Responses and Reforms to the Global Financial Crisis session at 12th International Conference

1. Financial Instability, Regulatory Reforms and
Bank Governance
- Lessons from the East Asian Financial Crisis
Srinivas Yanamandra

2. Background
• Project funded by ICICI Bank India
– To review international best practices of bank governance
• International best practices of bank governance subject to debate
– Post the 2007 financial instability that impacted global banking
system
• Debate narrows down to two alternative schools of thought
– Stability school, which argues markets are self-correcting,
equilibrium seeking entities that need not be subject to regulation
– Instability school, which views crisis as a result of endogenous
destablising nature of bank finance calling for greater bank
regulation

3. Conceptual Framework
• Stability school’s explanation to crisis is ineffective
– Focuses on monetary policy than regulatory powers of central bank
• Minsky’s Financial Instability Hypothesis offers alternative views
– Stability in markets is a destabilizing force
• With phases of regulatory capture, regulatory relapse and regulatory escape
– Bank finance introduces endogenous destabilizing forces in economy
• As the regulatory escape is accentuated by financial innovation
– Regulation should be viewed as a thwarting force
• To steer the evolution of financial structure with new initial conditions
• However, implementation of regulatory reforms is a complex task
– In view of ownership & management structures, information
asymmetries & risk management & incentive structures,
competition scenario, moral hazard and forces of globalization &
financialization
See: Rajan (2005), Kregel (2007), Bezemer (2011), Black (2010), Cooper (2010), Roubini (2010), Dymski (2010),
Keen (2011); Laeven & Levine (2008), Adams & Mehran (2003), Diamond (1984), Viral et al (2009), Allen & Gale
(2000), Alexander et al (2006), Kaminsky & Reinhart (2000), Froud et al (2002), Erturk (2003)

4. The Research Question
How does the pursuit of agenda of regulatory reforms, post the crisis, influence
governance arrangements at banks and assist them in maintaining resilience
during subsequent episodes of financial crises?

5. Research Methodology
• East Asian financial crisis used as the contextual setting, as it spans
– 15 year period (1993-2008) of growth-crisis-recovery-resilience
• Comparative case-study adopted as methodology, as it brings out
– Real-world complexities and institutional dynamics involved
• Implementation considerations
– Fieldwork countries: Thailand, Indonesia, Malaysia and Philippines
– Based on World Bank reports and review of other academic sources
– One bank in each East Asian nation taken as case study bank, based on
– Current stature and diversity (contextual, ownership & partnership)
– Fieldwork interviews carried across a mix of
– Case study bank officials (such as heads of risk management, internal audit,
compliance, corporate banking); and
– Industry officials (such as officials from regulatory agencies, consulting firms,
international financial institutions and rating agencies)
See: Radelet & Sachs (1998), Krugman (1998), Warr (2003), Stiglitz (2002), Fischer (1998), Adams (2008),
Mohanty & Turner (2010), Yin (2003), Hartley (2004), Bryman and Bell (2007), Flyvbjerg (2006), Akamatsu
(1961)

6. Key Research Findings (1)
• Favorable macro-economic environment prior to 1997
– Minsky’s hypothesis applies to East-Asian context
• Characterized by stable exchange regime and robust economic growth
• Policy and institutional mistakes led to weak regulatory oversight
– However, instability in emerging economies is not only endogenous
• Should factor additional aspects like global macro-economic perspectives,
political considerations, impossible-trinity principle
• Involves dynamics of panic dimension and contagion phenomenon
• Regulatory reforms post 1997
– Existing literature focused on review of Compendium of Standards by FSF
• Focus on independence of central bank and role of direct market discipline
– Research project further highlighted
• Enhanced usage of indirect market discipline (viz., through external auditors)
• Capacity building through regional co-operation (viz., SEACEN)
• Focused accumulation of foreign exchange reserves (viz. Chiang Mai Initiative)

7. Key Research Findings (2)
• Regulatory focus on risk-management
– Existing literature on regulation place emphasis on capital adequacy
– Minsky’s agenda focuses on regulating supply of credit growth
– Research project highlighted East-Asian regulatory focus on
• Building risk-management expertise of bank directors (viz., FIDE in Malaysia)
• Enhancing the credit appraisal standards of banks (viz., relating to cash-flow assessment
(Malaysia bond-market experience) and collateral valuation (IFC consultant experience in
Philippines)
• Stability through industry practices (Thailand real-estate agent escrow a/cs)
• Corporate un-hedged foreign currency exposure (Indonesia derivatives rules)
• Regulatory approach to financial innovation
– Minsky advocated regulatory mechanisms to handle financial innovation
– Research project highlighted East-Asian regulatory focus on
• Process innovation for efficiency; not on product innovation for growth
- Bank Baht experience with its strategic partner
• Augmenting risk skills of banks/corporate for handling financial innovation
- Bank Rupiah experience with its regulator

8. East Asian Resilience – A Minskian analysis
• Alternative arguments for East-Asian resilience in existing literature
– Improved bank governance vs. structural changes in macro-economy?
• Minskian agenda of regulatory reforms helps in integrating these views
• Regulation acted as a thwarting force against
– Endogenous destabilising forces and Global macro-economic forces
• Regulation steered evolution of a new banking business model
– Focused on domestic market, local funding, process efficiency
• Regulation thus facilitated improvements in bank governance
– As well as enhancing expertise at bank boards/senior management
• However, long-term sustainability of this model to be evaluated
– Challenges exist in terms of nurturing financial innovation, credit
information sharing, and impact of foreign flows

9. Policy implication
• Regulatory reforms in emerging economies to focus on creating
awareness of economic responsibilities
– At regulatory agencies
• By focusing on: central bank info-systems, capacity building, un-hedged
forex exposures, forex reserve management
– At banks
• By integrating risk management & governance with business strategy
– At corporates
• By promoting wider choice of hedge-financing options
• Pointers for further research
– Dynamics of Regulatory governance
– Bank Regulation as a proxy for Central bank communication
– Cash-flow analysis of borrowers for bank supervision/credit
assessment

10. Thank You
(dryanamandra@gmail.com)