FROM THE OFFICE OF PUBLIC AFFAIRS

Good afternoon.

It is a great pleasure for me to speak to the Asia Society today. I have had a long and fruitful association with the Asia Society, both as a board member for some years, and as a steady customer for its policy discussions.

From my perspective, today’s event is quite timely. I have just returned from a ten day trip to Malaysia, China, and South Korea. There, I announced a Bush Administration initiative to transform key emerging market financial sectors into engines for economic growth. I would like to elaborate on this new policy goal, which pertains directly to today’s conference topic, "Strategizing for an Uncertain Future in Asia."

Our initiative seeks to strengthen financial sectors in emerging markets by helping them introduce best practices gleaned from the most developed markets. Such practices include opening their economies to international financial firms’ resources and technology, and designing better domestic financial regulations and supervision. Financial sector strengthening consequently offers two fundamental benefits to those who undertake it. First, an open, well-regulated financial sector is more efficient and robust, and fuels growth throughout an economy. Indeed, all other sectors rely on financial intermediation for their growth. Second, perhaps more than any other economic sector, a strong financial sector protects an economy from external and domestic shocks. Thus it offers stability.

Clearly, growth and stability in the Asian economies are both high priorities for U.S. investors and multinationals doing business in Asia, just as they are sensible priorities for leadership in Asian countries. In light of the audience today, I should also point out two other benefits. Financial sector openness enables foreign investors to support the success of these economies with less systemic risk. And better regulatory supervision, along with openness, makes it easier for responsible governments to crack down on terrorist financing.

In my view, there is no better way to advance the Asian economies in the 21^st century, and to reduce risks for both foreign and domestic investors in those economies, than through strengthening their financial service sectors.

As we look around the world, we see that just about every advanced economy has an open financial sector, with a large number of firms competing for business.

For example, in the United States, imports of financial services, including insurance, totaled $19.3 billion in 2000. This accounted for 10 percent of all cross-border service imports into our country that year. Sales by foreign-owned financial firms operating in the U.S. were even more substantial. In 1999, the latest year available, sales of services in the U.S. by majority-owned finance and insurance affiliates of foreign companies totaled $94 billion. These affiliates account for more than ten percent of total U.S. revenue in these sectors.

Because the U.S. economy is open to these firms, consumers and businesses can choose from the most advanced, best-priced financial services in the world. To attract and keep their business, financial firms offer the highest possible returns to savers, and the lowest possible cost of capital to investors. Thus the competition leads to narrower spreads, and stimulates both savings and investment. Financial institutions, as they aggregate capital, must move it into the businesses and industry sectors where the institutions can earn the best risk-adjusted returns for their savers. That means investing in the businesses that can make the best use of their capital. In other words, those that offer the highest productivity. And rising productivity -- output per worker -- is the root of rising living standards.

At the same time, proper regulatory practices, including transparency in rule-making and adequate disclosure from firms, ensures that savers can choose the right level of risk and return for themselves.

The process of intermediating capital between savers and investors -- the job of the financial sector -- is one of the most fundamental components of modern capitalism. The faster and more efficiently the financial sector identifies the best growth opportunities and moves savings into them, the faster the economy can grow. That is why I like to say that an efficient financial sector is an engine for economic growth. It converts the fuel -- the potential -- of savings into kinetic energy for the economy.

The best way to increase efficiency in emerging market financial sectors is to expose domestic firms to the best practices of world-class financial institutions, so that domestic firms can learn from the best and compete. Just as Asian manufacturers excelled in the last century by learning, and then improving upon the manufacturing methods of the industrialized economies, Asian financial systems must do the same with financial services.

Empirical evidence supports the theory. A 2001 World Bank study found that countries with fully open financial services sectors grow, on average, one percentage point faster than other countries. These results corroborate an earlier World Bank study estimating that more open and competitive financial services markets increase national growth rates by 1.3 to 1.5 percentage points. Likewise, a recent WTO study of 27 emerging market countries found that allowing foreign financial firms to establish locally and to engage in a broad spectrum of financial activities contributed to greater financial sector stability.

A strong financial service sector is also important because it enhances economic stability. That is, it reduces risk for savers and investors. I want to focus on two types of risk, though there are many others – risk posed by globalization and risk posed by terrorism.

Few regions of the world have more than Asia reaped the benefits of globalization – the growing interconnection between economies. Export-led growth was basic to the so-called Asian Miracle of the past half-century, one of the great development success stories in economic history. Nevertheless, growing interdependence brings challenges of its own. Increasingly, our economies pedal in tandem. When the United States moves forward, so do many Asian economies, and the reverse is true as well.

For many emerging markets, especially those in Asia, the consequences of this economic integration are profound. Access to markets abroad means greater exports for Asian economies and greater profits for their firms. But economic integration also has its downside, and the turbulent winds of the global economy can swing a boom hard, fast, and unexpectedly. The slowdown in U.S. high tech manufacturing in the last few years hit many Asian component manufacturers’ exports in just that way.

A strong financial sector makes an economy more resilient to external economic shocks. One way it helps is by sustaining domestic demand when export demand falls off.

Again, consider the United States. During last year’s economic slowdown, our flexible financial sector -- in addition to well-timed tax relief and aggressive monetary easing -- powered a swift rebound. In particular, widespread access to home mortgage products and rapid, low-cost refinancing kept U.S. consumers spending until businesses could clear their inventories and begin to rebuild.

Another risk we are beginning to understand as an economic risk is terrorism.  Indeed, the terrorist attacks on September 11 were directed at the World Trade Center not only because so many people worked there, but also because the Twin Towers were symbols of the American economy, and the financial system in particular.

  While September 11 was a wake up call to America, several economies and financial sectors of Asia have long faced this threat.  The Philippine stock exchange was bombed in 2000 and the Korean financial sector has long had to cope with the threat of a military attack. 

A strong financial service sector helps our economies manage risk from terrorism in two ways.

First, modern financial institutions can detect suspicious activity, report it, and help law enforcement to disrupt terrorists before they can attack.  Modern financial institutions have information systems capable of searching millions of daily transactions.  Stringent laws against terrorist financing are most effective when financial institutions have the technology to implement the laws at a reasonable cost, without impairing normal operations.

Second, robust financial services help diffuse the risk of an actual attack. One of the reasons the American economy proved so resilient following September 11 was that the United States has well-developed volatility markets. These markets shifted risk from those who didn’t want it to those who were willing to bear it -- for a price, of course. When the risk was realized in that terrible moment, advanced financial instruments helped absorbed its financial impact.

At the same time, despite a devastating attack on the physical heart of our financial system, the American economy continued to function, thanks to our technologically advanced, highly decentralized financial infrastructure. Our payments system kept working. Our bond and stock markets re-opened in days. Since the attacks, we have hardened our critical financial infrastructure further.

The economic importance of a deep, flexible and resilient financial sector cannot be overstated. Gone are the days when a national airline or government-directed investments in manufacturing were the badges of economic development. In this decade, the great challenge for Asian countries in transition will be financial sector restructuring and development. The question, of course, is how to get there.

Transforming the financial sectors of Asian economies into engines of growth will be a challenge. But I believe the record shows that when policymakers are determined, they can act to strengthen their nation’s financial sector -- and succeed.

Consider Korea. In just four years, Korea has recreated its economy through financial sector reform, setting an example for the region. Failed banks have been recapitalized. Non-performing assets have been sold. Financial regulation and supervision have been strengthened. And Korea’s capital account has been substantially liberalized.

The results are clear. Private banks are again profitable. Capital ratios have improved, and the number of non-performing loans is down. Though the reform process is not yet complete, change for the better is well underway.

It is essential that countries that forge ahead to strengthen their financial systems will require enlightened policymaking, a deep commitment to openness, and the very best regulatory oversight and enforcement. Vested interests may object, and a new and deeper faith in the markets must be nurtured.

Let me say a word about regulation and supervision. Sound regulation and supervision are essential to the success of efforts to bolster the financial system. Every effort should be taken to apply new, transparent methods for drafting and applying regulations. Regulators should seek out the insights of the private sector before creating the rules of the game. We use these methods in the United States.

The U.S. Federal Reserve, for example, regularly publishes proposed regulations and asks for comments from the private sector in a reasonable period of time. During the implementation of our Gramm-Leach-Bliley bill -- which fundamentally reformed the U.S. banking, securities and insurance sectors -- the U.S. Federal Reserve sought out and received hundreds of comments from foreign banks. As a result, it made several significant changes to accommodate the many international banks doing business in the United States. Rules that specify how regulations will be implemented and how applications for licenses will be granted or denied are equally as important.

We are making some progress in improving the regulatory climate worldwide. Here in the United States, we have enacted the USA PATRIOT Act. Among other things, the Act requires financial institutions to terminate correspondent accounts maintained for foreign shell banks and to take reasonable steps to ensure that they do not indirectly provide banking services to foreign shell banks. Internationally, the United States, along with 28 other countries and territories, works with the multilateral Financial Action Task Force (FATF) to fight money-laundering and terrorist financing.

For the most part, Asian economies have been strong allies in the fight against terrorist financing. Hong Kong has been a strong advocate, as have Singapore, Malaysia and Thailand.  While the Philippines and Indonesia have recently passed anti-money laundering laws, improvements are still needed.  Furthermore, total assets blocked have been disappointing to date, particularly in Southeast Asian economies where we know terrorist cells operate.

My mission in Asia last week was to engage key policymakers in a dialogue aimed at building momentum for financial sector liberalization.  I believe we were successful in sparking the discussion.  We must continue to collaborate on financial sector development if the Asian economies are to enjoy the sustained growth and stability that a strong, modern financial service sector makes possible.  Asian prosperity in the 21st century depends on it.