The Scope, Prospects and Implications of New Forms of Financial Intermediation for Monetary Policy in ASEAN-4

Financial innovation supported by technology has created new financial instruments, especially for intermediating sources of funds, which may be defined as a new form of financial intermediation. This research study uses this term to examine the current conditions and prospects of new forms of financial intermediation by shadow banking institutions in four ASEAN countries of Indonesia, Malaysia, Singapore and Thailand. This research also investigates the impact of monetary policy on the shadow banks. The findings are summarized as follows: 1. The development of new forms of financial intermediation in ASEAN-4 is proliferating, which can be seen from the significant increase of shadow banking assets as a share of the total assets of either financial corporations or GDP as well as the rise in the ratio of broad money to GDP. Non-bank financial institutions which perform shadow banking activities have interconnections with the regular banking system via funding and borrowing. There are also common trends in that regular banks establish subsidiaries which engage in shadow banking activities. In general, non-bank financial institutions (NBFIs) that perform shadow bank activities conduct their operations through bond purchases and loans in the form of securities lending, repurchase agreements, credit derivatives and credit enhancements. NBFIs in these countries are not backed by the central bank in case of liquidity mismatches or deposit insurance in case of bank liquidations. Nevertheless, shadow banking regulation in these four countries is quite advanced, with a financial services authority or the central bank overseeing the sector’s activities. Almost all NBFIs in the ASEAN-4, barring mutual fund companies, are carrying out shadow banking activities as classified by the Financial Stability Board, but since they are covered by adequate regulations, NBFIs are no longer classified as shadow banks. 2. The new forms of financial intermediation herald an undoubtedly bright future for these countries as they encourage financial institutions to adopt financial technology and develop new forms of financial intermediaries. These trends are expected to lead to the development of broader and deeper varieties of financial products, which could enhance financial inclusion. While the growth of this phenomenon is accompanied by substantial innovations and benefits, it also creates heightened risks which need to be mitigated. Consequently, this situation presents an opportunity for NBFIs to create a variety of new products. In the absence of regulation and oversight by the authorities, this may lead to regulatory arbitrage. 3. Moreover, the rapid growth of new forms of financial intermediation has implications for the effectiveness of monetary policy. Using econometric analysis to assess whether monetary policy instruments (policy deposit rate, policy lending rate, policy repo rate and interbank interest rates) influence the shadow banking system, we found that monetary policy rates do not have a significant impact on the shadow banks’ returns, but in some countries the policy rate has an impact on shadow banks’ assets under management growth. 4. New forms of financial intermediation, which we define as new shadow banking activities if they are accompanied by financial technology, have increased significantly over time. While some of these activities are regulated by domestic Financial Services Authorities, there still appears to be a lack of regulation and supervision for these new entities, especially the ones which use and develop such technology. Thus, they can develop their business by exploiting regulatory arbitrage. Therefore, we recommend that the financial authorities step up their efforts to improve regulation and supervision by bringing shadow banking entities under the regulatory umbrella, with the aim of better understanding their business models as well as to obtain the data necessary to boost regulation or other policy responses.