MAS' Ravi Menon on Fed policy, China and global regulation

Monetary Authority of Singapore head speaks about Fed policy normalisation, China’s economic trials, global regulatory reforms, macro-prudential policy challenges and regional economic integration
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Ravi Menon was appointed managing director of the Monetary Authority of Singapore (MAS) in 2011 and is a member of the Financial Stability Board (FSB) Steering Committee, and chair of the FSB Standing Committee on Standards Implementation and the International Monetary and Financial Committee Deputies process. He was permanent secretary at the Ministry of Trade & Industry from 2007–11 and chaired the Apec Senior Officials Meetings in 2009. Menon worked previously as deputy secretary at the Ministry of Finance from 2003–07, where he was responsible for fiscal policy and government reserves. He oversaw the preparation of the annual budget statements and led a review of the investment policy of the Singapore Government Investment Corporation.

Menon began his career at MAS in 1987. During his 16 years there, he has worked in monetary policy; econometric forecasting; organisational development; banking regulation and liberalisation; and integrated supervision of complex financial institutions. Menon spent a year at the Bank for International Settlements in Switzerland, as a member of the secretariat to the Financial Stability Forum. Menon holds a Master’s in Public Administration from Harvard University and a Bachelor of Social Science in Economics from the National University of Singapore.

What do you make of the Federal Reserve’s efforts to normalise monetary policy?

There are two elements to the normalisation of monetary policy: the tapering of the Fed’s asset purchase programme and the eventual increase in interest rates that follows. We have been living through a very unusual period in the last five years of unconventional monetary policies. These policies were necessary at the time to lift the advanced economies out of recession, prevent a collapse of the financial system and provide a level of support for these economies to take off. While unconventional policies were beneficial in achieving these objectives, the prolonged application of these policies is not without consequence. There may be a point where the marginal cost of continuing these policies exceeds the marginal benefits. But that is a judgement call for the central banks of advanced economies to make.

From the perspective of Asia, these extraordinary policies have helped by preventing the advanced economies from going into a prolonged recession. But the persistence of unusually low interest rates for such a long period has posed other challenges for us. We welcome the normalisation of monetary policy, and our hope is that it is done in an orderly fashion, in a way that does not disrupt markets. But some vibrations in the market can’t be entirely avoided. While it is early days yet, the bark of taper has been worse than its bite – meaning there were more disturbances in the market in May last year when tapering was merely hinted at compared to market responses when it actually began. One hopes this will continue to be the case as tapering progresses.

When is the next big test?

The next big test will be the timeline for the raising of interest rates. The sooner we see a normalisation of monetary conditions globally, the better for us here in Asia and in emerging economies. The spill-over effects of unconventional monetary policies are not insignificant – volatility in capital flows, pressures in asset markets, a general increase in financial stability risks and a flattening of the yield curve that distorts investment decisions – these are not trivial consequences.

Are there structural problems that have emerged as a result of these policies?

There are longer-term structural challenges, for example, for pension funds. The long-term rate of return has been depressed for such a long period of time. What will be the impact on pensioners? So it’s not just about macroeconomics; there are broader economic and social consequences from low interest rates. Not to mention some of the distributional effects that these unconventional monetary policies have had. So there are good reasons to want to bring about a normalisation of monetary policies as soon as practicable, but done in an orderly fashion, so that it does not unsettle markets and gives economies time to adjust.

But you think the Fed has communicated its action reasonably well?

Under the circumstances, yes. They are sending two messages. One, that policy has to eventually normalise – that’s an important message so people do not think this is the new state of affairs and make investment decisions on that basis. Two, they are also giving notice that normalisation is not coming too soon, that it will be dependent on the state of the US economy. They have done a reasonably good job at communicating these messages, but there is no recipe or textbook answer on how to do this and little certainty on how markets will respond as interest rate normalisation takes place.

Some emerging markets have been vocal in expressing frustration with a ‘lack of communication’ about the Fed’s move to normalisation, perhaps because they were poorly prepared. What have you heard?

Most emerging market central bank governors that I have heard say that normalisation of monetary policy is welcome – all they want is that normalisation is done in a calibrated, clear, and orderly fashion. Some economies, which may not have been as cautious as they should have been during the boom years of easy money, may have a tougher time negotiating the exit of these policies. But it is hard to generalise across emerging economies. 

How do you assess the recent slowdown in growth in China?

The real issue in China is not about quarterly growth rates. China is at a major inflection point. It is undertaking a significant restructuring and reform effort, as charted in the Third Plenum announcements. In scale and ambition, this reform effort is unprecedented. It will not be easy to pull this off and China has to do this at a time when the growth momentum is slowing. So it’s not so much a case of whether the PMI is up or down next month, but whether Chinese policy-makers can achieve an orderly restructuring of the economy without too sharp a fall in growth. Growth has already moderated from over 10% on average to about 7–8%. Can they sustain the reform or even accelerate the reform effort, without too big a cost to growth and employment? The primary concern of Chinese policy-makers is that there is a large number of people coming into the work force each year and they do not want to see a big increase in unemployment.

The Chinese are also experiencing problems in the shadow banking, government lending and property sectors in the past couple of years. Can they manage the situation?

They are fully conscious of the risks that have built up in the system. You mentioned shadow banking, and it is a real issue. And the Chinese authorities have been taking steps. But deflating a real estate bubble is more art than science. You have to deflate it gently so it does not create disruption in the real economy. In a way, it is not unlike the Fed unwinding unconventional monetary policies; China is also unwinding the consequences of expansionary policies in the post-crisis period. But you cannot jam on the brakes and risk derailing the economy. There is a significant property market deflation occurring in China. In many Chinese cities, property prices have started to come down. Given how closely tied up the economy is with the real estate sector in China, this is not without risk. A sharp fall-off in prices could affect developers and banks and also have implications for local government financing. If China can manage this correction well, it would be a healthy development.

So there is still quite a set of challenges ahead for the authorities?

Indeed, yes. This is a 10-year transition they are making. And this is happening at a time of a slowdown in labour force growth towards zero, which in of itself will be a drag on GDP growth. They have to watch the situation closely. But so far, the record has been quite good.

What about in Singapore? You have a great long-term inflation record but had some issues with elevated inflation due to changing demographics and rising domestic costs. Is the exchange rate transmission mechanism still the right tool for the job?

If we look at the period of the Great Moderation, 1985 to 2005, inflation in Singapore averaged around 1.5% a year. If you take a longer horizon, it’s closer to 2%. We do not have an inflation targeting regime as Singapore is a small open economy that essentially imports inflation from abroad with the exchange rate as a filter. But the track record has set an expectation of inflation at around 2%. During 2010 to 2012, we had unusually high headline CPI inflation of 4–5%, mostly due to a rise in housing prices and car prices. Those were driven by domestic factors peculiar to us, although part of the property market boom can be traced to easy global liquidity conditions.

Notwithstanding these domestic sources of inflation, I believe the exchange rate-centred monetary policy regime remains valid. First, some 40 cents out of every dollar we spend is on imports, so imported inflation is still the major source of inflation. Second, exports are well in excess of 100% of GDP. It is still a very open economy, and the best macro tool you have at your disposal to manage export demand is the exchange rate, the prices at which our goods are sold on the international market. So both for managing export demand, and therefore aggregate demand, and for managing imported inflation, the exchange rate is the most important tool.

So it also affects domestic costs?

Yes, it does. When export demand is strong, production is strong, demand for labour is high, wages rise, and this feeds into a variety of domestic costs. The exchange rate is the best tool to manage and cool export demand and thereby the economy. So its role remains relevant.  But we have had some peculiar factors in the Singapore economy over the last three or four years – namely housing and car prices rising rapidly – which were not as easily addressed by the exchange rate tool. 

Did you have to resort to macro-prudential tools to address elevated inflation?

Since most of the inflation was coming from the property market and the car market, we had to resort to a variety of macro-prudential measures to address those specific cost pressures. We had to do this without dislodging the exchange-rate centred monetary policy, which remains focused on overall management of aggregate demand and imported inflation. We deployed targeted macro-prudential measures at these two sources of inflation over a period of some three years. Since 2010, we have adopted a tight monetary policy stance, which means a gradual appreciation of the Singapore dollar exchange rate against a trade-weighted basket of currencies. That has yielded benefits, and last year, inflation came down to 2.5%. For the first four months of this year, inflation has been below 2%. I don’t think it will stay below 2% for long, I think it is going to creep up back to about 2.5%, and that’s because of the transition the economy is going through right now adjusting to a slower growth in labour force.

Is that due to structural factors in the labour market?

We are reducing our dependence on foreign labour and have also seen a marked slowdown in the growth of the indigenous labour force. Both of these factors have combined to create a structural shortage of labour, putting upward pressures on wages. Until we complete a transition to a situation where more growth will come from productivity rather than labour, we are going to have to accept a slightly higher rate of inflation. This is an important exercise in communication: we are not letting go of inflation, but the 2% we have experienced in the past 20 or 30 years, we are not likely to see for the next five years or so. We will have to accept a slightly higher rate of inflation, of about 2.5%. But we have no intention to allow inflation to shoot up back to what we experienced over the last three years. We need to sustain the inflation control we have achieved going forward, which is why we have kept monetary policy on a tight leash, anchoring inflation expectations around 2.5%.

Do you view the exchange rate policy, combined with macro-prudential tools as the most effective regime for Singapore during the next five to 10 years? 

We definitely have to remain focused on the exchange rate as our instrument of monetary policy, managing inflation expectations and keep inflation under control. There will be periodic bouts of price pressures in specific sectors, where we need to take a more targeted approach. The macro-prudential policy toolkit will likely be a permanent feature of most central banks. ‘Do I think they will be used as forcefully and as extensively as they have been used in the last few years, looking into the future?’ I am not too sure. As global conditions normalise, there will be less need to use them but it will be good to keep this toolkit.

The international community is still in the early stages of creating a framework to assess the strengths of certain macro-prudential tools. What are your thoughts?

Macro-prudential policies are not a substitute for sound macroeconomic, monetary and fiscal policies. We are traditional in our view that monetary policy should remain focused on price stability and not try to chase too many other objectives and targets. But the central bank cannot ignore the broader dimensions of macroeconomic stability, which includes what is happening in the asset markets, and its implications for both price stability and financial stability. This is where macro-prudential tools come in handy, as a complement, rather than as a substitute, for monetary policy. To ignore their use would be to deprive oneself of an additional degree of freedom in trying to meet multiple objectives.

Do you have any lessons you can share?

The traditional understanding of macro-prudential policies, especially in advanced economies, is in terms of counter-cyclical capital buffers. Counter-cyclical capital indeed plays a useful role, but I am not sure they are sufficiently potent in being able to reign in asset market bubbles. Empirical studies and anecdotal feedback from banks indicate that changing the risk weights or raising the capital floor in a booming real estate market characterised by very keen competition, is not going to change pricing decisions a great deal, so capital measures will not have the desired effect. We need to use prudential tools and limits but in a much larger macro context. Traditional tools such as loan-to-value ratios, loan tenure limits, debt service ratios, debt to income ratios, would need to be dialled up considerably to be effective as macro-prudential measures. These prudential limits cannot be tweaked in small magnitudes to get the desired effect. 

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So very forceful measures are needed?

The scale of expansion in global liquidity and the consequent asset price booms that many Asian countries have faced suggests that macro-prudential responses would have to be quite forceful. We have learnt this from our own experience, having done several rounds of property market cooling measures. The first few measures were largely ignored – they did not make a real difference in sentiment or demand, and lending decisions. It was the accumulated effect of several rounds of these measures, and getting the calibration right, that finally turned sentiment, and stabilised the property market. Property prices have been much better behaved over the last 12-18 months. But it took us some time to get there, partly because we are experimenting on the right calibration. We were conscious not to precipitate a collapse in the market as that would cause an entirely different set of problems.

Is there is a learning process also – once people realise you are serious about deploying calming tools, they may change their behaviour more quickly?

The conventional wisdom in Singapore is that since we were an island, land was scarce, and with the economy and population growing, land prices and housing prices could only go up – it was a one-way bet. That psychology was quite difficult to break. There was also the sense that the government does not want to see a dramatic collapse in prices – so if your downside was protected and your upside was likely to be high, that’s a psychology that strongly favours demand for property. So to be taken seriously, the measures needed to be harsh. The current measures we have, with a loan-to-value ratio (LTV) of 80% for the first property, 50% for the second property and 40% for the third property, really made a difference. Credit became especially tight for investors in the second and third property. The debt service ratio and the limitation of the loan tenure added additional dimensions to curtail demand. The combination of these measures provided some sanity.

Is there a need for co-ordinated efforts?

Yes. Another feature of the macro-prudential policy toolkit that is often not appreciated sufficiently is that, in addition to capital buffers and prudential limits on credit, you may also need fiscal measures. Not all asset price pressures are driven by credit, some are driven by liquidity. We have seen a lot of this in Asia. Many people do not need to borrow to buy a house, there’s just so much liquidity and wealth. LTV limits therefore do not bind them. So MAS worked with the Ministry of Finance to complement our measures with fiscal measures, such as property transaction taxes that applied to both the buyer and the seller. These taxes were dialled up progressively over the last three years, so you could pay as much as 15% upfront in tax to the government when you purchase a third property. That changed the psychology quite a bit, because there is now a 15% target price appreciation just to break even on the property purchase. 

Is forward guidance adding to the clarity of the message coming from central banks or potentially boxing them in when it comes to future policy decisions?

Central banks have always been in the business of communicating their intent in a forward-looking way. When we communicate exchange rate policy, we do that in a simple fashion, looking at the inflation and growth dynamics over the medium term, and then describing our intent for the next six months. Most central banks, in a traditional sense, were already doing some form of forward guidance. The forward guidance that has emerged post-crisis is one that tries to make future actions highly conditional on certain factors. It started with ‘time dependent’ forward guidance – namely, ‘we would not change rates until a point in the future’. That was found to be wanting, as central banks have to adjust monetary policy in response to data not to fixed calendars. So many central banks switched to ‘data dependent’ forward guidance. That is not without problems either, because the data chosen to anchor expectations, which you think at a certain point in time was a good description of where you wanted to get to, might not be quite the metric you are looking for when you actually get there.

Can you provide an example?

For instance, focusing on the unemployment rate has its drawbacks because the unemployment rate is not as comprehensive an indicator as what central banks are looking for in a recovery. So the Fed has had to broaden its guidance by referring to labour market conditions, which takes away the precision of the old forward guidance. Or one might reach the employment threshold and realise the economy is not quite at the point where you want to change course, which is what is happening in the UK. It is tricky business. I appreciate what the Fed and Bank of England are trying to do, which is to influence and anchor rates expectations so that there would be greater confidence to spend and invest, and thereby lift economic growth. But doing this is not without its challenges. There is also the danger that as you give more information, the appetite for even more information grows even faster and you are constantly playing catch-up.

So you are not looking to do it any time soon?

We don’t see a need. We are in quite a different situation.

Singapore has become an increasingly important financial centre over the past couple of decades. But more recently, are you growing due to growth in Asia or due to a tightening of rules in the US and Europe?

Most of the growth in Singapore’s financial sector is the result of being plugged into Asian fund flows, as a centre servicing the region and benefitting from the growth in Asia. On the tightening of regulation in the advanced economies, one needs to be more precise as to which areas. If you take banking, and capital and liquidity rules, we have always had higher requirements than prescribed by the Basel minimums and the levels set in many advanced economies. For years, we’ve had much higher capital adequacy ratio requirements and a risk-based minimum liquid assets regime for some time now. We also had a risk-based capital regime for insurance companies, long before Solvency II. So, the regulatory developments in the advanced economies are coming up to where we would like to see the global standard, and it’s good that there is now a global consensus and a more level playing field.

What about for OTC derivatives?

The trading of OTC derivatives was previously unregulated the world over and proved to be a source of risk in advanced economies, particularly in the US. We have a massive global reform effort in that area, which will help to make global financial markets safer on balance. Asia is a step behind, and for a very good reason – the derivatives markets in this part of the world are much smaller and, more importantly, far less complex, and therefore pose less systemic risk. In Asia, we worry more about the safety of banks than about risks in OTC derivatives trading. But we are mindful that we live in a globalised economy, and if standards are raised elsewhere, you do not want flows of a highly risky nature coming here.

So, it is important that all of us collectively dial up our requirements on OTC derivatives. On that front, I do not see much shift in flows. If anything, our concern is the opposite. Will flows shift from Asia to Europe and America, because the central counterparty (CCPs) clearing houses are mostly in the UK and the US? If all trades are going to be centrally cleared, are you going to see a big migration in trading activity? Singapore does not place domestic jurisdictional requirements on where clearing takes place, only that trades are centrally cleared and that all relevant requirements like margining are met. But if most trades in a contract are cleared through LCH, would the trades also migrate? So you could see a shrinking of liquidity in certain financial markets in Asia, and this is a concern. We would like to see a world where there are several central clearing houses across jurisdictions, serving regional and domestic markets, for a better distribution of liquidity globally. But they must all meet the same global standards. 

And for fund flows linked to anti-money laundering, tax avoidance and so on?

There is a perception that as standards in these areas are tightened in the EU, centres like Switzerland, Luxembourg, Singapore and Hong Kong are likely to gain. That is not true. Established centres like Singapore and Hong Kong meet all the Financial Action Task Force (FATF) requirements. In the last FATF mutual evaluation that Singapore underwent, we were among the top five global centres in compliance with FATF requirements. But this is an area where the standards are continually being raised, so even as the standards for exchange of information are being raised in Europe, we are in a sense playing catch-up to meet those standards. We are conscious that we do not want a case where there is a flow of illicit funds from Europe to this part of the world. We are making sure that onboarding practices here are sound, and stepping up our own regime to keep pace with global developments.

When you look at the data for wealth management and private banking in Singapore, most of the growth has come from sources within Asia. The European share of private banking assets in Singapore has been relatively stable, despite stories you sometimes hear about funds being diverted to Asia. We are mindful that if an account is closed in Europe and opened in Singapore with the same bank, the entire onboarding procedure of robust customer due diligence is undertaken. You cannot just transfer an account. This sends the signal clearly that if the money is tax ‘non-compliant’, Singapore is not the place to come to.

Are you worried that US extra-territorial fines could hit Singaporean banks at some point?

Our banks have hardly got a presence in America. They are largely regional banks, and they have at best small rep offices in major jurisdictions in America and Europe. Apart from the Japanese banks, most Asian banks do not have a significant presence in the US, or even Europe. If offences were committed in the US by foreign banks operating in the US, it is within the rights of the US to take them to task. Although in banking supervision, actions taken are typically more discreet and of a supervisory nature rather than a criminal charge. The development that has worried some people is that banks are now being taken through the court process, which is different from how regulatory agencies usually handle these matters. The way most financial regulators, including the Fed, operate is to call in the errant bank, give it a dressing down, slap it with a capital charge, restrict some of its activities, ask for an audit report, and then watch the bank like a hawk to make sure the problems are redressed.  Large fines with publicity in newspapers is unsettling to some people.

You’ve had a number of operational problems with banks in Singapore. You publicly ‘dialled up’ the operational risk charge of DBS some years ago. Now Standard Chartered has had some data loss issues. What are you doing to address that?

Banks face operational risk events from time to time, and where these are due to lapses in controls and procedures, we would tick them off. These supervisory actions are almost always done outside the public glare. However, in the case of DBS a few years ago, their ATMs went down for a couple of hours and this created a fair amount of public disquiet. There was naturally public interest in what was being done by the regulator. So, atypically, we announced through a press statement that we were taking action against DBS Bank by imposing an operational risk charge and briefly outlined some of the supervisory steps we had taken. It was important to tell the public that we took this very seriously and DBS was not being let off lightly. But in most other cases when things go wrong and there is public interest, we say, ‘we are looking into it, we are taking action, but our dealings with financial institutions are confidential and we cannot say more’.

The Standard Chartered data theft last year was not quite on the same scale as DBS’s ATM outage in terms of impact, but was significant enough to generate public interest in knowing what was being done about it. So we put out a statement saying we were taking supervisory actions against Standard Chartered. We did not think we had to say more, as we did with the DBS situation, but we did say more than what we would usually say.

Singapore is an early adopter of Basel III. Is it robust enough?

We are happy the global minimum has been raised as it will help to make banking systems safer. It will also level the playing field a great deal and reduce the risk of arbitrage. We are generally happy with the Basel III process and have been actively engaged in it, working with other jurisdictions to help shape the outcomes. Is it enough? Well, capital and liquidity requirements on their own are not enough and financial regulators and supervisors need to watch over their banks closely. Much also depends on how well these standards are implemented and there is more work to be done on that front. There is also a need for consistency in the application of the rules. If the rules are not applied consistently, it undermines market confidence in the capital regime and in the banks themselves. The Basel Committee has done a very good job through the Regulatory Consistency Assessment Programme (RCAP) where they study deeply each jurisdiction’s application and implementation of the rules, to see if they are broadly comparable. This picks up on issues such as if risk weights are too generously applied.

So the issues around the implementation of risk weights and bank models are being addressed?

They are being addressed, but it’s going to take a while. The RCAP process is one of the ways in which it is being addressed. It is hugely laborious as it involves going into the innards of the system, not just looking at legislation but at actual models and practices, as well as the supervisory discretion applied. Second, there is the leverage ratio, which acts as a back-stop in case the risk weightings are dreadfully wrong and institutions end up being significantly under-capitalised relative to their risks. It is a good measure, provided it is calibrated appropriately. Third, there are industry efforts. There are proposals for a reference portfolio of assets, against which different banks can apply their models and derive their risk weights – which provides a common numeraire for comparison.  

How do you justify the high level of reserves that you hold?

The official foreign reserves that we keep on the MAS balance sheet are about 85–90% of GDP, so that is quite high by international standards. We think it is necessary because of the highly open nature of the economy and our exchange-rate centred monetary policy. Gross capital flows into and out of Singapore typically averages about 30% of GDP and our banking system assets are larger than GDP. The large reserves are a source of confidence in Singapore’s macroeconomic stability. But having large reserves does mean a higher degree of responsibility with respect to making sure they are well managed.

How well has the MAS managed its reserves in a climate of falling yields and an appreciating Singapore dollar? Are losses acceptable for the liquidity tranches?

Our reserves are managed fairly conservatively, with a strong focus on liquidity. So we are less vulnerable to the kinds of volatility and fluctuations you would see in typical fund managers’ portfolios. That is not to say that we will not face years in which returns can be affected by general market conditions but because of the conservative nature of the portfolio, the downsides are more limited. In the financial year 2008, we reported our first loss and that was due to investment losses occurring against the backdrop of a general decline across asset markets. But since then, we have made decent investment gains. Our portfolio is conservatively constructed so that, except in highly unusual circumstances like the market collapse of 2008, we should not be making losses. But currency translation losses, such as we experienced in the financial years of 2010 and 2012, where the investment return was positive but the overall P&L showed a loss, are a different matter. We do not worry about these currency translation effects, which has to do with the strengthening of the exchange rate of the Singapore dollar. So in our public communications, we make a distinction between our investment gains in their respective domestic currencies and the gains expressed in Singapore dollars.

Is that easy to communicate?

The analysts understand it quite easily – currency translation effects do not matter as the reserves are kept in foreign currency for the purpose of instilling confidence in the Singapore dollar and to finance obligations in foreign currency in a crisis situation. So the Singapore dollar value of the reserves does not matter. While it is more difficult to get this point across to the general public, we have been able to do so and it has not affected our credibility in any way. By the same token, when we have an exceptionally good year due to currency translation gains, we should acknowledge that this was mostly an exchange-rate effect and emphasise that the investment gains have not been extraordinary. 

You say you have a fairly conservative policy, mainly in very liquid assets that can be used in times of stress. But are you not also investing in less liquid instruments?

We have a diversified asset portfolio. Overall, it is conservative, with a strong emphasis on liquidity. But we have also an allocation to equities – although the allocation is much smaller than that of the Government of Singapore Investment Corporation or Temasek. Likewise, on the currency side, we are diversified across currencies. We do not disclose the percentage allocations to the various currencies. So, we do have allocations to less liquid asset classes and currencies, but we have several decision filters that we have to go through before we decide whether to invest in these asset classes or currencies.

How is the creation of a renminbi ecosystem in Singapore progressing?

ICBC started operating as a clearing bank in Singapore last year. That was a game changer, as the direct line to China provided the basis for growing renminbi liquidity here. We have seen good growth in renminbi loans and deposits since last year. We also want to see growth in renminbi investment instruments and the renminbi capital market. We have seen an increase in issuance of renminbi bonds, mostly by financial institutions but also by non-financial corporates. The next challenge is to have a more regular issuance by some of these players, so there is a more liquid market with a proper yield curve.

The other part of the ecosystem is trade financing. Being a major trading hub at the confluence of trade flows between China and South-east Asia, China and Australia and also China and Africa, and with a growing part of the China-South-east Asia trade being denominated in renminbi means there is good scope to grow renminbi trade financing out of Singapore. We are also seeing some active interest in commodities trades in renminbi, being the largest commodities trading centre in Asia, which is another piece in the ecosystem.

How has MAS been working with other Asean central banks to develop integration in the region?

We have good relations with the central banks in the region and we work closely on issues related to financial integration. Under the Asean Financial Services Agreement, for example, we are trying to create greater market access for insurance and banking, although banking is a more sensitive matter in many countries in the region. We have probably spent most effort trying to integrate capital markets. The capital markets in the region are too small relative to China and Japan. They need to be better integrated. The challenge is in making it happen. It is not as straightforward as reducing tariffs, which has been done very well, with most intra-Asean trade tariff free. Capital market integration is about attending to a wide variety of rules and regulations and streamlining and harmonising standards and processes. It is long-haul work. We’ve been at it for quite a few years. Initial progress was slow, but in the last couple of years it has stepped up pace, partly prompted by the 2015 deadline for the Asean Economic Community.

Do you think Asean will meet all the targets set out for 2015?

Not all. But we will meet most of them, and that will represent quite a significant improvement from what we had in the past. We are still nowhere near European levels of integration in capital markets, but small steps such as the Asean trading link takes us in the right direction, where you can actually open a trading account in Singapore and use the account to trade Malaysian and Thai stocks. It is a small step, and there are still issues of post-trade services that need to be integrated, so you are only getting half or one-third of the potential benefits of integration. It is something that we have got to keep working at.

 

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You mentioned banking integration was more sensitive. Was the failure of DBS to buy Bank Danamon in Indonesia due to issues about reciprocity?

Yes, reciprocity was an issue. We all operate quite different banking regimes. Unlike in Europe, we do not have and are not ready for a single passport system where you can branch freely across borders. There are still licensing requirements and admission requirements that vary from country to country. We are fairly liberal in allowing foreign banks to operate in Singapore to carry out offshore and wholesale business, but are more selective in our admission criteria when it comes to taking retail deposits. All regulators owe a special care of duty to domestic depositors. In a small country with many foreign banks operating as branches, we have little protection if something went wrong. Differences in the nature of the banking industry are among the issues that need to be sorted out between the two countries. 

Is there an effort to narrow the gap?

There is an Asean Banking Integration Framework Initiative (ABIF), over which there is close agreement. Active discussions are ongoing and we hope that an agreement can be concluded in time for the Asean Economic Community next year. It is not a single passport but it will make it a lot easier for banks in the Asean economies to set up operations in one another’s jurisdictions, with some degree of reciprocity, some degree of recognition, and some preferences given in market access, while safeguarding prudential standards.

Does a common passport require a common regulator?

Europe is now being prompted to go in that direction with a common supervisory mechanism, a common deposit insurance mechanism, and a common resolution mechanism. You need all three, if you have free branching of financial institutions across the region.

Will the new bank, insurance and pension regulations in combination hit long-term financing activities in Asia?

This is indeed an area of some concern. The new bank and insurance regulation globally makes a lot of sense from the prudential risk perspective. You do not want to compromise in this area, taking to heed the hard lessons of the last crisis. Rules should be calibrated based on the risks that activities pose. But when these rules are taken together cumulatively, they do challenge the ability of the financial sector to support some kinds of long-term economic activity. On the bank side, the capital and liquidity requirements for project finance are going to get tougher – and rightly so. Cross-border project finance of a long-term nature is inherently risky. From a micro-prudential standpoint, it is appropriate that there is a higher risk charge. But that means we have to think of new ways to promote the right-siting of capital to support infrastructure financing.

Is there a solution?

Banks are more suited to initiate project finance loans because they have the expertise on specific industry areas, such as energy or telecommunications.  The problem is they cannot keep these assets on their books for long. With the introduction of the net stable funding ratio liquidity reforms, they are going to find it even more difficult, as they normally do not have matching long term liabilities. So we need to create a capital market ecosystem for long-term financing, where exposures can be offloaded from the banks’ balance sheets to private investors, either through securitisation, project bonds or other mechanisms. The key is to make this an investable asset class to pension funds and insurance companies that are looking for long-term assets to match their long-term liabilities. Unfortunately, many of these project finance loans are not structured in a way that enables long-term fund managers to buy them readily off the shelf. The key is to structure the loans in a way that can allow them to be transferred, securitised and packaged, so that they can be bought by investors. We are working hard with the World Bank and other players to get the upstream structuring of these project finance loans right, so that later on, they can be transferred to capital market players.

What about problems from insurance regulation?

For insurance regulation, there is a movement towards the matching-adjustment principle. It involves matching long-term assets and long-term liabilities, so you do not have too high a capital charge for your long-term assets because you have a matching adjustment.  With this principle, we hope insurance companies will not be overly constrained in being able to invest in long-term assets. So there are a variety of things that we are doing to make sure the meaningful micro-prudential regulatory reforms that have been done do not unwittingly constrain long-term financing. The solution does not lie in relaxing prudential standards, it lies in creating an alternative ecosystem that can better distribute the risks to support long-term financing. 

Do you expect any positive results in the next year or so?

I am heartened by the progress we have made in the past year or so. It used to be that all long-term financing discussions started and ended with an observation that there is not enough money. Actually, there is a lot of money. The problem is that there are not enough bankable projects, projects that are structured in a way that allows this money to be invested. Sovereign wealth funds, insurance companies and pension funds are interested and are looking for long-term assets and yield. At the moment, it is too risky for them to invest their money in most infrastructure assets. But if we can get the structuring right, including portability of guarantees, then these assets become attractive. We will not be able to join all the dots by next year, but we will keep at it.

There were a number of senior management changes at the MAS this year. Why is that?

We are one organisation with four distinct functions: monetary policy, reserve management, financial regulation, and financial development. In most countries these roles are carried out by at least two or three different organisations. As a small country, we need to optimise our resources and I see strong synergies across these areas. But to realise the synergies, people need to be exposed, especially at the leadership level, to the different functions. So we have periodic moves of our senior management across different areas, to give them broader exposure. The second element is about renewal, which is to allow people to come up through the ranks. If you do not make a conscious effort in this, the tendency is that people stay in their positions for too long. So we need to continuously engineer this and move people up.

So there’s no restructuring going on?

There are always minor restructurings, like minor repairs to a house. We have made some changes on the capital market side – for instance, we did not have a division for OTC derivatives trading before, for the simple reason that there was no OTC derivatives regulation in the first place. But now we do. It is important that organisations do not stand still when the environment around them is changing so much. Rather than waiting many years to make a major overhaul, which can have a huge impact on people, it is better to make incremental changes every couple of years to keep up with developments. 

Do you think money should remain the preserve of central banks and why have you moved to regulate the virtual currency intermediaries in Singapore?

The first part is an existential question. It is hard to divine how technology and practices will evolve, 20 or 30 years from now. I would say virtual currencies have a role to play, but I doubt they will replace the fiat money that central banks issue – but I could be wrong. The great advantage I see in virtual currencies is that they make for very cost efficient and fast transfers. But they have no central bank backing. Also, if the value of this virtual money fluctuates a great deal, it does not meet the basic requirement of money as a store of value.

Nonetheless, digital currencies have a role to play, which is why we have not sought to ban them, or make it more difficult for them to operate. We still have Bitcoin ATMs here in Singapore. But we do see a clear and present danger in the form of money laundering and terrorism financing risk, because of the anonymity in virtual currency transactions. We have announced our intention to put in place regulation that will apply AML/CFT requirements – such as ‘know your customer’ – for all virtual currency intermediaries. Some of the intermediaries have welcomed regulation because it makes them more respectable and will weed out intermediaries that use virtual currencies for illicit purposes. So, while there is reason to be cautious about the risks, we have chosen to address these risks in a targeted way so that innovation can continue to take place.

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