Designing a financial market structure in post-crisis Asia

Abstract

Since the Asian financial crisis, strong and increasingly prevalent views have emerged that banks are no more functional and that economic development should rely on capital markets. Such views claim that the Asian crisis was caused by heavy dependence of firms' investment on bank loans and that Asian commercial banks did not function as properly as those operating in some advanced countries, due to crony relations among banks, firms, and governments. These views conclude that policies should place less emphasis on bank loans and that Asian countries should develop domestic capital markets as alternative more important sources of financing. This paper attempts to examine whether policy implications suggested by these prevalent views are justifiable by considering the following two categories of questions. The first category is about whether banks can be characterized as unsound and unfit institutions for economic development as often argued in the context of post-crisis Asia. Provided that existing economic theories and empirical studies clearly define basic functions and reason d'etre of commercial banks, one then needs to ask: what went wrong with the banking system in Asia? The second category of questions focuses on why corporate bond markets are underdeveloped in many emerging market economies. By analyzing factors deterring the development of corporate bond markets, the paper then examines whether, why, and how the markets should be developed. The paper stresses that banks' "relationships" with borrowing firms whose importance is justified by theoretical and empirical studies on banking have transformed into "cronyism" in Asia, owing to government interventions (in directing credit for financing selected projects and bailing out failing firms and banks regardless of their viability); lack of inadequate prudential regulations and supervision; ownership structure of banks; and, heavy reliance on collateral without proper monitoring.