Financial Innovation in East Asia
| Publication year | 2013 |
I. INTRODUCTION
Financial innovation has been defined as both the "technological advances [that] facilitate access to information, trading[,] and means of payment. . . and to the emergence of new financial instruments and services, new forms of [organization,] and more developed and complete financial markets."(fn1) While financial innovation has traditionally been associated with economic growth and development, the financial crises of the past decade have revealed the significant risks posed by innovations in the absence of adequate regulation. It is now clear that financial regulation must balance risk with innovation in order to maintain financial stability and support economic growth. This pragmatic approach to financial regulation was adopted in East Asia following the Asian financial crisis and is arguably one of the greatest financial innovations of the past decade. It is essential that such an approach be maintained in East Asia, and the West should be encouraged to look to and learn from the successes in East Asia as it attempts to recover from the global and European financial crises.
In the two decades prior to 2007, financial innovation was viewed in most countries as a desirable objective worthy of policy support. Institutional development was particularly encouraged-specifically law reform, deregulation, and financial liberalization. During this period, finance in Asia was generally viewed as suffering from a lack of financial innovation, with repressed markets and underdeveloped institutional infrastructure, particularly in the realm of law and regulation.
Since 2007 and the onset of the global and "Eurozone" financial crises, the general view of financial innovation has become much more nuanced. Financial innovation is no longer seen as universally desirable, particularly as many innovations of the preceding decades played a central role in the global financial crisis. Financial systems that had previously been characterized as suffering from excessive regulation and insufficient innovation, such as those of Canada and Australia, performed far better during the crisis than the highly innovative financial systems in the United Kingdom and United States. Likewise, while the financial systems of East Asia had been viewed as insufficiently innovative, they suffered relatively minor financial crises in comparison to the United States and Western Europe. As a result, views of financial innovation have changed significantly in a short period of time.
This Article considers the role of financial innovation in the past, present, and future development of East Asia. It begins with the question of whether, in fact, East Asia can be characterized historically as suffering from a lack of financial innovation. While East Asia has certainly been the source of many significant financial innovations historically, it is most commonly seen as having generally lacked innovation in the period since the World War II. We argue that this characterization is not entirely accurate and that, in fact, East Asia has continued to innovate in finance during this period. At the same time, perhaps one of its most important innovations has been an approach to finance that is both cautious and focused primarily on supporting real economic activity, particularly in the wake of the Asian financial crisis of 1997-1998. This pragmatic approach to financial innovation is largely responsible for the region's resilience during the global financial crisis.
From this background, we consider financial innovation in East Asia's future development. Given that finance in the individual economies of the region tends to be dominated by large domestic banks that often focus their lending on large firms, there is a clear need for alternative sources of funding. This is the area where financial innovation matters most for East Asia going forward. Specifically, we identify five areas where East Asia needs to focus on supporting innovation in order to maintain financial stability and also support economic growth and development: trade finance, mortgage markets, SME finance, non-bank finance, and mobile financial services. In each of these areas, innovation based on local circumstances and needs is vital to support financial stability and growth across the region.
II. FINANCIAL INNOVATION IN EAST ASIA'S DEVELOPMENT
Financial market professionals and various scholars have frequently characterized finance in East Asia as being insufficiently innovative.(fn2) Under this characterization, East Asia has been a "taker" of financial innovations from the West, usually receiving new financial strategies and techniques third-hand after their development in the United States and successful spread to Western Europe. Only at that point did Western financial institutions and professionals export successful techniques to East Asia in search of new opportunities for profit. That characterization, however, is historically inaccurate.
The Asian economies, particularly prior to the industrial revolution in Western Europe, were the source of some of the most significant historical financial innovations: Marine insurance and ship finance came from the Phoenicians, as did, arguably, early forms of venture capital and corporations; agricultural futures and paper currency were derived from China; group lending and insurance pools were common across the region and likely originated from China;(fn3) and bills of exchange, hawala, and covered bonds from the Islamic world and the Ottoman Empire further exemplify financial innovation originating from Asia.(fn4) As such, it is clearly incorrect to suggest that Asia, including East Asia, has always suffered from a lack of financial innovation and has always been a taker of financial innovations from Western markets. In fact, many of these early innovations, which originated in Asia, were central to the institutional framework that supported and funded the industrial revolution in Western Europe.(fn5)
Even in the second half of the twentieth century, Asia has been the source of a number of significant financial innovations. Three examples warrant particular attention: the developmental state, microfinance, and Islamic finance-all of which are important Asian financial innovations.
The model of the developmental state, pioneered by Japan and exported across the region, comprises the repression of finance to mobilize financial resources to support export industries and thus to support economic growth and development.(fn6) There are very significant limitations to the model, particularly as economies reach higher levels of development and fuller integration with the global economy and financial system. These limitations have been highlighted dramatically by Japan's two-decade financial malaise and the Asian financial crisis that commenced in 1997. Nevertheless, the model has been vital to the region's successful development. Likewise, the centrality of finance to the model is clearly an innovation, a very successful and influential one, albeit one with important limitations.
Microfinance emerged from Bangladesh as an Asian innovation and has spread around the world.(fn7) It is one of the most influential developments in finance in the past thirty years. The focus microfinance puts on lending small amounts to the poor to support economic activity and its use of a range of social techniques, such as group lending, to ensure repayment is an innovation clearly related to the actual conditions and needs in the region. Likewise, the region-particularly Malaysia and Pakistan-has contributed greatly to innovations involving Islamic finance,(fn8) which have been exported across Asia and also to Western markets.(fn9)
In addition, other areas of Asia-Pacific financial innovation include pensions, where Australia and Singapore are world leaders;(fn10) stored value cards or e-money, where innovations in Hong Kong have spread around the world;(fn11) and Internet and mobile banking, and financial services, where developed regions in East Asia lead the world.(fn12)
While Asia has not generated as much innovation in the past seventy years as North America and Western Europe, the region has nonetheless produced globally significant financial innovations that have contributed to real economic growth and development. It is thus clearly incorrect to characterize finance in Asia as lacking in innovation.
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