An integrated banking framework of the future: Can ASEAN avoid Europe’s mistakes?

Photo: Gunawan Kartapranata/CC BY-SA 3.0

As ASEAN works towards its ASEAN Banking Integration Framework goal, it is at risk of walking straight into the same traps as the EU did.

By Oliver Ward

Indonesian bank, Mandiri, looks set to become the first ‘Association of Southeast Asian Nations (ASEAN) bank’ operating in Malaysia. The state-owned bank was granted a status as a cross-regional lender and has announced plans to begin operations in Malaysia. The move is a major stride towards the Asian Development Bank’s goal of achieving an ASEAN Banking Integration Framework (ABIF) by 2020.

Financial integration is the last stepping stone

In 1997, 30 years after the birth of ASEAN, the Heads of States gathered in Kuala Lumpur and hatched their plan ASEAN Vision 2020. The plan outlined closer economic integration, with the “free flow of goods, services and investments.”

We are now 20 years down the road and so far, only services and goods have been “free flowing”. Global and local banks hold far more assets in Southeast Asia than regional banks. Just 9% of Malaysia’s bank assets are held by other ASEAN banks and in Indonesia the figure is 15%. In Singapore, national banks still control 80% of assets in the country.

Indonesia and the Philippines are making strides

Mandiri met the criteria to become a Qualified ASEAN Bank (QAB). They had sufficient capital and passed screening from monetary authorities in accordance with a bilateral agreement between Malaysia and Indonesia. QAB status gives Mandiri the same advantages as local Malaysian banks. QABs will receive preferential treatment over international banks operating in ASEAN, in hopes that this will spark competition in the banking sector and allow ASEAN banks to take a larger share of the banking market.

Indonesia has a fragmented banking sector. The three largest banks in the country only control 35% of assets. Banking penetration is poor among the population, leaving ample room for expansion. As a result, there is a great opportunity to establish an ASEAN conglomerate in Indonesia.

Indonesia has been making strides towards the ABIF goal. In 2016, after an agreement was reached with Malaysia, two Malaysian banks received QAB status and began operating in Indonesia. In June of 2017 the Financial Services Authority in Indonesia (OJK) began negotiations with the Banko Sentral ng Pilipinas (BSP) in the Philippines to explore the possibility of reaching a similar bilateral agreement.

The BSP has also unveiled plans to sign bilateral agreements with all five founding members of ASEAN this year. Armando M. Tetangco Jr., Central Bank Governor, said they would begin talks “in the next few months”.

Further financial integration will bring a host of opportunities

Not only is the goal to ease trade and investment across the region, but also to increase equality across the region. ASEAN nations are at different levels of economic and financial development. Granting all countries access to shared financial services and technology will increase economic development in less developed nations.

At the moment, less developed countries like Laos have high interest rates — a serious barrier to economic development. Laos has a lending interest rate of 22.6%, the highest in ASEAN, while Singapore and Malaysia have rates of 5.4% and 4.6% respectively. Increased banking integration would increase the competition in countries like Laos and drive down the interest rates. It would therefore allow more credit opportunities for Laotian businesses and stimulate economic growth.

Other fully integrated financial markets have reaped the benefits. In the European Union (EU) for example, more financial integration bought more economic stability and less inflation. Greater price transparency has allowed increased competition in their financial markets and has broken the hold of non-EU banks in the region. At the start of 2016, credit lenders from Austria, France, Germany and Italy made up 70% of EU lending, with non-EU lenders taking just 10% of the market.

Does Southeast Asia have the conditions to reap these benefits?

While the EU has reaped a fair share of benefits from financial integration, the conditions in Southeast Asia are not the same as those in Europe. One concern with increased financial integration is that rather than promote equality, it would only further reinforce inequality.

The European model allows only new countries with a stable political system and minimal corruption to join the market. In ASEAN, political instability and corruption in the region might lead to funds moving to countries with more stability and less corruption. This may mean countries like Singapore, Malaysia and Thailand taking the lion’s share of the benefits and leaving other, less stable nations behind.

Another challenge which will need to be addressed is differing financial regulations across ASEAN nations. Differing levels of deposit insurance, for example, would hinder the process of banking integration and stop QABs from competing on a level playing field.

Learning from mistakes and avoiding the same risks

Though the EU financial integration brought with it a fair share of benefits, ASEAN will also need to avoid the traps that the financially integrated systems in the EU fell into. The Eurozone crisis in 2009 crippled the EU. It showed that with more financial integration, more financial regulation is essential. National supervision is not enough to avoid the risks posed by a single banking market. ASEAN member states do not usually endorse super-national bodies and regional regulatory bodies as they feel it erodes their national sovereignty. However in this instance, failure to do so would leave the market open to abuse and open the region up to the possibility of a severe financial crisis later down the road.

These challenges need to be addressed

In the same way as in the EU, before a state can join the integrated market, they will have to be politically stable and corruption has to brought under control. Without this assurance, the adoption of an ABIF will not tackle inequality and underdevelopment but instead worsen it. Finances from less politically stable countries will be funnelled to more stable areas of the region and inequality will flourish.

The aim of the ABIF is to enable regional banks to compete on the same level as local banks. It is thus imperative that participants in the ABIF should meet a uniform set of criteria for joining the framework. Apart from ensuring equality, introducing a shared set of banking rules and regulations would address the issue of differing regulations in each state and remove the current barriers to financial integration.

Finally, ASEAN needs to install a super-national regulatory body. The eurozone crisis showed the world the potential pitfalls of financial deregulation. An ASEAN-wide financial governing body could spot potential disasters before they occur and modify regulations to avoid a crisis. It would also offer a solution to cross-border financial disputes and promote a level playing field across the region.

Once these issues have been addressed, ASEAN can build a fully integrated financial market stronger than any model in existence today. But, it will not be easy to get all the states to agree to a super-national regulatory body.

Without addressing these challenges, ASEAN is dragging itself down the same road as Europe did in 2009 and will emerge from it more fragmented and divided than ever. For the sake of ASEAN’s future, leaders need to invest in cooperation now.