RDP 9506: The Liberalisation and Integration of Domestic Financial Markets in Western Pacific Economies 3. Recent Developments in Bank Deposit and Loan Markets

The institutional arrangements and history of markets in the region vary widely by country, but the common thread in the past decade has been a clear shift in lifting controls on deposit and lending interest rates, on increasing the competitiveness of the domestic banking sector, and on improving supervision of the banking sector, largely in response to serious deteriorations in asset quality. Appendix 1 provides a chronology of relevant major banking reforms in each country for the past two decades. The account provided here is very brief, and the reader is referred to Fischer (1993), Fischer and Reisen (1993), Haggard, Lee and Maxfield (1993), Andersen (1993) and central bank annual reports for more detail and information.

As shown in Appendix 1, all countries in the sample have now instituted major liberalisation of deposit and lending rates, though the speed of reform has varied substantially by country. Singapore instituted reform in 1975, Australia in the early 1980s, Indonesia in 1983, Japan in 1985 to 1994, Malaysia in 1987 (deposits) and 1991 (loans), Taiwan in 1989, Korea in 1991 to 1994, Thailand in 1992 and Hong Kong in 1994 and 1995.

The formal liberalisation of rates, however, does not necessarily mean that monetary authorities have surrendered other, non-market based forms of control over institutional rates. The authorities at times use moral suasion (to attempt) to influence the setting of rates by banks, especially when they consider competition in the domestic banking system to be imperfect (as in Thailand, Indonesia, Japan and, to a lesser extent, Australia) or when they provide direct liquidity to banks (as in Indonesia and Japan). Moreover, the shift to a market-based system for the determination of interest rates has not necessarily meant that direct credit rationing and preferential financing have been discontinued (consider Indonesia, Korea, the Philippines and, to a lesser extent, Japan). Historically, public ownership of banks has also been important in Indonesia and, particularly, Taiwan in allowing the authorities to influence the rate outcome.

Generally speaking, monetary authorities have also tried to improve competition within the domestic sector, mainly through easing controls on bank branching (as in Indonesia and, more recently, the Philippines) and on foreign bank entry (as in Australia, Indonesia, the Philippines, Taiwan and Thailand), and through encouraging competition from smaller banks (as in Australia and, more recently, Indonesia) and non-bank financial intermediaries (NBFIs) (as in Korea and Thailand). These policies are not always successful. In Thailand, for example, NBFIs did not compete with banks since they were themselves largely controlled by the banks, and capital divestiture, initiated in the 1980s, proceeded only slowly and, while it did dilute shareholdings, it failed to break the control of the 16 Chinese families over the domestic banking system (Chaiyasoot 1993). While concentration ratios are generally a flawed measure of competition, since they do not take account of the contestability of markets, such ratios can be informative when branching and foreign bank entry are restricted. In most countries, a small number of large banks have typically dominated the banking sector, for example, Australia, Indonesia, Japan and Thailand. While the number of banks is larger in the Philippines, Hutchcroft (1993) reports that both national and private banks have engaged in express collusive behaviour. Privatisation has been touted as a key policy reform in some countries (Korea and Taiwan), though the process has sometimes been painstakingly slow (as in Taiwan) or only relatively superficial (as in Korea where the banks were privatised in the early 1980s but their presidents and directors continued to be appointed by government).

At times, however, the monetary authorities have been ambivalent in pursuing competition. While banks are free to set institutional interest rates in Singapore, the authorities largely exclude foreign institutions from the domestic banking market and continue to enforce tight controls on bank branching and automation (APEG 1995). Hong Kong, on the other hand, encourages foreign institutions but sanctioned a cartel to reduce competitive pressure in domestic bank markets until 1994. In Japan, the Ministry of Finance unsuccessfully attempted to use administrative guidance in early 1995 to prevent regional credit banks from offering competitive deposit rates (in the form of interest lotteries). Bank Indonesia initially opposed the 1983 financial reform package (Macintyre 1993), but adopted a pro-competition stance in the late 1980s which has resulted in a substantial expansion of private banking and increase in competition. The Indonesian, Malaysian and Philippine authorities have also used measures to reduce ‘undue’ or destabilising competition at times.

As in various European countries, problems with banks' asset quality have also been a recurring phenomenon in Western Pacific economies. In the 1990s, banks in Australia, Indonesia and Japan experienced serious difficulties with non-performing loans and bad debts, which led to major reform of banking supervision. Thailand suffered a series of financial failures from 1983 to 1986 due to poor supervision and management practices (mainly lending to executives and associates), which led to major, successful reform (Doner and Unger 1993). The Philippines has experienced four major crises of confidence in its financial institutions since the 1960s, reportedly due to weak supervision and corruption. The central bank was substantially restructured in June 1993, partly in response to this. Bad debts have also caused periodic major problems in banking in Korea, where the government has bailed out institutions (Choi 1993). Taiwan's banking sector, on the other hand, has largely been free of bad debt problems due to the high risk aversion of its commercial bankers (bankers face civil liabilities if they make loans which fail) (Cheng 1993).