How to strengthen Asia’s financial safety net
Past financial crises have demonstrated how adequate financial safety net arrangements—globally, regionally, and nationally—are vital to safeguarding financial stability.
Financial crises over the past two decades have underpinned the need for an adequate financial safety net to shore up market confidence during times of financial stress. An extended period of high growth in East and Southeast Asia was abruptly punctuated by the 1997/98 Asian financial crisis as a banking and currency crisis pulled the plug on high performing Asian economies. In response, the region’s policy makers adopted a wide array of reforms, including more flexible exchange rate regimes, stronger financial regulation and supervision, and enhanced regional cooperation to uphold financial stability and resilience. However, a decade later, the unfolding 2008/09 global financial crisis vividly illustrated no region and country can be shielded from spillovers of shocks permeating through tightly woven global financial networks.
As previous episodes of financial stress have illustrated, national crisis response mechanisms alone are insufficient to deal with a crisis that spreads rapidly across borders. As a result, the global financial safety net has evolved to encompass multiple complementary layers, comprising foreign exchange reserves at the national level, central bank swap lines at bilateral level, regional financing arrangements at regional level, and the International Monetary Fund (IMF) assistance at the global level. Unfortunately, recourse to IMF financing may be associated with a political stigma. Consequently, regional mechanisms to shore up market confidence, financial resilience and stability have emerged as increasingly relevant layer of additional support.
In the aftermath of the Asian financial crisis in 2000, the Chiang Mai Initiative was formed as a network of bilateral swap arrangements – essentially providing a regional pool of monetary resources that could be used to address short-term liquidity problems of countries in the region without having to seek IMF assistance. The global financial crisis in 2007/08 expanded the Chiang Mai Initiative into the Chiang Mai Initiative Multilateralization (CMIM). Established in 2010, it functions as a single multilateral contractual arrangement among ASEAN+3 economies. It currently has a lending capacity of $240 billion and is supported by the associated ASEAN+3 Macroeconomic Research Office responsible for economic surveillance during normal times.
Aside from providing an additional layer of needed liquidity, regional financing arrangements can further provide a more timely, targeted, and flexible response, as they are more familiar and have developed greater expertise with a strong understanding of the specific regional context. They have also developed strong country engagement which provides a solid foundation for regional policy coordination in risk identification, mitigation, and response.CMI = Chiang Mai Initiative, CMIM = Chiang Mai Initiative Multilateralization, EFSF = European Financial Stability Facility, ESM = European Stability Mechanism, FLAR = Latin American Reserve Fund (Fondo Latinoamericano de Reservas) IMF = International Monetary Fund. Source: ADB (2019).
Multilateral development banks play an important role in stabilizing the region’s economies during times of crisis and shoring up economic and financial resilience. An example of this includes providing support as part of a large international rescue package coordinated by the International Monetary Fund. In addition to providing a complimentary source of liquidity assistance, ADB’s support is grounded in its regional expertise, while also circumventing any stigma that might be attached to seeking IMF assistance.
Policy-based lending provides budget support to incentive good policies through structural reforms. In addition to conventional policy-based lending instruments, facilities tailored for crisis response were provided by ADB and other multilateral development banks after the Asian financial crisis and the global financial crisis. Past crisis episodes further triggered the finetuning of such crisis response toolkits.
In general, policy-based lending offers both crisis management and prevention functions, seeking to address the negative impacts of financial crises in the short term while enhancing an economy’s financial resilience to weather future financial episodes in the longer term. In the case of ADB, policy-based lending support has been concentrated in strengthening public sector management programs to limit the adverse social impacts of financial crises and in support of financial sector and capital market development to strengthen financial resilience in the long run.
While a multilayered financial safety net system is increasingly vital to safeguarding the region’s financial stability and resilience amid increasingly integrated financial markets, past crisis experiences have highlighted the need for a coordinated response.
First, strong coordination and a regular review, revisiting, and realignment of regional financing arrangements and multilateral development bank instruments is needed to ensure that support remains relevant, complementary, and most effective. This is particularly important in light of emerging challenges, such as growing economic and financial interdependence across borders or rapid advancement of financial technology which could create new risks. Regional development banks can moreover lead these policy discussions and knowledge exchange, and thereby help strengthen the region’s capacity to safeguard financial stability.
Second, regional dialogue and cooperation is essential for strengthening both ex-ante crisis-prevention measures—particularly, through regional economic monitoring and surveillance—and ex-post crisis-support mechanisms, for example, through enhancing the effectiveness and operability of the Chiang Mai Initiative Multilateralization. A key priority is to strengthen the surveillance function and capacity of the ASEAN+3 Macroeconomic Research Office in normal times to more effectively monitor potential liquidity risks and prevent an outbreak of financial volatility.
At times of financial crises, the enhanced operability of the Chiang Mai Initiative Multilateralization can translate into a more effective response to financial instability. In particular, several options can be considered for this. First, funding capacity of the Chiang Mai Initiative Multilateralization can be increased, for example through paid-in capital and subsequent issuance of bond. Second, ASEAN+3 member countries may consider increasing the IMF de-linked portion of the Chiang Mai Initiative Multilateralization, in line with growing ASEAN+3 Macroeconomic Research Office’s surveillance capacities. Third, the ASEAN+3 member countries may consider broadening the role and mandate of the Chiang Mai Initiative Multilateralization over time to strengthen regional financial regulatory cooperation.
For example, the ASEAN+3 member countries increasingly face challenges of monitoring and regulating activities of regionally active, systemically important financial institutions. In case financial trouble with these institutions poses systemic risks to the region’s financial markets and institutions, the Chiang Mai Initiative Multilateralization may have financial resources to inject capital and prevent the situation from developing into a full-blown crisis.
Finally, systemic and seamless coordination between the IMF, ASEAN+3 Macroeconomic Research Office, and ADB is necessary to ensure that regional crisis support and funding are most effective during times of crisis. This will also be in line with the G20 Principles for Effective Coordination Between the IMF and Multilateral Development Banks in Case of Countries Requesting Financing While Facing Macroeconomic Vulnerabilities which was laid out in 2017.
In addition, regular dialogue and close coordination between ADB and the IMF can help to ensure consistent policy signaling and can highlight potential areas for cooperation. More generally, the linkage of the Chiang Mai Initiative Multilateralization, ASEAN+3 Macroeconomic Research Office, and ADB lending with the IMF can help reduce moral hazard risks, and contribute to a more effective financial safety net, thereby enhancing financial stability and resilience in the region.