8

FIE

0

0.05

0.1

0.15

0.2

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

FME

34

Countries with Special Needs All sub-indices of CSNs are relatively too low (except FIE index) to correctly reflect financial and economic events due to their feature of illiquid markets. This suggests that financial markets and institutions in these countries are far from meeting the financial needs of private sectors. Although the size of FIE index is comparable to that of developing and developed countries, this can lead to a rise in the cost of credit without appropriate competition laws, which adversely affects the development of these countries.

Figure 21. CSNs Sub-indices

On the other hand, although the growth rate of FMD was significant between 2005 and 2008, it turned negative after this year. Sharp decrease of FMD after 2008 suggests that the global financial crisis in 2007 adversely affected the growth of financial markets in CSNs. There may be many reasons for this sharp decline, which should be researched. Furthermore, the existence of negative correlation between FMA and

0

0.02

0.04

0.06

0.08

0.1

0.12

19

81

19

84

19

87

19

90

19

93

19

96

19

99

20

02

20

05

20

08

20

11

20

14

FID

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

0.04

FMD

0

0.05

0.1

0.15

0.2

0.25

0.3

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

FIA

0

0.002

0.004

0.006

0.008

0.01

FMA

0

0.2

0.4

0.6

0.8

19

86

19

89

19

92

19

95

19

98

20

01

20

04

20

07

20

10

20

13

FIE

0

0.01

0.02

0.03

0.04

0.05

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

FME

35

FMD after 2012 implies that while big players (investors) existed from the financial markets (stock and bond markets), small players entered the markets.

SECTION 3 - FINANCIAL DEVELOPMENT AND GROWTH Financial institutions and markets influence saving and investment decisions and hence economic growth through several channels that are important for Asia and the Pacific. First, they mobilize savings from domestic and foreign sources for investment purposes, channel these resources into most productive activities, and increase total factor productivity. Second, they ease the trading of goods and services. Third, they enhance risk management by providing different alternative financial sources leading to diversification of risks. Fourth, they facilitate information production about enterprises and possible investment projects and enhance corporate governance, thus allocating capital to productive uses. Furthermore, developed financial systems can strengthen the transmission mechanism of monetary and fiscal policies, through more information sharing and diversification of instruments. Although recent studies68 suggest that financial development increases growth, its effects weaken at higher levels of financial development, and eventually become negative, which is called the “too much finance” effect. One argument is that too much finance increases the frequency of expansion and contraction, adversely affecting macroeconomic stability of countries leading to lower real GDP growth. Another argument is that too much finance leads to a diversion of talent and human capital away from productive sectors and towards the financial sector. Some have also argued that a very large financial sector may be subject to moral hazard or rent extraction from other sectors, both of which would lead to a misallocation of resources69. Furthermore, the recent financial crisis also raised concerns that the role of the financial sector was too large compared to the size of the domestic economy, bringing about the global financial crisis. For example, over the last three decades the United States financial sector grew six times faster than nominal GDP. However, “too much finance” effects are not relevant for Asia and the Pacific, as all countries in the region are well below the threshold for exhibiting adverse growth effects. Figure 22 illustrates the case of a set of countries at different stages of financial development on the estimated curve (see appendix 2 for more information on econometric model). It is worth emphasizing, however, that there is a wide band around the “turning point,” reflecting variation in countries’ fundamentals and institutional settings. Figure 18 shows that countries with the highest financial development index are close to the negative growth effect of being financially advanced. Broadly speaking, the estimated relationship suggests that an FD index between 0.36 and 0.5 (with 95% likelihood) could generate the largest cumulative growth returns (that is, moving from 0 to the growth maximizing point) in the range of 5½-6 percentage points, holding constant other determinants of growth. In sum, the threshold effect is not relevant for Asia and The Pacific countries, as all countries in the region are well below the threshold for exhibiting adverse growth effects. This shows the great growth potential of the region if proper policies are implemented to improve financial development.

Figure 22. Financial Development Effect On Growth

68

Barajas, Adolfo, Ralph Chami, and Seyed Reza Yousefi . 2013. “The Finance and Growth Nexus Re-examined: Do All Countries Benefit Equally?” IMF Working Paper 13/130, International Monetary Fund, Washington; Arcand, Jean-Louis, Enrico Berkes, and Ugo Panizza. 2012. “Too Much Finance?” IMF Working Paper 12/161, International Monetary Fund Washington, DC: Nili, M., and M. Rastad. 2007. “Addressing the Growth Failure of the Oil Economies: “The Role of Financial Development.” Quarterly Journal of Economics and Finance 46 (5): 726– 40. 69

Ratna Sahay, Martin Čihák, Papa N’Diaye, Adolfo Barajas, Ran Bi, Diana Ayala, Yuan Gao, Annette Kyobe, Lam Nguyen, Christian Saborowski, Katsiaryna Svirydzenka, and Seyed Reza Yousefi .2015. “Rethinking Financial Deepening: Stability and Growth in Emerging Markets” International Monetary Fund.

36

CONCLUSION

Given that all countries in the region are well below the inflection point for potential adverse effects of financial development on economic growth, financial development has a positive impact on economic growth, with the size of the effect varying across countries. The region’s financial sector can achieve the twin goals of inclusive growth and financial stability, taking into account demographic shifts, rapid urbanization, large infrastructure needs, and the evolving structure of economic activity in Asia itself. In this context, the financial sector should take on a bigger role than it has in the past and should, itself, become an engine of growth. However, the financial sector is not currently in sufficiently good shape to achieve the twin goals in the region. First of all, although the region has an abundance of domestic savings (current account surplus), paradoxically, it relies too much on foreign savings (inward FDI). This paradox can be explained by the underdeveloped financial markets and institutional investor base in the region. The Asian financial sector is dominated by short-term bank lending. This dominance has come at the cost of underdeveloped equity and bond markets in most countries. Underdeveloped equity and bond markets also prevent institutional investors from supporting equity and bond market deepening. In this context, the demand of funds by companies and individuals through financial markets (equity and bond markets) and bank credits is larger than supply of funds through domestic institutional investors and bank deposits in many Asian countries. This leads to the region depending on foreign investment to finance local funding needs and leads to a rise in the cost of capital. In this respect, countries should adopt policies that develop both financial markets and institutional investors to narrow the gap between demand and supply of funds. These policies could be related to the support of financial innovation, and integration and elimination of key impediments facing foreign and local institutional investors, which could improve the allocation of savings by narrowing the gap between demand and supply of funds and strengthen domestic resilience to external shocks.

37

On the other hand, FID and FMD are relatively very low in CSNs when compared to developing and developed countries in the region. This implies that financial institutions and markets in CSNs do not fully satisfy the funding needs of the private sector. The credit to deposit ratios of these countries also supports this argument. There can be two important reasons that prevent financial institutions from extending credit in these countries. First is the lack of appropriate finance infrastructure that prevents banks from lending money to customers who are unknown to banks, such as lack of credit bureaus. Second is having a disproportionate burden of regulations that prevents the development of capital markets and institutional investors. Furthermore, though it is widely known that increasing financial access deepens the markets, this does not work for CSNs. For example, while FIA was significantly increasing between 2006 and 2013 for CSNs, its effects on FID is very small (Box 3). In this respect, countries whose financial inclusion strategies are mainly based on increasing the number of bank branches and ATMs should shift their strategy to a new financial inclusion strategy positively affecting FID, such as by increasing SMEs’ access to finance through mobile banking. Currently, FIE plays a dominant role in creation of FI. This is because the region has a bank centric system that leads to increase in FIE due to lack of rival financial markets. However, this system without appropriate competition laws can lead to a rise the cost of credit, adversely affecting the development of countries. For example, although credit-to-deposit ratios were under 100% in most Asian economies at the end of 2014 (Table 6), banks` efficiency ratios performed very well. Moreover, bank interest margin has a weight of 0.21 within the efficiency subcomponent of FI, which comes in second among 6 ratios (see appendix 1). These imply that banks sold credit to the private sector at a more expensive rate than warranted.

38

APPENDIX 1-CONSTRUCTION OF THE INDEX70

I. The PPCA WITH GAUSSIAN MIXTURE METHODOLOGY

In this study the probabilistic PCA with Gaussian mixture methodology is used to find an index for financial development. In IMF 71 study, general PCA methodology was used to find a similar index. In our study and IMF’s study, PCA tool was effectively used to find normalized weights for variables that were selected to represent components of financial development such as Financial Depth (FID,FMD),Financial Access(FIA,FMA), Financial Efficiency (FIE,FME). The formulation of PCA is based on a linear projection of the data onto a subspace of lower dimensionality than the original dataspace. We can show that PCA can also be expressed as the maximum likelihood solution of a probabilistic latent variable model. This reformulation of PCA, known as probabilistic PCA (PPCA), has several advantages compared to conventional PCA:

Probabilistic PCA represents a constrained form of the Gaussian distribution in which the number of free parameters can be restricted while still allowing the model to capture the dominant correlations in a data set.

We can derive an expectation–maximization (EM ) algorithm for PCA that is computationally

efficient in situations where only a few leading eigenvectors are required and that avoids having to evaluate the data covariance matrix as an intermediate step.

The combination of a probabilistic model and EM allows us to deal with missing values in the data

set.

Mixtures of probabilistic PCA models can be formulated in a principled way and trained using the EM algorithm.

Probabilistic PCA forms the basis for a Bayesian treatment of PCA in which the dimensionality of the principal subspace can be found automatically from the data.

The existence of a likelihood function allows direct comparison with other probabilistic density models. By contrast, conventional PCA will assign a low reconstruction cost to data points that are close to the principal subspace even if they lie arbitrarily far from the training data.

Probabilistic PCA can be used to model class-conditional densities and hence be applied to classification problems.

The probabilistic PCA model can be run generatively to provide samples from the distribution.

70

World Bank, 2015 and 2016, Global Financial Database are used to construct this index 71

Katsiaryna Svirydzenka. 2016. “Introducing a New Broad-based Index of Financial Development” International Monetary Fund

39

Given the facts above by using PPCA we basically map a latent variable to target variable space using a matrix of coefficients, mean of the observed variable with an error. This is fundamentally factor analysis in statistics. Another explanation is sampling target variable Y from a normal distribution with target variables first 2 moments conditioned on the value of latent variable Z. As a result a typical model should be:

𝑌 = 𝑊𝑍 + 𝜇 + 𝜖

Here Y~𝑁(𝜇, 𝐶) and Z~ 𝑁(0, 𝐼). The parameter matrix C is covariance matrix of observed variable matrix Y. The covariance matrix can be decomposed:

𝐶 = 𝑊𝑊′ + Ψ

Here Ψ is particular covariance matrix of errors which are independent from latent variables and W characterizes covariance matrix of observed variables. The unknown W has no analytical solution since the parameters depend on unobserved components. Thus, based on the distribution of Y a maximum likelihood solution is inevitable. Then the estimation is based on following probabilistic construction.

For 𝜖~𝑁(0, 𝜎2𝐼) where error covariance matrix is assumed to be diagonal implies the conditional distribution of y as below:

𝑝(𝑦|𝑧) = (2𝜋𝜎2)−𝑑2 exp (−

1

2𝜎2 ||𝑦 − 𝑊𝑧 − 𝜇||)

Then based on the assumption that Z~𝑁(0, 𝐼) we can define latent variable distribution as:

𝑝(𝑥) = (2𝜋𝜎2)−𝑞2 exp (−

1

2𝜎2𝑥𝑇𝑥)

Therefore using Bayes rule we can find the probability model for Y as:

𝑝(𝑦) = ∫ 𝑝(𝑦|𝑧)𝑝(𝑧)𝑑𝑧

= (2𝜋)−𝑑

2|𝐶|−1

2 exp {(−1

2(𝑦 − 𝜇)𝑇𝐶−1(𝑦 − 𝜇) }.

The likelihood for a sample of observed variables is:

𝐿 = ∑ ln (𝑝(𝑦𝑛)

𝑁

𝑖=1

The formula above defines general PPCA framework, however the model can be extended to a state-dependent covariance matrix where the probability distribution of Y is the weighted average of different probability distributions.

The model for data is:

𝑌 = ∑(𝑊𝑖𝑍𝑖

𝑀

𝑖=1

+ 𝜇𝑖) + 𝜖

40

The model likelihood can be written as:

𝐿 = ∑ ln {∑ 𝜋𝑖

𝑛

𝑖=1

𝑝(𝑦𝑛|𝑖)

𝑁

𝑛=1

}

Here based on data we obtain mixture parameters 𝜋𝑖, 𝜇𝑖, 𝑊𝑖, 𝜎𝑖2 by maximizing likelihood above. The

maximization procedure can be obtained using EM algorithm (Expectation-Maximization) since this method is suggested (Dempster et al (1977)) for likelihood maximization at the existence of latent variables. Here the mixture ratios 𝜋𝑖 are latent since they cannot be directly observed from any data. The model parameters are given by

𝑅𝑛𝑖 =𝑝(𝑦𝑛|𝑖)𝜋𝑖

𝑝(𝑦𝑛)

�̃�𝑖 =∑ 𝑅𝑛𝑖

𝑁𝑛=1

𝑁

�̃�𝑖 =∑ 𝑅𝑛𝑖𝑦𝑛𝑖

𝑁𝑛=1

∑ 𝑅𝑛𝑖𝑁𝑛=1

𝑆𝑖 =1

�̃�𝑖𝑁∑ 𝑅𝑛𝑖(𝑦𝑛𝑖 − 𝜇𝑖)(

𝑁

𝑛=1

𝑦𝑛𝑖 − 𝜇𝑖)𝑇

The principal components 𝑊𝑖 can be found by standard eigen decomposition of covariance matrices, 𝑆𝑖 for each distribution in the mixture.

This methodolgy has been used in our analysis to calculate the financial development index using PCA analysis to determine the index weights which was used in IMF Working paper “Introducing a New Broad-based Index of Financial Development”. However, IMF’s methodlogy uses standard PCA method to determine weights, whereas in this paper we use aforementioned gaussian mixture PCA analysis to deterrmine weights which is supposed to better capture the differences in th data since we move from the idea that gaussian mixture is used for clustreing and models the complexities in the clusters better than standart PCA. This could give us more realistic weights to calculate financial development index. Thus we used the gaussian mixture as the main tool for the modelling the data components based on country clusters. After finding the 𝑊𝑖s we weighted them using each 𝜋𝑖 for particular distribution in the mixture then we squared them to obtain a norm of 1 which means the sum of weights of the index to be 1. Then we applied these weights to each ratio inside the subindices, FID, FMI, FIA, FMA, FIE,FME. After finding these indices we group them under upper indices FI and FM as suggested in the IMF paper. At the end we apply again standart PCA method to obtain weights for FI and FM to calculate final FD index.

41

Weights of Ratios

FID

Private to GDP 0.325

Pension fund assets to GDP 0.143

Mutual fund assets to GDP 0.0529

Life insurance premium volume to GDP 0.204

Non life insurance premium volume to GDP 0.274

FIA

Commercial bank branches per 100,000 adults 0.777

ATMs per 100,000 adults 0.222

FIE

Net interest margin 0.214

Lending-deposit spread 0.108

Non-interest income to total income 0.128

Overhead costs to total assets 0.12

Return on assets 0.284

Return on equity 0.143

FMD

Stock Market Capitalization to GDP 0.171

Stock Market Total Value Traded to GDP 0.319

International debt securities outstanding 0.332

Corporate bond issuance 0.176

FMA

Percent of stock market capitalization outside of top 10 largest companies

0.515

Value traded excluding top 10 traded companies to total value traded

0.309

Number of listed companies per 1.000.000 people

0.175

42

APPENDIX 2-ECONOMETRIC METHODOLOGY, ESTIMATION, AND RESULTS The regressions use a dynamic system generalized method of moments (GMM) estimator, as in Beck and Levine (2004), which was used with a set of controls: Regulatory Control, initial income per capita. The estimation is based on Arrelano-Bond (1991) and Arrelano-Bover/Blundell-Bond (1998) difference and system GMM estimation methodology. The GMM is used to deal with possible endogeneity problem in a regression with key macroeconomic variables. Additionally, a “banking crisis” dummy variable (Laeven and Valencia 2012) was also included to control for the increasing incidence of banking crises beginning in the 1990s, as suggested by Rousseau and Wachtel (2011). Moreover, we added control variables so as to avoid omitted variable bias. This is important since we need precise index coefficients in order to see correct sensitivity of real GDP growth to financial development index. The coefficient is also used in examining so-called inverse U relationship between GDP growth and financial development index. As suggested in IMF Working paper (2015) Initial GDP per capita, educational attainment, and government consumption/GDP was used in our panel model.

𝑦𝑖𝑡̇ = 𝛼 + 𝛽0𝐹𝐷𝑖𝑡 + 𝛽1𝐹𝐷𝑖𝑡2 + 𝛽2(𝐹𝐷 ∗ 𝐼𝑛𝑡𝑒𝑟𝑎𝑐𝑡𝑖𝑜𝑛𝑖) + 𝛽3𝑋𝑖𝑡

Finance and Growth: GMM Estimation Dependent Variable: 5 year Rolling GDP growth (1983-2013)

Coefficient St. Error (Adjusted)

z P-value

Financial Development Index (FD) 0.2458058 0.0849728 2.89 0.004

FD (Squared) -0.2819757 0.0911963 -3.09 0.002

Crisis *FD -0.015283 0.0077206 -1.98 0.048

Govtconsumption -0.0023868 0.0008563 -2.79 0.005

Initial per capital GDP -0.0012631 0.001372 -0.92 0.357

School Enrollment 0.001405 0.0000686 2.05 0.041

Constant 0.0272385 0.0204311 1.33 0.182

Arellano –Bond-P –Values AR(1) AR(2) Sargan Hansen 0.018 0.15 0.994 0.971 No. countries: 25 Observations:495 Instruments:15

From tables we can see that the general quadratic relation between indices and 5 year rolling real growth is significant at mostly 1% level significance level. As explained above we have an interaction term which is significant at 5% level and four control variables of which, school-enrollment and government consumption are significant at 5% and 1% levels respectively. The signs of the coefficients are in line with expected; financial development index is positive which means it increases GDP growth on average or namely has a positive long-run effect on growth. The government consumption and initial per capita GDP overshadow the boosting effect of financial development on growth, so a negative sign is expected. Most of the effect on GDP growth is due to financial development index. Crisis dummy and financial development index interaction term has a negative sign of -0.015 which is intuitive due to the hampering effect of crises on economies.

43

APPENDIX 3- FINANCIAL DEVELOPMENT INDEX OF COUNTRIES

FD Index FI Index FM Index

1 Australia 0.825 Australia 0.856 Hong Kong China 0.777

2 Japan 0.803 Republic of Korea 0.821 Japan 0.703

3 Republic of Korea 0.802 Japan 0.814 China 0.689

4 Hong Kong China 0.764 Hong Kong China 0.763 Singapore 0.685

5 Singapore 0.721 New Zealand 0.744 Republic of Korea 0.629

6 New Zealand 0.719 Malaysia 0.734 Turkey 0.622

7 Malaysia 0.716 Singapore 0.725 India 0.589

8 Thailand 0.663 Thailand 0.674 Thailand 0.560

9 China 0.624 China 0.616 Malaysia 0.558

10 Macao China 0.498 Macao China 0.552 Australia 0.540

11 Turkey 0.493 Viet Nam 0.496 Sri Lanka 0.513

12 Russian Federation 0.466 Russian Federation 0.490 New Zealand 0.497

13 India 0.451 Mongolia 0.481 Philippines 0.468

14 Viet Nam 0.447 Turkey 0.479 Indonesia 0.443

15 Philippines 0.436 Fiji 0.463 Russia 0.248

16 Mongolia 0.435 Nepal 0.450 Kazakhstan 0.236

17 Sri Lanka 0.433 Armenia 0.442 Georgia 0.031

18 Indonesia 0.433 Georgia 0.442 Mongolia 0.025

19 Fiji 0.418 India 0.436 Marshall Islands 0.020

20 Nepal 0.405 Vanuatu 0.435 Viet Nam 0.008

21 Georgia 0.4 Indonesia 0.432 Fiji 0.007

22 Armenia 0.399 Philippines 0.432 Lao_P 0.006

23 Vanuatu 0.392 Sri Lanka 0.424 Pakistan 0.006

24 Brunei Darussalam 0.37 Brunei Darussalam 0.411 Macao China 0.004

25 Kazakhstan 0.363 Bangladesh 0.395 Azerbaijan 0.004

26 Bangladesh 0.355 Samoa 0.391 Bangladesh 0.001

27 Samoa 0.346 PNG 0.387 DPR Korea 0

28 PNG 0.348 Bhutan 0.384 Afghanistan 0

29 Bhutan 0.346 Kazakhstan 0.377 Armenia 0

30 Cambodia 0.337 Cambodia 0.374 Bhutan 0

31 Azerbaijan 0.332 Azerbaijan 0.368 Brunei Darussalam 0

32 Pakistan 0.322 Pakistan 0.357 Cambodia 0

33 Maldives 0.32 Maldives 0.356 French Polynesia 0

34 Kyrgyzstan 0.301 Kyrgyzstan 0.335 Kyrgyzstan 0

35 Micronesia 0.294 Micronesia 0.327 Maldives 0

36 Solomon Islands 0.287 Solomon Islands 0.319 Micronesia 0

37 Tonga 0.281 Tonga 0.313 Myanmar 0

44

FD Index FI Index FM Index

38 Myanmar 0.268 Myanmar 0.297 Nepal 0

39 Tajikistan 0.258 Tajikistan 0.287 New Caledonia 0

40 Afghanistan 0.242 Afghanistan 0.269 Palau 0

41 Timor 0.0488 Timor 0.054 PNG 0

42 Marshall Islands 0.034 Marshall Islands 0.037 Samoa 0

43 Lao PDR 0.0253 Lao PDR 0.027 Solomon Islands 0

44 Palau 0.005 Palau 0.006 Tajikistan 0

45 Turkmenistan 0 Turkmenistan 0 Timor 0

46 Tuvalu 0 Tuvalu 0 Tonga 0

47 DPR Korea 0 DPR Korea 0 Turkmenistan 0

48 New Caledonia 0 New Caledonia 0 Tuvalu 0

49 French Polynesia 0 French Polynesia 0 Vanua 0

FID Index FIA Index FIE Index

1 Australia 0.8793 Macao China 1.000 Republic of Korea 0.850

2 Republic of Korea 0.8473 Russia 0.983 Malaysia 0.843

3 Hong Kong China 0.7918 Japan 0.888 Japan 0.841

4 Japan 0.7800 Mongolia 0.866 New Zealand 0.836

5 Singapore 0.7597 Australia 0.822 Macao China 0.836

6 Malaysia 0.7394 New Zealand 0.713 China 0.834

7 New Zealand 0.6849 Georgia 0.635 Australia 0.833

8 Thailand 0.6243 Republic of Korea 0.576 Viet Nam 0.827

9 China 0.5333 Samoa 0.558 Singapore 0.826

10 Fiji 0.3506 Armenia 0.542 Bangladesh 0.822

11 Viet Nam 0.3362 Hong Kong China 0.535 Philippines 0.818

12 Turkey 0.3129 Brunei Darussalam 0.524 Sri Lanka 0.813

13 Macao China 0.2690 Turkey 0.519 Nepal 0.813

14 India 0.2688 Vanua 0.513 Thailand 0.812

15 Russia 0.2644 Thailand 0.424 Indonesia 0.798

16 Nepal 0.2448 Sri Lanka 0.405 Bhutan 0.790

17 Mongolia 0.2042 Marshall Islands 0.370 Pakistan 0.789

18 Philippines 0.2022 Bhutan 0.348 Vanua 0.788

19 Indonesia 0.2012 Maldives 0.328 Kyrgyzstan 0.787

20 PNG 0.1989 Micronesia 0.320 Myanmar 0.784

21 Armenia 0.1846 Fiji 0.312 Hong Kong China 0.783

22 Kazakhstan 0.1805 Indonesia 0.295 Armenia 0.783

23 Vanua 0.1727 Malaysia 0.293 Georgia 0.779

24 Georgia 0.1687 India 0.290 Brunei Darussalam 0.773

45

FID Index FIA Index FIE Index

25 Sri Lanka 0.1551 Singapore 0.276 Mongolia 0.772

26 Cambodia 0.1548 Azerbaijan 0.268 PNG 0.758

27 Brunei Darussalam 0.1356 China 0.242 Maldives 0.757

28 Bangladesh 0.1350 Philippines 0.210 Samoa 0.755

29 Azerbaijan 0.1251 Pakistan 0.198 Cambodia 0.753

30 Bhutan 0.1060 Kyrgyzstan 0.192 Solomon Islands 0.744

31 Samoa 0.1037 Nepal 0.181 Azerbaijan 0.740

32 Pakistan 0.0833 Bangladesh 0.177 Tonga 0.735

33 Maldives 0.0794 Kazakhstan 0.170 Micronesia 0.720

34 Tajikistan 0.0756 Solomon Islands 0.165 Kazakhstan 0.712

35 Tonga 0.0744 Cambodia 0.124 India 0.712

36 Lao PDR 0.0518 Timor 0.110 Turkey 0.705

37 Micronesia 0.0513 Viet Nam 0.107 Afghanistan 0.696

38 Solomon Islands 0.0485 Palau 0.062 Russia 0.680

39 Kyrgyzstan 0.0437 Myanmar 0.060 Tajikistan 0.664

40 Timor 0.0322 Afghanistan 0.044 Fiji 0.663

41 Afghanistan 0.0098 DPR Korea 0 Timor 0.071

42 DPR Korea 0 French Polynesia 0 DPR Korea 0

43 French Polynesia 0 Lao PDR 0 French Polynesia 0

44 Marshall Islands 0 New Caledonia 0 Lao PDR 0

45 Myanmar 0 PNG 0 Marshall Islands 0

46 New Caledonia 0 Tajikistan 0 New Caledonia 0

47 Palau 0 Tonga 0 Palau 0

48 Turkmenistan 0 Turkmenistan 0 Turkmenistan 0

49 Tuvalu 0 Tuvalu 0 Tuvalu 0

46

FMD Index FMA Index FME Index

1 Hong Kong China 0.925 Hong Kong China 0.769 China 0.444

2 Singapore 0.680 Japan 0.746 Turkey 0.348

3 Australia 0.560 China 0.725 Japan 0.209

4 Republic of Korea 0.476 Singapore 0.695 Republic of Korea 0.190

5 China 0.446 Turkey 0.678 Thailand 0.149

6 Japan 0.436 Republic of Korea 0.656 Australia 0.104

7 Malaysia 0.416 India 0.655 India 0.101

8 Thailand 0.406 Thailand 0.587 Viet Nam 0.094

9 Georgia 0.272 Malaysia 0.585 Hong Kong China 0.085

10 Philippines 0.260 Sri Lanka 0.573 Singapore 0.068

11 Turkey 0.227 New Zealand 0.548 Russia 0.057

12 Mongolia 0.217 Australia 0.545 Malaysia 0.056

13 Kazakhstan 0.195 Philippines 0.503 Indonesia 0.047

14 Marshall Islands 0.177 Indonesia 0.490 Philippines 0.033

15 Russia 0.172 Russia 0.262 New Zealand 0.023

16 New Zealand 0.160 Kazakhstan 0.246 Sri Lanka 0.022

17 India 0.151 DPR Korea 0 Kazakhstan 0.007

18 Indonesia 0.135 Afghanistan 0 DPR Korea 0

19 Sri Lanka 0.114 Armenia 0 Afghanistan 0

20 Fiji 0.060 Azerbaijan 0 Armenia 0

21 Viet Nam 0.057 Bangladesh 0 Azerbaijan 0

22 Lao PDR 0.055 Bhutan 0 Bangladesh 0

23 Pakistan 0.051 Brunei Darussalam 0 Bhutan 0

24 Macao China 0.037 Cambodia 0 Brunei Darussalam 0

25 Azerbaijan 0.034 Fiji 0 Cambodia 0

26 Bangladesh 0.005 French Polynesia 0 Fiji 0

27 DPR Korea 0 Georgia 0 French Polynesia 0

28 Afghanistan 0 Kyrgyzstan 0 Georgia 0

29 Armenia 0 Lao PDR 0 Kyrgyzstan 0

30 Bhutan 0 Macao China 0 Lao PDR 0

31 Brunei Darussalam 0 Maldives 0 Macao China 0

32 Cambodia 0 Marshall Islands 0 Maldives 0

33 French Polynesia 0 Micronesia 0 Marshall Islands 0

34 Kyrgyzstan 0 Mongolia 0 Micronesia 0

35 Maldives 0 Myanmar 0 Mongolia 0

36 Micronesia 0 Nepal 0 Myanmar 0

37 Myanmar 0 New Caledonia 0 Nepal 0

38 Nepal 0 Pakistan 0 New Caledonia 0

47

FMD Index FMA index FME Index

39 New Caledonia 0 Palau 0 Pakistan 0

40 Palau 0 PNG 0 Palau 0

41 PNG 0 Samoa 0 PNG 0

42 Samoa 0 Solomon Islands 0 Samoa 0

43 Solomon Islands 0 Tajikistan 0 Solomon Islands 0

44 Tajikistan 0 Timor 0 Tajikistan 0

45 Timor 0 Tonga 0 Timor 0

46 Tonga 0 Turkmenistan 0 Tonga 0

47 Turkmenistan 0 Tuvalu 0 Turkmenistan 0

48 Tuvalu 0 Vanua 0 Tuvalu 0

49 Vanua 0 Viet Nam 0 Vanua 0

48

REFERENCES Acemoglu, D., S. Johnson, and J. Robinson. 2004 “Institutions as the Fundamental Cause of Long-Run Growth.” NBER Working Paper 10481. National Bureau of Economic Research, Cambridge, Massachusetts. Alter, A., and B. Yontcheva. 2015. “Financial Inclusion and Development in the CEMAC.” IMF Working Paper 15/235, International Monetary Fund, Washington. Arcand, Jean-Louis, Enrico Berkes, and Ugo Panizza. 2012. “Too Much Finance?” IMF Working Paper 12/161, International Monetary Fund Washington, DC. Andrew Sheng. “Capital Market Development in Asia and the Pacific Region.” 2014. Pacific Trade and Development Working Paper Series. Paper No. 36-03. Andrew Sheng, Chow Soon Ng and Christian Edelmann, 2013. “Asia Finance 2020 Framing A New Asian Financial Architecture” Allianz, 2015. “Allianz Global Wealth Report”. Asian Development Bank. 2015. “Financing Asia`s Future Growth” Barajas, Adolfo, Ralph Chami, and Seyed Reza Yousefi . 2013. “The Finance and Growth Nexus Re-examined: Do All Countries Benefit Equally?” IMF Working Paper 13/130, International Monetary Fund, Washington. Beck, Thorsten, Berrak Büyükkarabacak, Felix Rioja, and Neven Valev. 2009. “Who Gets the Credit? And Does it Matter? Enterprise vs. Household Credit across Countries.” Center Discussion Paper, Tilburg University, Tilburg, Germany Beck, T. 2008. “The Econometrics of Finance and Growth.” Policy Research Working Paper 4608, World Bank, Washington Boyd, H. J., Ross L., and B. D. Smith. 2001. “The Impact of Inflation on Financial Sector Performance.” Journal of Monetary Economics 47: 221–48. Cecchetti, Stephen G., and Enise Kharroubi. 2015. “Why Does Financial Sector Growth Crowd Out Real Economic Growth?” BIS Working Paper 490, Bank for International Settlements, Basel De Gregorio, Jose, and Pablo Guidotti. 1995. “Financial Development and Economic Growth.” World Development 23 (3): 433–48 Djankov, S., C. McLiesh, and A. Shleifer. 2005. “Private Credit in 129 Countries.” NBER Working Paper 11078. National Bureau of Economic Research, Cambridge, Massachusetts. Eugster, Johannes. 2014. “Nonlinear Marginal Effects of Finance on Growth.” Unpublished, International Monetary Fund. Ernst and Young, 2016. ”EY Asia-Pacific insurance outlook” Hannah Levinger and Chen Li , 2014. “What’s behind recent trends in Asian corporate bond markets?” Hans Genberg . 2016. “Discussion Paper, First High-Level Follow-up Dialogue on Financing for Development in Asia and the Pacific.” UNESCAP

49

Gelb, A., S. Tordo, H. Halland, N. Arfaa, and G. Smith. 2014. Sovereign Wealth Funds and Long-Term Development Finance. World Bank Policy Research Working Paper, No. 6776. Washington, DC: World Bank Goldman Sachs. 2013. ASEAN’s Half a Trillion Dollar Infrastructure Opportunity. Asia Economic Analyst, No: 13/18. Goldman Sachs International Monetary Fund, 2013. “Global Financial Stability Report.” International Monetary Fund. 2016. “Regional Economic Outlook: Asia and Pacific” International Organization of Securities Commissions (IOSCO). 2012. Development and Regulation of Institutional Investors in Emerging Markets. Madrid: IOSCO. International Organization of Securities Commissions (IOSCO). 2016. “Securities Markets Risk Outlook” Invesco. 2015. Global Sovereign Asset Management Study 2015. Invesco. ICI, 2014. “ICI Global Research Perspective” Katsiaryna Svirydzenka. 2016. “Introducing a New Broad-based Index of Financial Development” International Monetary Fund Levine, Ross. 2005. “Finance and Growth: Theory and Evidence.” In Handbook of Economic Growth, edited by Philippe Aghion and Steven Durlauf, New York: Elsevier, 865–934 Levine, Ross, Norman Loayza, and Thorsten Beck. 2000. “Finance and the Sources of Growth.” Journal of Financial Economics 58 (1/2): 261–300 Loayza, Norman, and Roman Ranciere. 2006. “Financial Development, Financial Fragility, and Growth.” Journal of Money, Credit and Banking 38 (4): 1051–76. McKinsey. 2011. The Emerging Equity Gap: Growth and Stability in the New Investor Landscape. McKinsey Global Institute McKinsey. 2013. Infrastructure Productivity: How to Save $1 Trillion a Year. McKinsey Global Institute ME Tipping, 1999. “Mixtures of probabilistic principal component analysers, Neural Computation 11(2), pp 443”. 1999. MIT Press Naureen Adnan, 2009. “Measurement of Financial Development: A Fresh Approach, 8th International Conference on Islamic Economics and Finance” Nili, M., and M. Rastad. 2007. “Addressing the Growth Failure of the Oil Economies: “The Role of Financial Development.” Quarterly Journal of Economics and Finance 46 (5): 726– 40. OECD.2013. “Pensions at a Glance Asia/Pacific” OECD. 2014a. Pooling of Institutional Investors Capital. Selected Case Studies in Unlisted Equity Infrastructure. Paris: OECD Publishing. OECD. 2014b. Pension Markets in Focus. Paris: OECD Publishing.

50

OECD. 2014c. Annual Survey of Large Pension Funds and Public Pension Reserve Funds 2014. Paris: OECD Publishing. OECD. 2014d. Annual Survey of Investment Regulation of Pension Funds. Paris: OECD Publishing. Ötker-Robe and Pazarbasioglu. 2010. “Impact of Regulatory Reforms on Large and Complex Financial Institutions” Philip Turner, 2009. “Weathering financial crisis: domestic bond markets in EMEs” Park, T. K. 1998. “Private Infrastructure Development in Asia” The Journal of Project Finance 4(3): 25–33. Price Waterhouse Coopers, 2015. “Asian Passports, the coming of age An overview and its demand”. Ratna Sahay, Martin Čihák, Papa N’Diaye, Adolfo Barajas, Ran Bi, Diana Ayala, Yuan Gao, Annette Kyobe, Lam Nguyen, Christian Saborowski, Katsiaryna Svirydzenka, and Seyed Reza Yousefi .2015. “Rethinking Financial Deepening: Stability and Growth in Emerging Markets.” International Monetary Fund, Washington Ratna Sahay, Jerald Schiff, Cheng Hoon Lim, Chikahisa Sumi, and James P. Walsh. 2015. “The Future Of Asian Finance”. International Monetary Fund Ray, S. 2015. “Investment Finance and Financial Sector Development” ADBI Working Paper No. 522. Severinson, C., and J. Yermo. 2012. “The Effect of Solvency Regulations and Accounting Standards on Long-Term Investing: Implications for Insurers and Pension Funds” OECD Working Papers on Finance, Insurance and Private Pensions. Singh, R. J., K. Kpodar, and D. Ghura. 2009. “Financial Deepening in the CFA Franc Zone: The Role of Institutions.” IMF Working Paper 09/113, International Monetary Fund, Washington. Tressel, T., and E. Detragiache. 2008. “Do Financial Sector Reforms Lead to Financial Development? Evidence from a New Dataset,” IMF Working Paper 08/265, International Monetary Fund, Washington. World Bank, 2016. Global Financial Database.

The State of Finance in Asia and the Pacific