World Bank Urges Asia To Develop Bond Markets
East Asian banking systems have revived since the 1997 financial crisis, but the region needs to develop its bond markets to provide a market price for risk, according to a report by the World Bank.
“While progress has been made in strengthening the banking sector in the region, policymakers need to focus on further developing the securities market and the bond market in particular,” says Homi Kharas, the World Bank’s chief economist for East Asia and Pacific.
Much of the limited growth in the bond markets in the region has been on account of bonds issued by governments, largely to restructure the banking system, Kharas says. “The key issue is the lack of liquidity in the secondary market, which affects the efficiency of these markets and limits the overall size of corporate bond markets,” he says.
The report cites the accumulation of $1.6 trillion in foreign exchange reserves and $9.6 trillion in financial sector assets, as of the end of last year, as the most significant development in the region since the 1997 crisis. But it says that the region needs to develop mechanisms for the sharing, transfer and pricing of risks.
Strengthening implementation of corporate governance and information disclosure is of paramount importance to enable investors to price securities accurately, the report says. “Further efforts are needed to strengthen the oversight of the boards of directors and to improve the effectiveness of audit committees,” it says. The concept of audit committees is new, it adds, and often these committees are not effective.
There is a need to be able to price corporate bonds with reference to a benchmark interest rate, the report says. For the price of a government bond to be a good reference, China, for instance, would need to move away from price-controlled auctions, it says. Benchmark bond issues must also be large and stretch across the maturity spectrum, it adds.
“A second important element for corporate bond pricing is the existence of good credit rating agencies,” the report notes. “Rating agencies play a very important role in helping to determine the credit risk and thus the spread pricing of corporate bonds.”
Control over China’s corporate bond market likely will be transferred to the China Securities Regulatory Commission from the National Development and Reform Commission at the end of this year. Prime Minister Wen Jiabao will chair a ministerial meeting later this year to consider financial reform, particularly the further development of a bond market that will give corporations an alternative to state-owned banks for financing.
Under the current system, companies can borrow at low, government-controlled interest rates from the banks without regard to the risks of the loans. This has required the government to periodically bail out the banks by purchasing their non-performing loans.
The development of supporting infrastructure, such as repurchase markets, margin trading and derivatives, can be an important means of reducing transaction costs, according to the World Bank report. This would also allow market participants to manage and transfer risks to those better able and willing to bear them and would help advance the development of robust financial systems overall, it says.
Gordon Platt
