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Systemic risks are far less than in 1997, yet much can go wrong

In some boardrooms in Seoul, people remember how a storied Wall Street name came to the brink of buying the credit card division of Korea Exchange Bank (KEB) in 2001, then walked away at the last minute. KEB had been a victim of the Asian financial crisis and had to sell off part of its assets. Now, scrubbed back into health, some of those assets were on the table but the Wall Street bank wasn’t satisfied.

This month, the boot was on the other foot.

Lehman Brothers, a 158-year-old icon of American capitalism, was on the block. But the chill winds blowing from Wall Street gave the managers of Korea Development Bank, led by a man who once ran the Lehman business in South Korea, reason to pause. In the end, they walked away from the deal.

Similarly, Korea Asset Management Co decided not to buy some loans on the books of Merrill Lynch & Co.

On Sunday, Lehman went bust and Merrill was rescued by Bank of America.

‘There was a time when the Americans used to hammer us,’ says an Asian investment banker who was part of the KEB negotiations in 2001. ‘They talked down to us on transparency, on the need to enhance shareholder value, on strengthening boards and other best practices. Now, all that has blown up in their face.’

Asia itself has come a long way since the crash of South Korea’s Hanbo Steel signalled the start of its economic and financial meltdown in 1997. Outside of Japan, economies are still expanding briskly, though the pace has slowed. Its banks are in better shape. The loan books are cleaner and few here have any significant exposure to the sub-prime crisis.

Unlike in 1997, most notably in Thailand, short-term foreign currency debt is also moderate. Except in the odd case like Pakistan, foreign currency reserves are strong. South Korea had just US$9 billion (S$13 billion) in reserves at the end of 1997. Last month, it had more than US$240 billion.

Systemic risks, therefore, have greatly eased.

Yet much can still go wrong, if only because of the enormity of the financial tragedy unfolding in the United States and the impact of that US$10 trillion economy on the rest of the world.

‘What we are witnessing on Wall Street is a once-in-a-lifetime event,’ says a senior Singapore banker.

‘It is too early to tell how much we in Asia will be affected. Most of us have cleaned up our balance sheets and improved risk management but then, a lot of banking is also interrelated.’

Others worry that Asian financial institutions are too prone to ape some of the intricate financial industry practices of the West, such as credit default swops.

While such tricky manoeuvres hold forth the promise of massive reward for the banks and for the experts who put them through, there is fear that this may sometimes be happening at the cost of massive risk to the institutions themselves.

Some analysts think that Asia, after beavering away at improving its banking and regulatory standards post-crisis, may have got a trifle complacent about protecting the larger economy.

For one thing, many governments failed to build up domestic spending enough to cushion themselves against a drop in demand in their top market - the so-called G3 economies comprising the US, European Union and Japan.

The Asian Development Bank (ADB) took note of this in its latest Outlook, released this month.

‘Asia remains heavily dependent on the G3 for its major export markets and has not uncoupled from industrial countries’ business cycles,’ the ADB said. ‘That uncoupling is a myth.’

With demand dropping off in the G3, export-led Asian economies are having to fight harder to grow.

China’s recent cut in interest rates is an effort to sustain the double-digit expansion that has helped lift living standards for millions of its citizens. Indeed, some analysts think The People’s Bank of China’s move signifies a ‘recoupling’ with the US Federal Reserve.

‘It is too late for this cycle for Asia to consider decoupling Asia from the G3,’ says Dr V. Ananth-Nageswaran, head of strategy for Bank Julius Baer in Singapore. ‘But never too late for the next cycle.’

Optimists will hope that the Lehman-Merrill episode may be the trough that spells a reversal of the current turmoil in the global financial edifice.

But even as their own financial institutions are vastly stronger now than a decade ago - much of the cosy relationship between conglomerates and their banking arms has been unwound, for instance - Asian investors are bound to worry.

Lehman’s biggest unsecured creditors include a host of Asian companies with names like Sumitomo Mitsui, Mizuho and Bank of China.

Yesterday, there were lines in front of the Singapore offices of AIA, the subsidiary of giant insurance company AIG that is seen as the institution most at risk now, particularly after a ratings downgrade.

Many Singaporeans wanted to dump their AIA insurance plans, even though the Monetary Authority of Singapore (MAS) has said AIA’s Singapore funds are segregated from the parent company’s. The regulator had also advised Singapore customers to avoid acting ‘hastily’.

Like MAS, other Asian regulators and the industry under their supervision should probably be ready with damage control measures, even if the crisis is not of their making.

Looking out on the carnage on Wall Street, it is hard to imagine that Merrill’s famous bull logo will disappear from the world’s financial markets.

Goes to show perhaps that when a herd stampedes, even the sturdiest animal has to yield. And that is why much more could still go wrong.

Source : Straits Times - 17 Sept 2008