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MAKING FINANCIAL
INTERMEDIATION WORK
Diverse and efficient channels
of financial intermediation help economies to cope better with
financial crisis. Monetary Authorities have a role in helping
these channels to develop.
A speech made by Alan Greenspan
on 27 September 1999 is of particular interest to emerging markets.
Drawing on the experience of the global financial crisis of 1997
and 1998, he pointed out one of the most important general principles
in financial intermediation: the need for diversity and back-up
facilities.
As usual, these words from someone
who must now be one of the most influential men on earth are wise
indeed. The process of financial intermediation is of crucial
importance to any economy. It is a process through which an economy's
savings are transformed into capital investment. If the process
is efficiently organised, it boosts economic growth, with consequent
improvements in the standard of living for the people. If instead,
money is saved under mattresses and those wishing to invest lack
funds, then economic development is seriously hampered. The question
then is how to achieve and maintain efficiency in this important
process.
The initial task must be to build
the various channels of financial intermediation. Fortunately,
market forces can usually be relied upon to perform that role
by establishing the familiar channels of banking and capital markets,
including those for debt and equity. The role of the monetary
authorities is a largely supplementary, albeit important one.
It focuses traditionally on the protection of depositors and investors,
but usually only on the small ones who cannot always be expected
to protect themselves. For this and other related purposes, financial
markets are regulated and financial intermediaries are supervised.
But there is also a wider role for
monetary authorities in the development of financial intermediation.
Much though we might wish to leave markets to develop freely on
their own by responding to the forces of supply and demand, there
is a possibility that one among the channels of financial intermediation,
together with its intermediaries, might become too dominant, while
others remain persistently underdeveloped. Obviously, the important
process of financial intermediation should not be overly dependent
upon one channel or one group of intermediaries, who may be vulnerable
to adverse developments of one kind or another. When a crisis
occurs, as it inevitably will even with the best regulatory system
in place, the hope is that there would be alternative channels
for savings to continue to flow adequately into capital investment
in order to sustain economic expansion.
Last year in the United States the
banks served as an effective back-up for the capital markets,
as the latter seized up following difficulties in funding leverage.
A consortium of banks came to the rescue of LTCM and the economy
continued to grow impressively. Earlier, in 1990, when it was
the banks in the United States that seized up as a consequence
of a collapse in the value of real estate collateral, the capital
markets were able to substitute for the loss of bank intermediation.
Although the situation in Hong Kong
is somewhat better than in many of the emerging markets around
the globe, the degree of diversity seems inadequate. Our debt
market, although more developed than those of many others in the
region, is by no means an effective back-up for the banks. Indeed,
when we experienced a seizing up of bank financial intermediation
in the early eighties as a result of the collapse of the property
market and the failure of a number of banks, our debt market did
not really play a significant role as back-up. Funding for investments
was hard to come by. Although, as a very external oriented economy,
Hong Kong cannot escape worldwide economic trends, the impact
on the economy generally and on the financial industry in particular
could have been less severe if we had had a deep and liquid debt
market as back-up.
The same happened in the financial
crisis of the last two years. Asset prices, and thus the value
of bank collateral, fell sharply. There was no banking crisis.
But to prevent adverse effects on their financial viability, the
banks understandably adopted, and are still adopting, a conservative
lending strategy. The total amount of domestic loans for use in
Hong Kong has been falling continuously for 16 months, causing
hardship for borrowers, in particular for the small and medium-sized
enterprises. This might have been one significant reason behind
the rather sharp fall we saw in our gross domestic product.
Alan Greenspan puts it well: "diversity
within the financial sector provides insurance against a financial
problem turning into economy-wide distress". And, he adds,
"steps to foster the development of capital markets in those
economies should also have an especial urgency". Indeed,
we need to intensify our efforts, which we began in early 1990,
to develop the debt market in Hong Kong.
Joseph Yam
28 October 1999
More information on Debt Market
Development can be found here.
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