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, * 'Il 3 " ·'i'I·· • •• · .. • Governing Finance A VOI.UME IN THE SERIES Cornell Studies in Money edited by Eric Helleiner and Jonathan Kirshner A East Asia's Adoption of International Standards list of titles in this series is available at www.ccrrnellpress.ccrrnell.edu. Andrezv Walter Cornell University Press Ithaca and London /8'1)l1S tv3'1 2(j)(J) ,.B (..{ S� Contents Copyright C 2008 by Cornell University All rights reserved. Except for brief quotations in a review, this book, or parts thereof, must not be reproduced in any form without permission in writing from the publisher. For information, address Cornell University Press, Sage House, 51 2 East State Street, Ithaca, New York 1 4850. First published 2008 by Cornell University Press Printed in the United States of America Library of Congress Cataloging-in-Publication Data List of Figures vii Walter, Andrew. List of Tables ix Governing finance: East Asia's adoption of international standards I Andrew Walter. p. cm. - (Cornell studies in money) Includes bibliographical references and index. institutions-Southeast Asia-State supervision. institutions--Korea (South)-State supervision. Korea (South) 2. Financial 3. Financial 4. Corporate 5. Corporate goverance­ 6. Accounting-Standards....o ....s utheast Asia. 7. Accounting-Standards--Korea (South) II. Series. I. Title. HG18 7.A789W34 2008 and Financial Governance 1 1 . The Asian Crisis and the International Financial Standards Project 8 2. A Theory of Compliance with I nternational Standards 29 3. Banking Supervision in Indonesia 50 4. Corporate Governance in Thailand 78 5. Banking Supervision and Corporate Governance 65 7'.83330218-dc22 in Malaysia 99 6. Banking Supervision, Corporate f'JOvernance, 20070 29235 Cornell University Press strives to use environmentally responsible suppliers and materials to the fullest extent possible in the publishing of its books. Such materials include vegetable-based, low-VOC inks and acid-free papers that are recycled, totally chlorine-free, or partly composed of nonwood fibers. For further information, visit our website at www.comellpress.cornell.edu. Cloth printing Xl Xlll Introduction: International Standards ISBN 978-0-801 4- 46 45-0 (cloth: alk. paper) 1 . International financial reporting standards. governance-Southeast Asia. Acknowledgments Abbreviations 10 9 8 7 6 5 4 3 2 1 and Financial Disclosure in Korea 126 7. Practical and Theoretical Implications 166 Appendix: The Key International Standards and Codes 185 Notes 189 References 2 11 Index 227 Figures Figure 1.1. Structural conditionalities in 1MF programs, Indonesia, Korea, and Thailand: 1997-2000 19 Figure 2.1. Four stages of compliance and compliance failure 32 Figure 2.2. Effects of crises on compliance (international standards with high monitoring and private sector compliance costs) 44 Figure 2.3. Pro-compliance pressure and domestic compliance costs favor mock compliance outcomes 47 Figure 2.4. Private sector compliance costs and third party monitoring costs by standard 48 Figure 3.1. Indonesian banks: CARs and NPLs, 1997-2005 65 Figure 5. 1. Malaysia: CARs and NPLs, 1997-2005 106 Figure 6. 1. Korean domestic commercial banks: Average CARs and NPLs, official estimates, 1992-2005 131 Figure 6.2. Korean banks: Return on equity 1993-2004 138 Figure 6.3. Korean banks: Provisions on substandard and below loans (SBLs) as % of total SBLs, 1999-2002 139 Figure 6.4. Korean banks: Large exposure ratio, 2000-2005 141 Tables Table 1.1. SDDS subscription, posting, and compliance dates, selected countries and groups 4 Table 1.1. Financial stability forum: Twelve key standards for sound financial systems 9 Table 1.2. FSSA and ROSC modules completed (published and unpublished) as of I July 2004, major emerging market countries 13 Table 1.3. Country membership of selected international organizations (2002) 26 Table 3.1. Banking regulation-related conditionalities in Indonesia's IMF programs 53 Table 3.2. IMF assessment of Indonesia's BCP compliance, September 2002 57 Table 3.3. Classifications of Indonesian bank inspections, 1998-99 63 Table 3.4. Indonesian asset classification and provisioning standards, post-crisis 64 Table 3.5. Official capital and NPL ratios, major Indonesian banks, first quart�r 2002 66 Table 4.1. Selected corporate governance rules, T hailand, and Asian best practice, 2003-4 82 x Tables Table 4.2. CLSA summary corporate governance scores, Asia 2002 91 Table 5.1. Selected corporate governance rules. Malaysia, and Asian best practice, 2003-4 1 12 Table 6.1. Asset classification standards and provisioning requirements for Korean banks 137 Table 6.2. Revised Korean credit ceiling regulations 140 Table 6.3. Major Korean companies: Selected areas of formal lAS compliance, 2003 financial statements 156 Table 6.4. Major Korean banks: Scores on BCBS 1999 sound financial disclosure standards 159 Table 7.1. Substantive compliance, circa 2005 169 Acknowledgments T hanks are due to various individuals and institutions who assisted in the research and preparation of this study: the staff at the Institute of De­ fence and Strategic Studies at NTU in Singapore where I spent a very enjoy­ able year as a visiting fellow, and Barry Desker and Yuen Foong Khong for encouraging me to apply for a fellowship there and for supporting my re­ search; Yeeming Chong for her friendly and efficient assistance; the LSE for granting me a year's leave to conduct initial research over 2001-2; the Korea Foundation for inviting me to Korea in summer 2000 and for arrang­ ing a series of interviews; the Japan Foundation Endowment Committee for funding a research trip to Tokyo in 2002; my former and current research students, including Yong-Ki Kim, Thitinan Pongsudhirak, Wang-Hwi Lee, and Hyoung-kyu Chey, who helped to organize interviews in some countries and who responded to various requests for information; Hogi Hyun for his assistance and hospitality in various parts of the world; Leonard Sebas­ tian and Devi Santi for helping to arrange interviews in Jakarta; Michael Wood for introductions in Asia; Jean-Fram,:ois Drolet and Oskar Tetzlaff for data collection; Vanessa West for editing the bibliography; Paula Durbin­ Westby for preparing the index; and finally to the many interviewees in different countries who generously provided information and often further assistance to this project. Mark T hatcher made helpful comments upon the general argument and parts of the manuscript. T hitinan Pongsudhirak and Kheamasuda Reongvan both gave helpful comments on the Thailand chap­ ter. Two anonymous reviewers provided extensive and constructive com­ ments on the whole manuscript, prompting a fundamental restructuring and many alterations to details. Roger Haydon and the series editors at xii Acknowledgments Cornell provided a generous mixture of advice and encouragement at cru­ cial points. TeresaJesionowski aud Herman Rapaport both provided many helpful suggestions on how to improve the final product. None of the above is in any way responsible for remaining errors. T his book is dedicated to Nina and our wonderful children, Lara and Ben, and to my parents. A.W. Abbreviations ADB Asian Development Bank ADR American Depository Receipt AMF Asian Monetary Fund APEC Asia-Pacific Economic Cooperation BAFIA Banking and Financial Institutions Act (Malaysia) BC...BS Basle Committee on Banking Supervision BCP Basle Core Principles for Banking Supervision BFSR Bank Financial Strength Ratings (Moody's Investor Services) BIS Bank for International Settlements BI Bank Indonesia BNM Bank Negara Malaysia BOK Bank of Korea BOT Bank of Thailand CAMELS Capital adequacy, Asset quality, Management, Earnings, Liquidity, CAR Capital Adequacy Ratio and Sensitivity CCL Contingent Credit Line (IMF) CCS Comprehensive Consolidated Supervision CEO Chief Executive Officer CPSS Committee on Payments and Settlements Systems CDRC Corporate Debt Restructuring Committee (Malaysia) DCF Discounted Cash Flow DPM Deputy Prime Minister DR Depository Receipt DSBB Dissemination Standards Bulletin Board (IMF) DTA Deferred Tax Asset xiv Abbreviations EMEPG EPB EPF ESOP FATF FDI FDIC FIDF FHC FLC FSA FSAP FSC FSF FSLIC FSS FSSA FY G7 GIO G20 G22 GAAP GATT GODS GLC GOI IAIS lAS lASB IBRA ICGN IFAC IFIs IFRS IMF IMFC 100 IOSCO KASB KCCG KDB KDIC Emerging Market Eminent Persons Group Economic Planning Board (Korea) Employees Provident Fund (Malaysia) Employee Share Ownership Program Financial Action Task Force Foreign Direct Investment Federal Deposit Insurance Corporation (United States) Financial Institutions Development Fund (Thailand) Financial Holding Company Forward-Looking Criteria Financial Services Authority (United Kingdom); Financial Services/ Supervisory Agency (japan) Financial Sector Assessment Program Financial Supen'1sory Commission (Korea) Financial Stability Forum Federal Savings and Loans Insurance Corporation (United States) Financial Supervisory Service (Korea) Financial System Stability Assessment Financial Year Group of Seven Group of Ten Group of Twenty Group of Twenty Two Generally Accepted Accounting Principles General Agreement on Tariffs and Trade General Data Dissemination Standard Government-Linked Company Government of Indonesia International Association of Insurance Supervisors International Accounting Standards International Accounting Standards Board Indonesian Bank Restructuring Agency International Corporate Governance Association International Federation of Accountants International Financial Institutions International Financial Reporting Standards International Monetary Fund International Monetary and Financial Committee (IMF) Institute of Directors International Organization of Securities Commissions Korea Accounting Standards Board Korean Committee on Corporate Governance Korea Development Bank Korea Deposit Insurance Corporation Abbreviations KFAS KITC KLSE KSE LLL LOI MAS MASB MEFP MICG MITI MSE MOF MOFE NBFI NEAC NEP NGO NOP NPL NTA NYSE OBS OECD OFC PCA PCG PPP PSPD ROA ROCA ROSC ROE SC SODS SEC SET SFC SME SOE TRIS UMNO 'WT O Korea Financial Accounting Standards Korea Fair Trade Commission Kuala Lumpur Stock Exchange Korean Stock Exchange Legal Lending Limit Letter of Intent Monetary Authority of Singapore Malaysian Accounting Standards Board Memorandum of Economic and Financial Policies Malaysian Institute of Corporate Governance Ministry of International Trade and Industry (Japan) Ministry of State-Owned Enterprises (Indonesia) Ministry of Finance Ministry of Finance and the Economy (Korea) Non-Bank Financial Institution National Economic Action Council (Malaysia) New Economic Policy (Malaysia) Non-Governmental Organization Net Open Position Non-Performing Loan Net Tangible Assets New York Stock Exchange Office of Banking Supervision (Korea) Organization for Economic Cooperation and Development Offshore Financial Center Prompt Corrective Action Principles of Corporate Governance (OEeD) Purchasing Power Parity People's Solidarity for Participatory Democracy (Korea) Return on Assets Risk management, Operational control, Compliance, and Asset quality Report on the Observance of Standards and Codes Return on Equity Securities Commission (Malaysia) Special Data Dissemination Standard Securities and Exchange Commission Stock Exchange of T hailand Securities and Futures Commission (Korea) Small or Medium Enterprise State-Owned Enterprise Thai Rating and Information Services Co. United Malays National Organisation World Trade Organization xv Introduction International Standards and Financial Governance The financial contagion that spread from Thailand in mid-1997 to the rest of Asia and then on to Brazil, Russia, and finally to the developed world's financial centers was a m;:yor shock to the global economy. It was also a shock to global political elites and a watershed in the long-running debate about the need for reform of the global financial architecture. Faced with a crisis that destabilized some of the world's most rapidly growing countries, governments in the major developed countries responded by launching one of the most ambitious governance reform projects in living memory. Its main objective was to transform domestic financial governance in emerging mar­ ket countries and, in particular, to eradicate the "cronyism, corruption, and nepotism" assumed to lie at the heart of Asia's (and by extension most of the developing world's) financial vulnerability. The envisaged transformation was consistent with a new consensus in Western policymaking and academic circles. In promoting the adoption of "international best practice" standards of regulation, the reform project ad­ vocated a transition from a relational, discretionary approach to regulation to a more arm's-length, nondiscretionary approach. Others have summa­ rized this as a transition from a "developmental" state toward a neoliberal "regulatory" state (e.g.,Jayasuriya 2005) .1 A key characteristic of "regulatory neoliberalism," best seen as an ideal type, is the delegation of regulation and enforcement to strong "independent" agencies. The act of delegation itself has become associated with international best practice as the preferred solution to time inconsistency and policy capture problems.2 The model of regulatory neoliberalism suggests that the agencies that apply and enforce regulation should be technocratic, apolitical, and insulated from predatory 2 G<;verning Finance vested interests. Once achieved for financial regulation, developing coun­ tries might more fully-and hopefully much more safely-participate in the global financial system. How was such a convergence upon regulatory neoliberalism to be achieved? The governments of major countries saw the solution in the elaboration of best practice international standards of financial regula­ tion and the promotion of developing country compliance with these stan­ dards. Compliance with international standards is different from the ideal type of regulatory neoliberalism, but it has been seen a,s the main means of bringing about convergence upon the latter. I argue that this approach has serious flaws. First, the international standard-setting process is inevita­ bly politicized and often produces standards that are sometimes vague and at other times inappropriate to the circumstances of particular countries. Second,even when international standards do approach current "best prac­ tice," country compliance is often poor and the international mechanisms for promoting compliance are weak. The focus of this book is primarily upon the latter problem.In particular, what determines the quality of compliance with international standards? And, related to this, why is poor quality compliance sustainable over time despite the apparently considerable pressure from multilateral institutions and capital markets to adopt international standards? At various points I discuss why some international standards are of poor quality or inappro­ priate for many developing countries, but my main focus is upon the com­ pliance problem and the obstacle this places in the path of convergence upon regulatory neoliberalism. The problem is not simply that regulatory neoliberalism is an ideal type that can never be fully realized in practice. Rather, I argue that the depth of the compliance problem reveals that the main sponsors of the interna­ tional standards project misconstrued the politics of state transformation and so underestimated the possibility of reform failure. Behind the vision of encouraging a transition toward regulatory and institutional best practice is a strong presumption that Western rules and practices could be patched relatively easily onto developing political economies thereby de-politicizing financial regulation. In practice,however,we see a highly politicized reform process in which domestic groups that stand to lose from these reforms mobilize to block or to modify it. In some countries, and in some areas of regulation, these groups have successfully penetrated the new regulatory frameworks, with the result that the quality of compliance with interna­ tional standards varies widely. Low compliance with international standards does not always mean poor quality regulation (though it often does). In the more successful coun­ tries, political and economic elites have adapted international standards to suit local conditions. Notably, contrary to the prescriptions of regulatory International Standards and Financial G