Banking on ASEAN integration

The ASEAN Banking Integration Framework is one layer of the ASEAN Economic Community, an entity modelled on the European single market. The AEC comprises four interrelated ambitions: realising a single market and production base; creating a highly competitive economic region; achieving equitable economic development; and full regional integration into the global economy.

ASEAN comprises Indonesia, Malaysia, the Philippines, Singapore and Thailand, the so-called ‘ASEAN five’ countries, and their poorer counterparts in the grouping, Cambodia, Laos, Myanmar and Vietnam, known as the CLMV countries.

As with the European single market, the aim is to initiate the free flow of goods, services, investment, capital and skilled labour. While progress has been made within ASEAN towards convergence – tariff-free trade is rapidly becoming the norm in the region – financial market integration is a more challenging proposition.

This is because of vastly differing levels of economic development between countries and the complexities of financial regulation. While a case can be made that there exists a genuine philosophical and political will to move towards greater financial market integration, the reality is that a bilateral rather than a multilateral path is the likely outcome.

The banking system continues to be the most developed financial sector in many ASEAN member states and hence it is axiomatic to the financial integration envisaged as a crucial component of the AEC.

In December 2014, the ASEAN central bank governors endorsed ABIF and its attendant guidelines, while the ASEAN Framework Agreement on Services (AFAS) was signed by the ASEAN finance ministers in March 2015, formalising the aim of full banking integration by 2020.

Key agreements will be made between individual countries rather than all members at the same time, and it will probably take many years before a genuine single financial market is achieved. Still, progress is steadily being made to harmonise rules and regulations and to achieve a level of mutual recognition.

“Most likely, the full realisation of ABIF will lead to consolidation in the region’s banking sector. ASEAN still has a relatively fragmented banking system, with many institutions present in individual markets. There are few banks that genuinely cover the entire region. But it seems likely that ABIF will encourage a move towards fewer, albeit larger, pan-regional financial institutions,” said Frederic Neumann, co-head of Asian Economic Research at HSBC in Hong Kong.

“ABIF should improve funding access, especially for small and medium-sized enterprises. These will be able to draw on a bigger pool of savings, deeper capital markets, and financial institutions better placed to gauge and absorb risk. ABIF will thereby significantly help to raise competitiveness across the region.

“It should also do so indirectly by raising competition within markets, by levelling access to cheap funding across individual firms, helping smaller ones compete with larger ones. In turn, greater local competition should also improve the overall competitiveness of ASEAN.”

Qualified success

Central to ABIF is the concept of the Qualified ASEAN Bank (QAB), which allows banks which meet stringent criteria in terms of business activity, capitalisation and product lines to operate effectively outside their market of domicile.

Under ABIF, QABs will act as “special banks” with preferential treatment over non-QABs or non-ASEAN foreign banks. In ASEAN countries that have a multi-layered banking licensing regime, QABs stand to gain more than non-QABs or non-ASEAN foreign banks due to their operational flexibility. And QABs can offer a broader suite of banking products and services at the same level as local banks.

“The QAB concept and brand is a cornerstone of ABIF and in essence seeks to encourage the regionalisation of strong ASEAN banks in a cross-border framework. There is a patchwork of banking regulations within ASEAN that can otherwise act as market access barriers. The aim of ABIF is to bridge this patchwork by allowing QABs to have similar business scope as domestic banks of the host economy,” said Boon Hiong Chan, head of market advocacy APAC at Deutsche Bank in Singapore.

“The ASEAN banking integration framework process has been moving faster than most people expected. There have been a number of recent milestones to this end, including an Indonesian bank attaining the designation of a Qualified ASEAN Bank (QAB) status, having met the key criteria required, and letters of intent signed between the central banks of Philippines and Indonesia that includes QABs.”

These milestones highlight the somewhat piecemeal and bilateral characteristics of ABIF and point to what is likely to be a drawn-out process, with the possibility that the full integration of banking in ASEAN envisaged to be complete by 2020 might take much longer, if indeed it occurs with the comprehensiveness of the ABIF mission statement.

“There are numerous moving parts including prudential requirements, disclosure, compliance and conduct, and data security. The harmonisation to which ABIF aspires is characteristic of similarly mature banking markets of developed countries. With ABIF, it is hoped that there can be closer financial market integration done in an ASEAN way of regional standards and regulatory harmonisation and without overshadowing local needs.”

Realising potential

Indonesia represents the potential envisaged in ABIF. ASEAN banks’ presence in the country is manifested in foreign branches and joint venture banks, where networks are extensive. An example of the potential for expansion outside the domicile country is one joint venture bank that has more offices in Indonesia than in its home country.

Meanwhile, the contribution to wallet from Indonesian banking operations has been hefty, with some ASEAN banks in Indonesia as a result able to establish financial conglomerates, acquire leasing companies or set up Islamic banks in that country. And it is perhaps telling that of the four bilateral arrangements established under ABIF, three have involved Indonesia.

“A perceived risk of ABIF is domination of the host economy’s banking ecosystem by the bigger well-capitalised QAB-branded banks. But that view is probably overdone. Smaller banks can benefit from the QAB banks which can act as cross-border intra-ASEAN bridges, via payments and helping them to meet stringent compliance regimes,” said Chan.

One of the benefits to the ASEAN region that is likely to accrue as a result of fully implementing ABIF is a reduction in financing costs due to a secular decline in term funding rates. Interest rates in ASEAN vary widely, with Singapore enjoying the lowest lending interest rate at 1.25% for the cost of six-month money (the Sibor rate), while short-term borrowing rates in Laos are a relatively stratospheric 9%.

The implementation of ABIF is expected to drive down lending interest rates in ASEAN as a result of increased competition in the banking industry.

Meanwhile, the architects of ABIF aim to create strong pan-ASEAN regional banks able to compete with global banks.

Even though local banks in ASEAN emerged relatively unscathed from the global financial crisis, having adopted comparatively prudent lending practises as the result of the region’s own financial crisis in the late 1990s, and have in the period since grown substantial asset bases and product lines, in terms of scale, asset and presence, global banks such as Standard Chartered Bank and Citibank have a stronger presence in the region.

Ravi Menon, managing director of the Monetary Authority of Singapore, put succinctly and revealingly one of the core hopes of the ABIF when he wrote: “As ASEAN becomes an economic powerhouse, so must our ASEAN banks.”

The vision is for a large local player such as a Development Bank of Singapore or Malaysia’s Maybank to give the large Western universal banks a run for their money.

Meanwhile, the asymmetry existing in terms of political stability, levels of corruption and superior regulation means the CLMV countries that have a strong need for fund inflow will be sidelined by the ASEAN five, which score higher in terms of those criteria.

This structural impediment might even out eventually, although on what seems likely to be a drawn-out timeline. Another concern is that ABIF will increase the risks of financial contagion in the region as banking systems become more closely intertwined.

“Hot money” inflows into relatively high-yielding local bond markets are notorious for destabilising Asian financial markets when they are reversed by capital flight. Still, there is the hope that financial technology innovations such as blockchain may enter the picture to ameliorate these risks.

“The potential for fintech to play a crucial role in ABIF is only beginning to dawn on its participants, where QABs can roll out their unique fintech solutions across ASEAN. In this regard, the Monetary Authority of Singapore is working closely with the IFC for the ASEAN Financial Innovation Network that can create conducive regulatory frameworks which will enable fintech solutions to operate across the region. There will be new and greater scalability and a multiplier effect then,” said Deutsche Bank’s Chan.