Ratings

Asia's rapid growth requires that its financial systems develop the capacity and efficiency to service its needs. This can only happen when global standards and practices are brought to local capabilities and institutions in a continuous process of learning and adapting. The experiences of mature markets reveal both the gains from innovation and the risks of taking it beyond its limits.

There are three key attributes common to all good financial systems. One, the efficient pricing of the two "commodities" that are traded in financial markets--time and risk. The second is transparency; all investors can access information. The third attribute is the maintenance of minimum standards of prudence to protect all participants from inevitable shocks.

There is no doubt that most countries in the Asian financial landscape have progressed a long way down this path. Bank domination has diminished, making space for markets. Regulatory frameworks are enforcing disclosure and prudential requirements. In fact, the rapid growth of inflows from abroad into most of these countries testifies to their ability to inspire confidence in global investors.

The financial sector, however, is simply not keeping pace with the rate of economic growth and transformation in the region. A prime example of this is the laggardly development of bond markets in emerging economies. It is well known that bond markets facilitate the rapid development of infrastructure at both local and national levels. Without them, such development is constrained by the capacity of public finances to allocate tax revenues to this goal. Bond markets make feasible a range of public and private combinations, both operationally and commercially.

The reasons why these markets are slow to develop are well understood. Barriers include limits on participants, limits on transactions, and high taxes--all of which are within the powers of government to address.

The fundamental point is that the current Asian dynamism will only be strengthened by speeding up the transformation of its financial sector. China and India, together, generated more than 40% of incremental global GDP (in purchasing power parity terms) each year between 2005 and 2007. China invests about 45% of GDP, while India invests about 38%. Other emerging economies in the region also have comparable investment rates, financed both by high domestic savings and large foreign inflows. These trends create opportunities for a significant shift in global financial activity to the region.

The recent actions by two prominent Japanese institutions--Nomura Securities acquiring the Asian operations of Lehman Brothers and Mitsubishi UFJ buying a substantial stake in Morgan Stanley--is a reflection of the rising aspirations of regional financial players. Other regional institutions will also seek to play a larger role in servicing the growing needs of the region.

Of course, not every country can be a regional, let alone global, financial hub; we already have Hong Kong and Singapore. But with greater intraregional coordination, we will see a quantum leap in their scale of operation--and possibly that of a couple of new hubs--plus the range and depth of their services and the benefits they impart to the region.

Such coordination is already evidenced by the complex network of regional agreements that are in place. Essentially, these are driven by the recognition that the growth of the region provides opportunities that no country can afford to forego. What is true for commodities and products is also true for services, including financial services.

At this time--when the focus is primarily on risk--we need to remind regulators and market participants not to lose sight of the long-term objective of creating a financial system that will continue to meet the needs of a growing and maturing regional economy. Recent developments in the U.S. should not be seen as a sign that financial sector liberalization and deregulation are the root cause of the problem and, as such, to be resisted or slowed. Rather, these developments should underscore the need to balance the sometimes-conflicting requirements of profitability, innovation, and safety by finding the right combination of market incentives and regulatory boundaries.

The real lesson is that neither incentives nor boundaries will work well without the other. Unfettered markets will see participants taking risks that can affect the entire system, while over-intrusive regulation will hinder the system's development, rendering it increasingly incapable of servicing the economy's needs. The challenge is to find a sustainable balance between the two. A coordinated process of financial sector reform, with compatible standards of disclosure, risk measurement, and prudential norms would help create a regional financial marketplace that's beneficial to all. Standard & Poor's is committed to supporting this process by providing independent information and insights about Asian markets to investors both within and outside the region.