Participants
Brian Caplen – editor, The Banker
Gautam Banerjee – executive chairman, PricewaterhouseCoopers
David Conner – CEO, OCBC Bank
Ray Ferguson – regional CEO, Singapore and south-east Asia, Standard Chartered
Loh Boon Chye – Asia-Pacific head of CIB, Deutsche Bank
Heng Swee Keat – managing director, Monetary Authority of Singapore
JY Pillay – former chairman, Singapore Exchange
Lester Gray – CEO, Asia-Pacific, Schroders
Among AAA rated sovereigns, Singapore is regarded by rating agencies as the most vulnerable to external economic shocks. This is because of the openness of its economy and its small size relative to other AAA nations such as the US, Germany, France and the UK.
Then there are those aspects of Singapore related to its role as an international financial centre (IFC) that also involve risks. Singapore has banking assets equivalent to 242% of gross domestic product (GDP) and gross external debt of 203% of GDP, although overall the country is a net external creditor for both the public and private sectors, including banks and non-banks, of 153% of GDP.
In the financial crisis, countries such as the UK, Iceland and Ireland discovered that large private sector banking assets could end up as sovereign liabilities under stressed conditions. Public sector balance sheets could be badly damaged as a result (although in the UK this was caused by overspending rather than by the costs of bailing out the banks).
In Singapore, the banks weathered the storm even though the economy experienced its deepest recession since independence. Emergency measures introduced during the crisis included a temporary, and now lapsed, blanket guarantee of retail and wholesale banking deposits backed by S$150bn ($117bn).
The economy subsequently bounced back, growing 14.5% last year and prompting the Monetary Authority of Singapore (MAS) to tighten policy in April 2010 in anticipation of inflationary pressures. For its quick response to the changing circumstances as well as its role in regulating the banks and slowing down the subsequent property boom, The Banker made MAS managing director Heng Swee Keat its Central Bank Governor of the Year 2011 for Asia-Pacific (see January 2011 issue of The Banker).
In a round table discussion held in Singapore last month to commemorate the award, Mr Heng and leading members of the financial community explored the challenges Singapore faces in balancing its role as an IFC with the need to maintain macroeconomic stability. This report is based on comments made at that discussion together with quotes from other analysts and bankers interviewed in Singapore.
Economic policy
Policy challenges can change very quickly, especially in an open economy such as Singapore’s. From a recessionary scenario requiring loose monetary and fiscal policy during the crisis, Singapore quickly moved to a scenario in which large capital inflows, booming property markets and inflationary pressures became the challenges.
The city state has always kept a close watch on asset price bubbles and has introduced a number of measures, including lowering loan-to-value ratios, to cool down the current buoyant property market. Recognising the limitations of monetary policy in a small, open economy, Singapore uses exchange-rate targeting rather than interest rates as its main policy tool.
Mr Heng says: “One challenge we are facing is the growth differential between different parts of the world. Following the financial crisis, there have been different responses and the pace of recovery varies between economies. The emerging economies have generally recovered quite strongly and many of them are now feeling rising inflationary pressures, including Singapore. At the same time, many advanced economies that have been much more affected by the financial crisis have to repair their balance sheets and undergo fiscal consolidation. This will take some time.
"The resulting differences in monetary conditions are causing a flow of capital from the advanced countries to the emerging economies. However, in more recent weeks, with the more positive data in the US – or events that suggest there is greater risk in emerging economies – you see some flowback [of capital] to the US markets. We have to be prepared to manage this volatility.”
Having witnessed the bursting of property bubbles in the US and some European countries, Asian policy-makers are now concerned that their own property markets could overheat. The MAS changed the maximum loan-to-value ratio from 90% to 80% for owner-occupiers in February 2010, and in January 2011 a further package of measures was introduced.
Mr Heng says: “We have always taken a slightly different position from other central banks [in dealing with asset bubbles]. Some have maintained that it is difficult to predict asset bubbles, and you just clean up after the event [when a bubble bursts]. Ever since the MAS was established, our supervision of the banking sector has been very conservative. For many years, we have had an explicit loan-to-value restriction on property lending, because if you look back at earlier financial crises, the bulk of them were caused by excess leverage, particularly in the mortgage sector. The current crisis is no exception.”
Interestingly, bankers in Singapore do not object to these restrictions because they consider that the rules guard them from excessive competition.
David Conner, chief executive officer of OCBC, Singapore’s third largest bank says: “Guidelines on loan-to-value ratios [from the central bank] are very useful in preventing market competition from overshooting, possibly leading to an ugly clean-up subsequently.
"These rules are useful for us because they would prevent one bank from taking that incremental step against another bank to get more loans, and going incrementally further against yet another bank and so on. You could wind up with home loans with zero down-payment, 100% loan-to-value and possibly even more. That is dangerous lending. We saw this happen in the US, and if that had been prevented, we would not have seen anywhere near the level of crisis that we actually saw.”
Singapore’s conservative policy reflects its vulnerability to external shocks. A report by Fitch Ratings, published in August 2010, says: “As an export-oriented economy, Singapore is highly exposed to external trade and financial shocks despite its reasonably diversified industrial structure. Output, inflation and fiscal revenue are more volatile than in other AAA sovereigns and the maintenance of a strong net financial and foreign asset position is an important underpinning of Singapore’s AAA status, given the vulnerabilities faced by such an open and small economy relative to large benchmark AAA sovereigns.”
The decision to use exchange-rate targeting rather than interest rates as a key policy tool also relates to the openness of Singapore. JY Pillay, a former managing director of the MAS and one of the architects of Singapore’s post-independence development, says: “Since the 1980s the economy has become even more open, so the exchange rate has continued to have a far bigger impact on output and inflation in Singapore than interest rates. And the extent that we have chosen to have free capital movements, together with management of the exchange rate, means that the interest rate is a given.”
Future of globalisation
Singapore’s development has been built on contemporary economic trends such as the increased role played by multinational corporations (MNCs) and their need for bases in different parts of the world, as well as the increased levels of trade and capital flows arising out of this trend. The nature of the flows changes over time but Singapore continues in its efforts to capture them.
Mr Pillay says: “I think we were the first emerging country to recognise the importance of globalisation and this has served us well over the years because we have been able to take advantage of globalisation but at the same time we have tried to protect ourselves from its ill effects.”
PricewaterhouseCoopers’ executive chairman covering Singapore, Gautam Banerjee, says: “For a small country that is as open as Singapore, there are significant economic policy challenges. The financial services sector is very important for us but we also have to make sure that investment in the manufacturing sector – whether by local companies or MNCs – continues to keep pace. It is very easy for financial funds to flow in and out very quickly, so we need to balance that with fixed-asset investments that will be here for the long term. As a country, we have always said that about 26% to 28% of GDP must come from the manufacturing sector. It is important to do that or you will open yourselves up to greater volatility.”
Ray Ferguson, regional CEO for Singapore and south-east Asia at Standard Chartered, says: “In terms of Singapore’s role as a hub, the trading flows are changing. We are seeing flows from China to Africa coming through entities here. We are seeing Thai and Indonesian companies access the market here to do mergers and acquisitions in Europe. This is very different from the early days, when Western MNCs came here as part of a West to East capital flow."
Standard Chartered, of course, is itself one of the MNCs attracted to Singapore and which has transferred global operations to the country over time.
Mr Ferguson says: “We run a number of global businesses from Singapore. We are rather like Singapore in that we don’t have a domestic hinterland to retreat to. We are doing business across Asia, Africa and the Middle East. We did not make an instant decision to move – lock, stock and barrel – a whole set of head office functions to Singapore. [It has happened bit by bit] as Singapore has developed in terms of housing, education and health as well as in terms of physical infrastructure and regulation.”
Banking regulation
Key to developing as an IFC is good regulation and Singapore’s banks were protected from the ill effects of the crisis by high capital ratios. This does have an impact on banks’ profitability and part of the solution to this might be through regional expansion. Internationally, there is a danger that regulation now moves from being too loose to being too restrictive. Bankers say that to remain competitive as an IFC, Singapore should not go down the road of an overzealous regulatory response to the crisis.
While the MAS’s minimum capital requirements for banks stand at 6% Tier 1 and a total capital adequacy ratio of 10%, the Tier 1 ratios of the three major Singapore banks (DBS, UOB and OCBC) are in the 13% to 15.5% range. A report by the analysts CreditSights notes: “In comparison with their international and regional peers, the Singapore banks have faced a challenge in competing successfully and at the same time achieving a good return on equity (ROE) given their unusually strong capital base.”
One solution is to expand regionally and both UOB and OCBC have strengthened their south-east Asian operations – which were historically strong in Malaysia – by buying medium-sized banks in Indonesia over the past 10 years. UOB also bought a bank in Thailand and has 18% of its assets in south-east Asia excluding Singapore. The equivalent figure for OCBC is 24%. DBS has taken a different route by expanding into Hong Kong, Taiwan and China and has 26% of its assets in these locations. OCBC purchased ING’s Asian private banking business in 2009 and rebranded it Bank of Singapore.
OCBC’s Mr Conner is concerned that the forthcoming Basel III regulations will make overseas expansion more difficult. “One trend of Basel III appears to be against globalisation,” he says. “Large global banks are being penalised with the need to hold more capital. Many local regulators are proposing that banks with sizeable operations in their countries incorporate locally and hold excess capital at the subsidiary level. These local regulators also require us to be locally sufficient in terms of our funding capabilities.
"If we are running corporate bank activities, we are expected to raise deposits from consumers to fund these activities, instead of borrowing in the inter-bank market – which is typically done by international banks – which makes funding very inefficient."
At the same time, Mr Conner raises the issue of how Singapore’s regulatory response needs to be moderate. He says: “For Singapore to further develop as a competitive financial centre, we must maintain a good balance of not getting excessive in terms of regulations. I don’t think we need the capital levels that Switzerland is proposing for its banks. Nor do I think we need to carve out retail banking business and require them to be capitalised on a standalone basis, as is being discussed in the UK.
"I also don’t believe we need a Volcker Rule [on proprietary trading] as in the US. In my institution, we run a universal bank with an insurance company, a brokerage business, an investment bank and a commercial banking business, and with the help of a very effective regulator, we came through the last crisis very well."
One post-crisis initiative of the MAS is to insist that banks have dedicated risk committees, but Mr Heng does not feel the size of a bank is an issue. He explains: “It is a question of looking at the details of such things as asset-liability matching, otherwise you [would rush to the assumption] that a big bank must always be in trouble and a small bank will always be all right. But that is not the case. One lesson from the crisis is that different banks have very different kinds of businesses and balance sheets.”
He continues: “When we announced that we want the banks to have dedicated risk committees and highly qualified people to sit on them, we are not doing this on the basis of past or current situations. We are looking at the future. One lesson of the financial crisis is that things are going to be more challenging in future in terms of managing volatility, or managing within new banking rules, or [taking account of] new products. Banks will need executives who are plugged into that kind of landscape.”
Investors, it seems, may prefer safer banks to highly profitable but risky ones. Deutsche Bank’s Asia-Pacific head of corporate and investment banking, Loh Boon Chye, says: “Investors today want safer banks rather than higher returns. If the system is safer and banks can generate consistent ROEs of 15% and above, as well as withstand the next downturn, that is no bad thing.”
Role as an IFC
Being an IFC of course entails hosting many more services than just commercial banking – Singapore is the world’s fourth largest foreign-exchange (FX) centre, with an average daily turnover of $266bn, as recorded by the Bank for International Settlements for April 2010; it is a major wealth management centre, with assets under management of more than S$1000bn; the Singapore Exchange is in expansion mode with a proposed merger with the Australian Securities Exchange; and Singapore is a leading centre for trading in commodity derivatives.
The FX business has grown on the back of Singapore’s role as a hub for MNCs. Mr Loh says: “It is important to emphasise the role the financial industry plays in servicing the 3000 MNCs in Singapore. We are the fourth largest FX market in the world and the second largest in Asia; there is the Asian dollar market for funding. These all add to our status as an IFC.”
In the wealth management business, there is keen interest from European private banks wishing to relocate to Singapore. Winston Ngan, head of financial services at Ernst & Young, who did not attend the round table discussion, says: “We are getting a lot of enquiries from private banks in Europe that wish to open up in Singapore to tap into the growing Asian wealth management market and also meet the needs of their European customers who want exposure to Asia.”
Singapore’s attractiveness to this type of investment is enhanced by the quality of the physical infrastructure together with high standards of education and health. But the country no longer has much of a cost advantage over major centres such as New York and London.
Lester Gray, chairman of the Investment Management Association of Singapore, says: “We do not view Singapore as a low-cost operating hub. Salaries and compensation levels for senior executives here are not that different from the levels in London. Locating here is not about cost arbitrage. It is about finding the best place to locate the resources you need and managing flows across the region.”
Cost pressures in salaries and rents are an issue for some investors. Mr Banerjee says: “GDP growth figures in an economy such as Singapore’s can be misleading. In an economy that is so open and so export-driven, GDP numbers only give you part of the picture. Growth in GDP of 14.7% [the Singapore figure for 2010] doesn’t translate into the same growth in business revenues, yet it puts a huge strain on costs and salaries.”
Stock exchange
Mr Pillay, who is a former chairman of the Singapore Exchange, says that the proposed merger with the Australian Securities Exchange would set in motion similar developments across the region. The Singapore Exchange is also introducing a new trading system, Reach, which will be the world’s fastest, with an order response time of 90 microseconds (see article on high-frequency trading [HFT] in emerging markets in this issue of The Banker).
“The deal between the Singapore stock exchange and the Australian stock exchange is groundbreaking for Asia,” says Mr Pillay. “If it goes ahead, it will lead on to many other interesting developments – between exchanges within Asia as well as between exchanges in Asia and those outside the region.”
Will it also make Singapore a more attractive destination for Chinese initial public offerings (IPOs)? “SOEs [state-owned enterprises] and large Chinese companies where there is regulatory influence will still go to Hong Kong [for IPOs] for some time to come. But the merger [of the stock exchanges] could make us more attractive for companies in the commodities and mining sectors.”
There are concerns about HFT and whether it can precipitate market crashes. Mr Pillay says: “[HFT] is what the industry wants and therefore we are providing it, but there are pitfalls. I don’t think the response should be not to accept risk. We keep the risk but carefully monitor it.” Singapore Exchange is introducing pre-trade risk controls imposing new limits on the number of contracts that can be traded in a given period as well as other restrictions.
Mr Gray says: “There is still some debate as to how much of a liquidity advantage HFT really brings to a market. Fundamental investors expect an exchange to keep its technology moving forward, but I think the active encouragement of high-frequency trading in a small market needs watching very carefully.”
Business outlook for 2011
Most bankers in Singapore are cautiously optimistic about the business outlook for 2011, with Asian economies growing strongly. But few believe that Asia’s fortunes are completely decoupled from the US and European economies and the difficulties faced in these regions could still have knock-on effects in Singapore. Conditions are likely to remain volatile for some time to come.
Mr Loh says: “Last year in Asia there was almost $300bn of equity raising, $400bn of debt raising and almost $350bn of mergers and acquisitions, 60% of which was cross-border. Even though growth will moderate, the prospects for 2011 remain good. Intra-regional and inter-regional activity will drive a lot of these capital markets flows. One challenge will be whether the market holds out. If you look at the past six weeks, [the volatility] in the stock market is clearly telling us something about overvaluation and how bubbles are forming [in parts of the region].”
