Theme Paper and Special Reports

Part 1
Theme Paper and Special

Reports
Theme Paper
1
Expanding Long-Term Financing
Through Bond Market Development:
A Postcrisis Policy Task
Jonathan Batten and Yun-Hwan Kim
I. Introduction
The Asian nancial crisis suggests many policy tasks to be ad-

dressed, not only in the regions worst hit economies, but also in other
developing countries. One of these is to diversify the source of indus-
trial nancing, which has historically been concentrated in the form of
intermediated borrowings. For example, the crisis countries1 relied on
short-term external borrowings from both domestic and foreign banks for
their long-term development resources. This was the result of policies
that focused on the establishment of bank-centered nancial systems
without adequately encouraging alternative modes of nancial contracting.2
While the bank-centered nancial system approach has successfully
contributed to the high-economic growth achieved in the region (since
banks are more e¬ective monitors of nancial environments characterized
by asymmetric information in underdeveloped nancial markets), it has
also resulted in overreliance within the industry sector on short-term bank-
intermediated borrowings. In July 1997, as the crisis struck Indonesia,
two thirds of the total corporate sector foreign debt (US$64.6 billion)
was short term, with the average maturity of all private sector debt (oc-
cupying about 80 percent of the countrys debt) being approximately 18
months. Such industrial nancing behavior caused two critical nancial
1. The crisis economies in this paper refer to the worst hit countries,
namely, Indonesia, Republic of Korea, Malaysia, and Thailand.
2. See Walter (1993) for a discussion of the di¬erent modes of nancial
contracting and a stylized model of the financial intermediation process. Also,
Harkansson (1999) argues that a developed bond market reduces systemic risk
and the probability of crisis.
6 Government Bond Market Development in Asia
mismatches: a maturity mismatch and a currency mismatch. The maturity

mismatch was the consequence of unhealthy nancing practices, characterized
by large, long-term investments under the nancing of short-term bank
borrowings.3 In addition, the practice involved a serious currency mismatch
without the provision of a proper currency hedging arrangement. In fact,
the currency mismatch was implicitly protected by overvalued exchange
rates, arising from foreign exchange misalignments in these countries.
The nancial sectors of the crisis economies have developed much
less successfully than the real sectors. Financial sector weaknesses are
deep-seated and pose problems in the overall economy. The countries in
question have failed to vigorously address these weaknesses during the
high growth period of the past four decades. While real sector growth
was successful, nancial sector development lagged behind. Evidence of
strength in the real sector can be seen in low ination, high growth,
scal discipline, and signicantly advanced manufacturing capacity. By
contrast, the nancial sector remains weak largely due to government
intervention in the operation and management of nancial institutions,
direct scal support for a signicant number of special-purpose banks,
implicit government guarantees about banks operations, and an improper
nancial sector development strategy, which downplays the role of capi-
tal markets. Due to this underlying situation, the Asian crisis is viewed
as a liquidity crisis rather than a macroeconomic crisis.
Until now, the crisis countries restructuring policies have focused
on the stabilization of nancial markets (particularly banking and foreign
exchange markets), recapitalization of viable banks, the workout of heavily
indebted corporations, reform of corporate governance, and resolution and
management of nonperforming loans. Excluding Indonesia, where the re-
structuring process is sluggish, the crisis countries e¬orts have generally
been successful and contributed to the recent, rapid economic recovery
particularly in the Republic of Korea and Malaysia, where governments
are taking the lead. The speed of restructuring here is fast, although the
ongoing e¬ort has resulted in many related problems and issues, such as the
accumulation of huge nonperforming assets in the hands of asset manage-
ment companies (AMCs), the injection of large public funds for bank
recapitalization, and the related nationalization of several banks.
3. Best international practice, as well as some banking laws, suggests that

a commercial bank which is generally entitled to receive only short-term deposits
up to one year, should try to match the average maturities of risk sensitive assets
and liabilities. Regulators usually require this maturity mismatch to be within a
specic band that is determined by the banks size, its experience, and the infra-
structure available to manage and measure risk.
Expanding Long-term Financing 7
While the crisis economies must maintain their ongoing restructur-

ing e¬orts, they must also start to consider the postcrisis policy agenda
to prevent the recurrence of similar crises in the future, and to lay stron-
ger foundations for sustainable long-term development. An important
goal in this context is to diversify the source of industrial nancing
through the development of deeper capital markets, which remain under-
developed in these countries; bond markets in particular. Actively tapping
international bond markets to nance long-term industrial projects is
also recommended.
In the postcrisis period, the industrial corporations in Asian devel-
oping economies, including those in the crisis economies, will experience
some signicant changes in the nancing environment. Specically, both
foreign and domestic banks will be extremely cautious about providing
credits. 4 This will result in bank disintermediation, as in the United
States (US) and, to a lesser extent, Japan and European countries,5 though
for di¬erent reasons. Given that bank intermediated nance still forms
the single most important source of industrial funds in Asian developing
countries, this change underlines their need to develop disintermediated
nancing. The potential for developing domestic bond markets is great
given the high savings rates in these countries.
E¬ective capital markets may play several positive roles, rst through
greater diversication of nancing, an easier process of risk transforma-
tion and smaller concentration of nancial risks. Second, having access
to swifter ows of diverse information, capital markets may check and
screen nancial risks more e¹ciently and quickly than bank credit de-
partments, leading to more appropriate nancing decisions being taken.
More e¬ective capital markets can also deepen a developing countrys
nancial base, with far-reaching positive implications for development
resource mobilization.
4. From 1996 to 1999, the levels of international bank lending to Asian

developing countries decreased signicantly. See Chapter II for details.
5. International portfolio diversication and the yield-seeking behavior of
globalized investors has increased the opportunity cost of bank deposits, and
contributed to bank disintermediation and a broadening of securities markets in
many advanced countries. For example, the total market value of assets managed
by US mutual funds (roughly US$5 trillion) and invested in securities markets
surpasses the total value of deposits in US banks. Japanese and European nancial
markets are largely following US trends, though the pace is slower (see Schinasi
and Todd-Smith (December 1998)).
II. Trends of Industrial Financing in the Asian Crisis Economies
Industrial nancing comprises new equity and debt nancing through

bank intermediated or direct securities issues in domestic or foreign bond
markets. The focus of this Study is on debt nancing. The following section
highlights trends in the domestic debt and equity nancing, international
bank nancing, and international bond issues of Asian crisis economies.
A. Domestic Debt and Equity Financing
The nancial systems of the four crisis economies are very di¬er-
ent. The economies of Indonesia and Thailand are easily characterized
as bank-centered nancial systems where banks are required to exert a
signicant monitoring role arising from both equity as well as debt ex-
posures. Malaysia has a more developed equity market, which suggests
better levels of investor protection and governance. This legal protec-
tion should both facilitate arms length bank nancing while also
encouraging disintermediated nancing. Meanwhile, the Republic of Korea,
with its chaebol structure, displays a web of interconnected corporate
cross-holdings. Added to the corporate control processes within these
nancial systems are the divergent inuences of the state, small groups
of founding families, and also shareholders, who are often poorly orga-
nized and lacking in political inuence. The mitigation of these agency
factors and the di¬erent degrees of development of institutional and
legal infrastructure have a¬ected the structure of the respective bond
and equity markets in the crisis economies.
The size of bond and equity markets and domestic bank lending
in the crisis economies at year-end 1998 is shown in Table 1. All crisis
economies have signicantly large banking sectors and much smaller
bond and equity markets. The table clearly shows how domestic nanc-
ing in these countries has traditionally relied on the banking sector.
Malaysia has the largest market for bank loans and equity market capi-
talization in relation to gross domestic product (GDP), while the Republic
of Korea has the largest corporate bond market in relation to GDP (27.3
percent), followed by Malaysia (5.1 percent), Thailand (2.6 percent), and
Indonesia (1.5 percent).
TABLE 1
Bank Loans, Corporate Bonds, and Equities in Asian Crisis Countries
and the US, End-1998
(percent of GDP)
Outstanding Bank Outstanding Equity Market

Loans Corporate Bonds Capitalization
Indonesia 60.2a 1.5 16.2
Republic of Korea 43.5 27.3 30.7
Malaysia 148.4 5.1 134.4
Thailand 108.7 2.6 26.3
US 38.8 43.2 158.1
a
at the end of 1997.
Source: Countries Monetary Authorities and Bloomberg Investor Services.
The crisis economies heavy reliance on bank intermediated nance

is evident in comparison with the large, integrated nancial market in
the US,6 where bank lending and corporate bond markets are of a simi-
lar magnitude (38.8 percent and 43.2 percent). The ratios suggest that
the Republic of Korea has the most disintermediated debt market whereas
Indonesia has the least. Malaysia, however, has an equity market in which
capitalization is comparable in GDP terms to that of the US. Since inter-
mediation via traditional nancial institutions and direct securities market
processes compete with one another in terms of e¹ciency, it is impor-
tant to identify those factors that have prevented the development of
nonintermediated forms of nancing in the crisis economies.
TABLE 2
Outstanding Corporate Bonds in Asian Crisis Countries and the US
(percent of GDP)
Country December 1996 December 1997 December 1998

Indonesia 1.9 2.5 1.5
Republic of Korea 18.2 21.4 27.3
Malaysia 6.1 7.1 5.1
Thailand 2.8 2.8 2.6
Source: Countries Monetary Authorities and Bloomberg Investor Services.
6. Given the large di¬erence in historical backgrounds and underpinning frameworks

between nancial systems, it is not advisable to directly compare these countries with
the US. However, because the US has the most advanced capital market, it may serve
as a comparator country in discussing bond market development.
The three-year trends from 1996 to 1998 shown in Table 2 suggest

that only the Republic of Korea has increased corporate bond nancing
over the period, from 18.2 percent to 27.3 percent, while levels in the
other three countries, despite some year-to-year uctuations, have gener-
ally remained unchanged. The US, however, assisted by the ongoing
recycling of bank loans through various securitization vehicles, shows
evidence of continuing disintermediation, with levels of bond nancing
increasing over the period from 37.1 percent to 43.2 percent. This shows
that bond markets in the crisis countries remain at a modest level. During
the immediate fallout of the nancial crisis in the Republic of Korea,
commercial banks became extremely cautious about new lending and
were eager to withdraw old loans to meet the Bank of International
Settlements (BIS) capital adequacy ratio. This led industrial corporations
to tap bond markets as a substitute form of nancing. In Malaysia, the
banking sector was well capitalized before the crisis, with capitalasset
ratios exceeding 10 percent. Therefore, Malaysian banks did not drasti-
cally cut loans to the industry sector. Indonesia and Thailand did not
signicantly reduce bank loans either. However, Indonesia, Malaysia, and
Thailand have all been keen to develop corporate bond markets, par-
ticularly since the crisis.
B. International Bank Financing
The levels of international lending (by BIS reporting banks) to the

crisis economies between 1996 and 1999 are shown in Table 3. This
table provides a summary of lending levels to the crisis economies and
the Asia-Pacic region generally, with more specic details of lending to
individual countries provided in the Appendix. The table shows that
1996 lending levels peaked in December at US$247.9 billion. By June
1999, the gure had dropped signicantly to US$160.7 billion.
In nominal terms, this appears to be linked to a withdrawal of
lending to Asia generally (an overall decline from US$367.1 billion to
US$287.0 billion) and an increase in lending to other developing coun-
tries (an increase from US$692.6 billion to US$809.6 billion). In percentage
terms, the largest reductions in bank lending throughout the period were
experienced by Thailand (50 percent) and the Republic of Korea (37
percent). This suggests that postcrisis international bank lending to the
a¬ected economies was characterized by the rebalancing of investor port-
folios away from the Asian region to other developing countries,
particularly in Eastern Europe.
While Asia enjoyed a privileged position as the major recipient of
international lending to the developing world in 1996 (53 percent of all
TABLE 3
International Bank Lending to Crisis Economies
(in US$ billion)
Dec Dec June Dec June

1996 1997 1998 1998 1999
Total Developing Countries (TDs) 692.6 891.7 860.7 842.7 809.6

Total Asia (TA) 367.1 378.8 319.6 299.4 287.0
Indonesia 55.5 58.0 48.4 45.0 43.8
Republic of Korea 100.0 93.7 71.6 65.6 63.5
Malaysia 22.2 27.3 22.8 20.9 18.6
Thailand 70.2 58.5 46.4 41.2 34.7
Total Crisis Countries (TCs) 247.9 237.5 189.2 172.7 160.7
(TA/TDs) % 53.0 42.5 37.1 35.5 35.4
(TCs/TDs) % 37.8 26.6 22.0 20.5 19.8
Average Maturity (Crisis Economies)
Less than 1 and 1 year (in percent) 61.2 60.5 51.7 50.3 50.1
Average Maturity (Total Asian Economies)
Less than 1 year and 1 year (in percent) 61.5 60.3 53.0 52.5 51.4
Note: Asia includes Afghanistan; Bangladesh; Bhutan; British Overseas Territories; Brunei; Cambo-
dia; Peoples Republic of China; Fiji Islands; French Polynesia; India; Indonesia; Kiribati; Democratic
Peoples Republic of Korea; Republic of Korea; Lao Peoples Democratic Republic; Macao; Malaysia;
Maldives; Mongolia; Myanmar; Nauru; Nepal; New Caledonia; Pakistan; Papua New Guinea; Philip-
pines; Solomon Islands; Sri Lanka; Taipei, China; Thailand; Tonga; Tuvalu; US Pacic Islands; Viet
Nam; Wallis-Futuna Islands; Western Samoa. Singapore and Hong Kong, China are treated as o¬shore
banking centers and are not included.
Source: BIS (1999) Consolidated International Banking Statistics for End-June 1999 November and
BIS (1997), The Maturity, Sectoral and Nationality Distribution of International Bank Lending: Second
Half 1996, Basle July.
lending), this picture changed rapidly in the wake of the regional crisis,
with Asia accounting for only 35.4 percent of lending by June 1999. Of
this, the amount directed specically to the crisis economies fell from
37.8 percent in December 1996 to just 19.8 percent in June 1999. In
other words, not only has international lending shifted away from Asia
as a whole, but of the reduced funds lent to the region a greatly limited
sum has been allocated to the crisis economies.
This situation has ensued due to two factors. First, there is evidence
of a structural shift away from bank-intermediated lending by Japan7
owing to that countrys own domestic crisis and an aversion to yen-
denominated loans by regional borrowers. Thailand and the Republic of
7. In June 1999, Japanese banks only accounted for 26.1% of US$287

billion claims to Asia compared with 30.3% of US$378.8 billion in December
1997 (BIS, 1999, Table 2).
Korea have experienced the smallest reduction in loans from Japan, while
Indonesia and Malaysia have been hardest hit.8 However, while the re-
duction in lending from Japan has been partly o¬set by lending from
European banks, the absolute quantity of loans has fallen. Second, the
reduction in lending reects rethinking by developed world lenders about
the creditworthiness of the Asian region as a whole and the crisis economies
in particular. This risk reassessment has been manifest in higher (credit)
spreads on bank intermediated loans and higher yields on bonds trading
in secondary markets. Though the price of debt has risen, the signicant
reduction in lending has increased liquidity concerns for the region.
Information on the average maturity of lending to Asia and to the
crisis economies is also provided in Table 3. At the peak of lending in
1996, most loans to Asia (61.5 percent) and the crisis economies (61.2
percent) had a maturity of less than one year. Though the maturity of
loans has subsequently been extended, the crisis economies still bor-
rowed 50.1 percent of loans as short maturities in June 1999. However,
this gure masks the fact that the increase in average loan maturity is
more a function of the nonrollover of short-term loans.
Though not recorded in Table 3, most international lending over
the period to the Republic of Korea was directed towards the banking
sector (from 65.9 percent in December 1996 to 57.4 percent in June
1999), while lending in the other three crisis economies was aimed at
the private sector (an average of 62.5 percent in December 1996 and
69.2 percent in June 1999). The anomaly in the case of the Republic of
Korea is probably due to the concentration of the banking market and
the nancial arrangements in place between the Korean chaebols. Other
key points relating to international lending to the crisis economies have
been the increase over recent years in levels of lending to the public
sector rather than to other industry sectors, and the fact that capital
inows through banks were not sensitive to movements in interest rate
di¬erentials, resulting in banks increasing their domestic lending once
they had borrowed unhedged from abroad.9
C. International Bond Issues
Recent Trends. International bond issues comprise bonds issued in Eu-

robond markets or in foreign domestic bond markets such as in Japan,
8. Details of international bank nancing to each of the crisis economies

are provided in the Appendix.
9. Kawai and Takayasu (1998) make this point concerning Thailand, though
it may be generalized to other crisis economies.
TABLE 4
International Bonds Issued by Asia-Pacic Economies
(US$ billion)
Country Mar 94 Mar 95 Mar 96 Mar 97 Mar 98 Mar 99
Australia 42.1 50.1 53.7 88.5 80.4 86.9

China, Peoples Republic of 9.6 13.0 12.0 13.0 14.8 13.9
Hong Kong, China 10.9 14.7 12.4 17.5 20.1 22.3
India 3.0 3.3 3.7 4.6 5.9 5.7
Indonesia 1.4 3.1 3.9 5.6 5.8 4.5
Japan 279.8 276.6 226.2 188.4 145.5 127.9
Korea, Republic of 0.0 19.4 23.4 40.6 48.1 48.3
Malaysia 17.7 4.4 5.9 10.1 12.1 12.5
New Zealand 6.5 5.9 5.4 6.3 7.9 7.0
Philippines 0.0 2.0 2.2 6.4 8.0 9.9
Singapore 1.2 1.0 1.2 2.5 3.2 5.7
Taipei,China 3.3 2.4 2.8 3.8 5.7 6.5
Thailand 0.3 4.0 5.4 9.9 11.5 12.4
Total: Crisis Economies 19.4 30.9 38.6 66.2 77.5 77.7
Total: Developed Economies 329.6 333.6 286.5 285.7 237.0 227.5
Total: All Economies 375.8 399.9 358.2 397.2 369.0 363.5
Note: Nepal, Democratic Peoples Republic of Korea, Pakistan, and Viet Nam are excluded from the
table since there were no international bond or note issues recorded. Crisis Economies are Indonesia,
Republic of Korea, Malaysia, and Thailand. Developed Economies are Australia, Japan, New Zealand,
and Singapore.
Source: BIS, International Banking and Financial Market Developments (various issues), Table 13
International Bonds by Nationality.
United Kingdom (UK), and US. Details of these issues are provided in
Table 4. In 1999, total international bond issues by crisis economies
(US$77.7 billion) were signicantly smaller than the intermediated -
nance o¬ered by international banks (US$160.7 billion). However, it
would be expected that these markets compete with one another on
e¹ciency criteria. The larger size of the intermediated nance market is
consistent with a higher entry or cost structure, and may well inhibit the
ability of the Asian crisis economies to tap this market as a debt alternative.
International bond nancing by the crisis economies has increased
from US$30.9 billion in 1995 to US$77.7 billion in 1999 (an increase
of 128 percent over the period). The Republic of Korea has been the
largest issuer, while the level of international bonds issued by Japan has
fallen, a function of the well-documented Japan premium, reecting
the higher yields demanded by investors holding yen bonds in o¬shore
markets. The international issues from the crisis economies have largely
focused on bond issues in the US market (termed yankee bond issues)
by quasi-government or sovereign borrowers. Though these securities
have to be registered,10 borrowers have been encouraged to bypass na-

tional banking systems and pursue direct security market processes due
to declining issuing and compliance costs, and the withdrawal of lend-
ing by international banks to the region following the Asian crisis
(⫺4 percent in 1999 and ⫺21 percent in 1998). In addition, while the
US Securities and Exchange Commission (SEC) discourages the sale of
Eurobonds to US citizens (there are provisions which enable the sale
and subsequent trading of Eurobonds as private placements), strong in-
vestor demand for high-yielding domestic issues has encouraged issues
from better-rated issuers in crisis economies.
Thus, on the one hand, US investors have recently emerged as the
largest buyers of crisis economy bonds, while US nancial intermediar-
ies have historically demonstrated a lack of interest in pursuing
intermediated bank lending business in crisis economies. This apparent
anomaly is explained by the sanctity of the US nancial system and
investors faith in the US legal process. The US nancial system is better
able to resolve the information asymmetries that exist between crisis
economy borrowers and potential investors, while simultaneously o¬er-
ing better investor protection than that provided by nancial intermediaries
operating in the domestic nancial environment.
Despite the noninvestment grade status of most of these domestic
US issues, investors can take comfort from their quasi-government or
sovereign status. Historically, few nongovernment or quasi-government
issuers have tapped these markets, since they have little or no issuance
history and lack the marketability of a sovereign issue. The interest rate
spreads of unknown or new issuers demanded by the markets has also
been wider than those demanded by similarly rated European or US
corporations in recent years, and may have discouraged borrowers.
The attractive feature of the yankee market is that it is available to
the noninvestment grade corporate issuers (credit rating lower than BBB)
from crisis economies. Apart from Indonesia (which is currently
noninvestment grade), corporate issuers in other crisis economies have a
sovereign ceiling at the investment grade level (see Table 5 below).
Emerging market issuers are generally unable to tap the international
Eurobond market,11 which has a preference for investment grade issues,
10. Domestic bond issues in the US must be registered with SEC under
the US Securities Act of 1933.
11. Bond credit rating agencies categorize corporate bond issuers into nine
major classes according to perceived credit quality. These ratings classes include
investment grade issuers: AAA, AA, A, and BBB, and noninvestment grades:
BB, B, CCC, CC, and C. Bonds with ratings below C are bonds in default or of
and is also largely a US-denominated market.12 From the borrowers per-

spective, however, the degree of substitutability of these di¬erent markets
is ultimately a function of cost. For example, there were signicant increases
in the level of o¬shore issues prior to 1995, largely due to the decline in
spreads of issues over US Treasuries of similar maturity. Following the Asian
crisis there was an increase in spreads which discouraged international
issues in favor of domestic issues and loans from international banks.13
TABLE 5
Credit Ratings of Crisis Economies (as at 10 March 2000)
Standard & Poors Sovereign Long-Term Debt Rating

Country
Foreign Currency Domestic Currency
Indonesia CCC⫹ B⫺
Korea, Republic of BBB A
Malaysia BBB A
Thailand BBB⫺ A⫺
International bond issues by the crisis economies were also under-

taken against a background of ongoing change in the regions risk
transformation capability, through the use of forwards, futures, and op-
tions (see Table 6). Key to this has been the changing role of Singapore
and Hong Kong, China since the handover to the Peoples Republic of
China. Many international transactions are now being booked through
Singapore instead of Hong Kong, China. For example, foreign exchange
turnover in Singapore is now US$139 billion per day compared with
Hong Kong, Chinas US$78.6 billion (BIS 1999).
bankrupts. The two major agencies use slightly di¬erent notation to refer to
equivalent credit risk categories. Standard & Poors use upper-case capitals (e.g.,
AAA), while Moodys Investor Services use an upper case rst character and
have any remaining characters lower case (e.g., Aaa). This paper uses the Stan-
dard & Poors notation.
12. Worldwide, the US dollar is the most frequent currency of Eurobond
issue, with US$1,673.4 billion, followed by the Japanese yen at US$407.1 billion,
the Deutsch mark at US$369.4 billion, the pound at US$308.3 billion, the French
franc at US$191.3 billion, the Swiss franc at US$141.5 billion, the Italian lira at
US$117.9 billion, the Dutch guilder at US$105.3 billion, the ECU at US$99.3 billion,
and nally the Luxembourg franc with US$37.8 billion in outstandings (BIS, 1998
Table 13B).
13. See Chart 5, Kamin and von Kleist (1999:17) for graphical evidence of
the decline in spreads (19911997). Lenders favored Asian issues (e.g., spreads on
Latin American issues with the same characteristics as Asian issues were 39 percent
TABLE 6
Comparison of International Bank Lending and International Debt
Securities of Crisis Economies, 19961999
Change in Levels of Bank Change in Levels of

Lending International Bond Issues
Country (Dec 1996 June 1999) (Mar 1996 Mar 1999)
Indonesia ⫺11.7 ⫹3.1
Korea, Republic of ⫺6.5 ⫹48.3
Malaysia ⫺3.6 ⫺5.2
Thailand ⫺35.5 ⫹12.1
Risk transformation capability is crucial when the bulk of both

intermediated nance and international bonds are denominated in nonlocal
currencies. For example, apart from some o¬shore issues denominated in
Hong Kong, China and new Taiwan dollars, regional borrowers usually
issue securities in US dollars. To avoid potential translation losses arising
from the revaluation of foreign currency-denominated bonds, issuers would
normally undertake a foreign currency swap into local currency and an
interest rate swap from xed to oating rate coupons. The absence of
these derivatives in a local market would e¬ectively restrict the hedging
alternatives available to a corporation.
There have been a number of transactions in 1999, which have
highlighted the ability of Asian issuers to tap international markets. Specic
transactions include (i) Federation of Malaysias US$1 billion sovereign
bond issue priced at 330 basis points; (ii) Development Bank of Singapores
US$750 million issue priced at 200 basis points (2 percent) above US
Treasury paper; (iii) Globe Telecom and Bayan Telecom of the Philippines
issue of US$220 million and priced at 709 basis points over US Treasury
paper; and (iv) Republic of Koreas US$3 billion xed rate 10-year bond
issue priced at 300 basis points.
The key features of these transactions, which encouraged high-
yield investors, were the size of the issue (which ensured adequate
liquidity), the size of the spread (which compensated investors for the
risks of holding emerging market bonds), and the marketing of the issues
(which included government and Central Bank representation during the
higher). This may be due to the fact that (i) Latin American and Eastern European
countries exhibited greater volatility than Asian economies (K and VK: 18), and/
or (ii) greater supply, since Latin American countries issue more bonds than
Asian countries (Eichengreen and Mody (1997). But as K and VK note, Asia,
while not issuing bonds, tends to take out more loans. This suggests economic
stability as the key factor for deciding spreads.
international promotion or roadshow prior to the actual issue arranged

by high-prole and credible bookrunners).14 Also, each of the issues had
a simple xed rate pricing structure and were quasi-government, if not
sovereign, issuesapart from the Philippines Globe Telecom and Bayan
Telecom, which were private sector issues. It is unlikely that a more
complex structure (for example having a call feature) would have found
favor with investors, or that smaller tranches o¬ered over a range of
maturities would have satised the markets desire for liquidity,15 since
smaller issues fragment the distribution of bonds. However, the key feature
of very large (jumbo) Eurobond issues by prime name corporations is
that they are all simple xed rate US dollar-denominated securities.
Implications
The replacement of intermediated nance with international bond

issues suggests a degree of substitutability between these two forms of
nancing. However, the prevalence of issues by quasi-government or
sovereign issuers reects reluctance by international investors to hold
nonsovereign paper, suggesting that substitute forms of nancing are
only available to high quality issuers. Such reluctance, at this time,
e¬ectively caps the quantity of debt that could be placed into the inter-
national bond markets. Alternately, the markets may display the crowding
out of corporate issuers by the public sector, or be unable, rather than
unwilling, to price corporate debt, since appropriate infrastructure (such
as benchmark yield curves) is not available.
While bond issues and intermediated nance may be substitutes for
some risk classes of borrower, Table 6 (which provides a comparison of the
changes in international bank lending and international bond issues in the
period following the Asian crisis) clearly shows that increases in international
bond issues have not adequately replaced the reduction in the levels of in-
ternational bank lending in Indonesia, Malaysia, and Thailand. Only the
Republic of Korea has been able to successfully tap international bond
markets for additional funding. While each countrys experience has been
14. Capital Data Bondware (Euromoney) generally list the following rms
as the major bookrunners of emerging market bonds: JP Morgan, Merrill Lynch,
CSFB, Union Bank of Switzerland, and Lehman Brothers.
15. It is di¹cult to assess what issue size is necessary to maintain ad-
equate liquidity. One of the worlds largest Eurobond issuers (Federal Home
Loan Mortgage Corporation or Freddie Mac) suggests one bullet maturity issues
of at least US$4 billion every quarter. (Euromoney June 1998: Borrowers, A
Mad Rush for Liquidity).
di¬erent, the reduction in funding by international lenders is part of a much

larger withdrawal of private sector funds from the region (see Table 7). The
liquidity aspect of the Asian crisis may be addressed by increasing the num-
ber of long-term nancing options through the development of more viable
domestic bond markets in crisis economies, and by improving the access of
these borrowers to international bond markets.
TABLE 7
Financial Flows to Emerging Market Economies by Region
(US$ billion)
1996 1997 1998 1999

Private Flows, Net 327.9 265.7 147.8 148.7
Latin America 97.3 107.7 97.5 68.8
Europe 50.4 74.5 35.1 31.9
Africa/Middle East 3.8 15.7 9.4 8.7
Asia/Pacic 176.3 67.9 5.8 39.3
Five Asian Economies 108.1 ⫺0.2 ⫺36.4 ⫺3.7
O¹cial Flows, Net 7.6 38.9 52.8 11.9

Latin America ⫺10.5 ⫺2.6 15.7 5.5
Europe 11.2 6.1 8.1 3.0
Africa/Middle East 1.8 ⫺1.3 ⫺2.2 ⫺1.0
Asia/Pacic 5.0 36.7 31.2 4.3
Five Asian Economies ⫺1.6 29.9 26.9 1.4
Note: The Five Asian Economies are Indonesia, Republic of Korea, Malaysia, Philippines,
and Thailand.
Source: The Institute of International Finance, Inc. (1999).
III. An Overview of Domestic Bond Markets in Crisis Economies
A. Background
While crisis economies have historically relied on intermediated

nance for debt funding, there is evidence that direct securities issues
are gradually becoming a viable form of nancing. Each of the crisis
economies has had di¬erent experiences in this regard, in that there has
not been a consistent approach to the development of individual bond
markets, nor has there been a concerted attempt to unilaterally develop
bond market infrastructure across the region. For example, attempts to
establish an Asia-Pacic securities settlement system by the ADB have
been unsuccessful. Since the processes involved in trading, issuing and
settling securities are transaction-based and subject to economies of scale
and scope, these processes lend themselves to unilateral approaches that
secure and maintain e¹ciencies. The objective of the next section is to

describe the trends across the Asia-Pacic region, and then to focus on
the bond markets in each of the crisis economies. This chapter provides
an overview of key features of each of these markets. The later chapters
provide an insight into those factors which have hindered the develop-
ment of bond markets, and propose strategies for their development.
B. Recent Trends of Bond Financing
A comparison of bond markets in the Asia-Pacic region is provided

in Table 8. The data in this table is obtained from sources including the
BIS and the Reuters Fixed Income Database. While there are limitations
to the available data, the Table makes a number of key features evident.
First, there has not been a signicant increase in the size of the
crisis economies domestic bond markets between 1996 and 1999 (US$320
billion in 1996 and US$308 billion in 1999). In other words, there was
no compensating increase in domestic market issues to o¬set the reduction
in international bank lending and the poor performance in international
bond markets. It is worth noting that while Japan saw a considerable
reduction in international bond issues during the same period (from US$226
billion to US$128 billion), the level of domestic bonds issued increased
substantially (from US$4.862 trillion to US$5.131 trillion). This highlights
the advantage of having the infrastructure to facilitate the substitutability
of debt. Second, the proportion of total debt issued by the public sector
is relatively low. Since the overall size of each of these markets is also
small, this suggests that benchmark securities are unlikely to be liquid
or frequent in maturity. Market participants would therefore be unable to
construct accurate government yield curves for use as a basis for pricing
corporate debt issues. Overall, the data suggest that there has not been
any sustained development of domestic debt markets in recent years.
This highlights the need to develop policies to facilitate development
and ensure future access of corporations to a suite of nancing alternatives.
IV. Major Obstacles to Development of Domestic Corporate

Bond Markets
A. Traditional Negligence of Domestic Bond Markets
The traditional negligence of domestic corporate bonds by the in-

dustry sector in the crisis economies is largely due to (i) cheaper nancing
through overseas bank borrowing; (ii) bank dominated domestic nan-
cial systems; and (iii) agency problems arising from family-owned
corporations.
TABLE 8
Domestic Debt Markets in Crisis Economies
Compared with Key Regional Economies
(US$ billion)
Mar 95 Sep 95 Mar 96 Sep 96 Mar 97 Sep 97 Mar 98 Sep 98 Mar 99
Australia 155.40 162.80 174.90 180.30 189.60 173.00 163.00 154.10 170.80
(% Public Sector) (71.36) (70.82) (69.41) (66.44) (63.98) (60.35) (57.98) (52.50) (50.50)
China, Peoples
Republic of 146.50 152.90196.40
(% Public Sector) (67.92) (64.94)
(64.97)
Hong Kong, China 29.00 29.00 30.60
(% Public Sector) (14.78) (14.48)
(18.96)
Indonesia* 0.8 1.1 1.9 1.8 1.3
(% Public Sector) (32.5)
Japan 5,394.30 5,095.20 4,979.80 4,862.00 4,548.70 4,663.70 4,438.10 4,329.90 5,130.80
(% Public Sector) (68.73) (69.66) (69.03) 0 0 (70.93) (70.74) (72.02) (72.05)
(70.12) (69.91)
Korea, Republic of 230.20 238.80 222.70 233.80 164.60 199.00 235.00
(% Public Sector) (18.77) (17.92) (19.08) (19.12) (19.56) (19.80) (21.40)
Malaysia 69.40 74.60 60.40 59.60 55.30 61.30
(% Public Sector) (43.66) (39.41) (37.42) (34.73) (37.25) (37.03
New Zealand 19.50 20.60 20.60 22.20 19.90 18.60 59.70 15.10 16.30
(% Public Sector) (100.0) (100.0) (100.0) (100.0) (100.0) (100.0) (26.13) (100.0) (100.0)
Singapore 49.00 49.00 53.50 50.6 015.80 15.10 18.60
(% Public Sector) (94.90 )(94.90) (95.51) (95.45) (86.08) (86.09) (89.25)
Thailand* 6.50 10.9 11.3 12.1 10.8
(% Public Sector) (100.0) (30.3) (30.2) (26.8) (56.4)
Total: Crisis
Economies 320.20 307.4 268.2 308.4
Developed
Economies 5,569.2 5,278.6 5,224.3 5,113.5 4,811.7 4,905.9 4,676.6 4,514.2 5,336.5
All Domestic
Debt 5,569.2 5,278.6 5,558.1 5,530.1 5,217.5 5,321.1 5,179.9 5,054.1 5,980.1
Note: (i) The Table records the total (size) of domestic debt markets in US dollars as reported in Table 15 Domestic
Debt Securities, Bank for International Settlements International Banking and Financial Market Developments (vari-
ous issues) for Asia-Pacic and key regional economies. Nepal, Democratic Peoples Republic of Korea, Pakistan,
Philippines and Viet Nam are excluded from the Table since there were no domestic debt issues recorded; (ii) The
Crisis Economies are Indonesia, Republic of Korea, Malaysia, and Thailand; (iii) The Major Developed Econo-
mies are Australia, Japan, New Zealand, and Singapore; (iv) The gures in parentheses are the percentage of the
total issued by the public sector. The remainder is the amount of private sector domestic issues; (v) The March 1999
gures for Indonesia and Thailand were not published in the BIS Tables and are estimates based on the Reuters Fixed
Income Database; (vi) The pre-1999 gures for Thailand are year-end gures from the Bank of Thailand; (vii) The
pre-1999 gures for Indonesia are year-end estimates from Asiamoney, May 1999the decomposition by sector is not
available; (viii) The March 1998 gures for Singapore reect the di¬erent treatment of the issues by the Central
Provident Fund (CPF) of Singapore by the BIS. Pre-March 1998 data include these CPF bonds issues.
Cheaper Financing through Overseas Bank Borrowing. For a long

time, most of the crisis economies have been taking steps to liberalize
their nancial sectors, and immediately before the crisis their domestic
nancial markets were virtually fully open to foreign capital. In the case
of Indonesia, Republic of Korea, and Thailand, domestic banks, nance
companies, merchant banks, and large conglomerates could borrow foreign
funds with almost no regulatory restrictions or supervisory screening.
Foreign borrowings were sometimes encouraged by the nancial authori-
ties to quickly ll the domestic nancing gap. It was therefore not sur-
prising that domestic nancial institutions and industrial corporations
borrowed huge amounts of foreign funds, generally of short maturity (it
was possible to extend or rollover the borrowings). The major factors
that accelerated such borrowings were a substantial di¬erence between
domestic and foreign interest rates and a rigid foreign exchange policy,
causing a signicant appreciation of local currencies.16
Before the crisis, domestic lending rates were much higher in Indonesia
and Thailand than the one-year London interbank o¬ered rate (LIBOR)
rates on US dollar lending, while the gap between domestic and overseas
rates was moderate in the Republic of Korea and Malaysia. The gap between
the two rates in the early 1990s was as high as 1216 percentage points per
annum in Indonesia, and 58 percentage points per annum in Thailand. In
the rst two countries, domestic lending rates were generally roughly 25
times higher than the LIBOR each year. Under these circumstances, together
with the misalignment of exchange rates as discussed below, domestic
banks and corporations, as rational economic entities, must have made
best e¬orts to maximize their borrowing from international nancial markets.
The domestic interest rates in all the economies before the crisis
were much higher than international interest rates. Table 9 shows the
trends of interest rates in the crisis economies as well as in international
nancial markets.
TABLE 9
Comparisons of Domestic and Overseas Interest Ratesa
(percent per annum, period average)
1993 1994 1995 1996 1997 1998 Oct

1999
Indonesia 20.6 17.8 18.9 19.2 21.8 32.2 22.8
Korea, Republic of 8.6 8.5 9.0 8.8 11.9 15.3 9.0
Malaysia 9.1 7.6 7.6 8.9 9.5 10.6 6.8
Thailand 11.2 10.9 13.3 13.4 13.7 14.4 8.3
LIBORb (US$) 3.64 5.59 6.24 5.78 6.08 5.53 5.7(Jul)
a
Commercial bank lending rates, unless otherwise stated; b for one year.
Source: ADB, Key Indicators, and IMF, International Financial Statistics, various issues.
16. An expectation that the local currency will not depreciate more than the
interest rate di¬erential between the two countries encourages unhedged foreign
currency borrowing. International parity relationships predict that over time interest
rate di¬erentials equal the actual depreciation or appreciation of floating-rate currencies.
Table 10 shows the purchasing power parity (PPP) indices of the

crisis economies in the 1990s. These were calculated on the basis that a
currencys nominal exchange rate against the US dollar (an index for
which 1990 = 100) is compared with a relative consumer price index
(CPI), derived from the local CPI divided by the US CPI. If this is 100,
the currencys value against the US dollar, as of 1990, remains unchanged.
If it is lower (higher) than 100, the currency is overvalued (undervalued)
compared to the 1990 level. It is a simplied PPP index in that only the
US CPI, rather than that of all major trading partners, is used. Neverthe-
less, it could provide the general trend of the real value of each currency
in the pre-crisis 1990s. The Table suggests that all the countries curren-
cies were overvalued during this period, especially in Indonesia, Malaysia,
and Thailand.
TABLE 10
Purchasing Power Parity of Crisis Economies Currencies
(1990 ⫽ 100)
1990 1991 1992 1993 1994 1995 1996

Indonesia
Relative price (I) 100 104.9 109.6 119.7 128.0 135.7 140.6
Exchange rate(II) 100 105.8 110.2 113.3 117.3 122.0 127.1
PPP(II/I) 100 100.9 100.5 94.6 91.6 89.9 90.4
Rep. of Korea
Relative price (I) 100 104.9 108.1 110.0 113.9 115.8 118.1
Exchange rate(II) 100 103.6 110.3 113.4 113.5 109.0 113.7
PPP (II/I) 100 98.8 102.0 103.1 99.6 94.1 96.3
Malaysia
Relative price (I) 100 100.2 101.8 102.4 103.5 106.0 106.7
Exchange rate(II) 100 101.7 94.2 95.2 97.0 92.6 93.0
PP(II/I) 100 101.5 92.5 93.0 93.7 87.4 87.2
Thailand
Relative price (I) 100 101.4 102.4 102.8 105.4 108.4 111.5
Exchange rate(II) 100 101.4 101.8 101.0 99.6 100.1 101.5
PPP(II/I) 100 100.0 99.4 98.2 94.5 92.3 91.0
Source: IMF, International Financial Statistics Yearbook 1998.
Combining the interest rate gap and the PPP index shows that
foreign borrowing was a protable precrisis nancial method in these
countries. International interest rates were always cheaper than local rates,
encouraging domestic rms and nancial institutions to borrow from
abroad. The borrowing was further protected by the exchange rate re-
gime that has continued to keep the local currencies overvalued, making
foreign loans even cheaper.
Bank-Centered Domestic Financial Systems. These countries have gen-

erally attached higher policy priority to the banking sector than to capital
markets. Although capital market development has not been neglected,
the banking sector was treated as the most important nancial sector for
various reasons. In the process of seeking a high growth strategy since
the early 1960s, the banking sector served as the main supplier of nancial
resources, which were mobilized from both domestic and foreign mar-
kets. Capital markets remained underdeveloped, preventing them from
nancing industrial projects through diversied sources. As stated above,
corporate bond markets are particularly sluggish in all these countries.
The signicant progress achieved by the Republic of Korea has only
occurred recently since the crisis.
Bank-centered nancial systems have also favored the high eco-
nomic growth outcomes of many developing economies, since they provide
more e¬ective monitoring in nancial environments characterized by
asymmetric access to nancial information.
Under these circumstances, it may be argued that banks are better
able to ration scarce resources to priority sectors, although there is evi-
dence that these decisions may be inuenced by both outside parties
(e.g., the decision by four Indonesian state banks to lend US$2.7 billion
to then President Suhartos son, Bambang Trihatmodjo, to build the Chandra
Asri petrochemicals plant), or family members in rst family-owned banks
and corporations. In the latter case, family members are able to inuence
managerial objectives, resulting in resources not being optimally allo-
cated. These outcomes reect poor governance structures that fail to
address underlying legal problems.17
Agency Problems Arising from FamilyOwned Corporations. Industrial

rms in developed economies generally rely upon debt nancing rather
than issuing new equity, which dilutes control and exacerbates agency
problems. The choice of nancing has been shown to follow a pecking
order (Myers 1984), where rst choice is given to internal sources of
funds (e.g., retained earnings), then external sources in the form of addi-
tional debt or equity, in both private and public markets. Mitigating
agency concerns and those problems arising from asymmetries in infor-
mation (usually the opacity of nancial information), and di¬erences in
legal protection, in terms both of the content of the laws and the quality
of their enforcement (La Porta et al. 2000), appear to dictate the choice
between the various combinations of debt and equity instruments.
17. Jensen and Meckling (1976) originally investigated agency problems.

Many emerging countries lack the nancial and technical infra-

structure to enable the satisfactory development of public security markets.
As a result, traditional rm nancing is largely through banks, which
assume a vital corporate governance role as part of their intermediation
activities. However, the governance function may be inuenced by the
signicant ownership of lending institutions by entrepreneurs and their
families, who may also occupy prominent management positions, or by
the signicant cross-ownership between nancial intermediaries and cor-
porate borrowers. These insiders may get preferential treatment through
the diversion of various assets, expense maximizing behavior in its various
forms, or inuencing the investment and dividend decisions of the rm.
The ownership structures of both banks and other nancial inter-
mediaries and large private sector rms in the crisis economies may be
categorized as examples of the family-state model where either a small
group of founding families, or a pervasive state, plays an important role.18
These structures vary from the nominally privatized and largely state-
owned Korean banks (with nonbank intermediaries generally privately-
owned) to the largely family-owned banks of Malaysia (which directly
control many of the nonbank intermediaries).19
Apart from the Korean nationwide banks, the domestic nancial
institutions in the other crisis economies are generally small by world
standards, so the contagion e¬ects of imprudent lending to local rms
can be more extreme. There is also pressure from the government (e.g.,
in Malaysia) for specic intermediaries to consolidate, to gain scope and
scale e¹ciencies while still maintaining a local character, since the banks
play an important role in understanding the cooperative dimensions that
exist between family, kin, and the community. In e¬ect, local banks are
required to solve the potential information opacity and asymmetry prob-
lems between rm borrowers and providers of funds that have arisen due
to poor disclosure and accounting standards.
Aside from concerns over equity dilution, and although not gener-
ally discussed in the empirical literature on agency theory, the capital
structure choices of rms (both nancial and non-nancial), may also be
made to maintain the asymmetries in information that exist between and
18. See Nestor and Thompsons (1999) discussion of the di¬erent sys-
tems of corporate governance, which vary from the outsider model (in the US
and the UK), to the insider model, of which the family/state model is a subcat-
egory.
19. Casserley and Gibb (1999: Exhibit 11.3) estimates signicant family
ownership of the 15 largest banks in Thailand (27 percent of stock), Indonesia
(47 percent of stock), Malaysia (59 percent of stock) and Philippines (60 percent
of stock) at year-end 1997.
within family owners, on top of the well-documented asymmetries that

exist between owners and managers. For example, there has been an
ongoing debate in the economic development literature on the expected
behavior of family members in family-owned rms when additional funds
are required for the rms expansion. These arguments center upon the
information asymmetries between family members, and may be seen as
an extension of theories popular in development literature where kin-
ship (family) links are seen as an obstacle to economic development.
The argument suggests that family members, in rms where there is a
signicant founding family presence, may be reluctant to provide addi-
tional savings to support new investment, since this signals information
on individual wealth to other family members. The family members who
may not be directly involved with the rm may then attempt to free ride
on the e¬ort of their wealthier kin. Firm managers may be able to avoid
this source of conict and borrow directly from nancial intermediaries,
thus avoiding the ancillary problems of equity dilution (if new nonfamily
equity is brought into the rm) or equity readjustment within family
groups.
However, the use of intermediated nance to overcome equity re-
adjustment concerns between family members has been complicated by
the use of negative pledges in loan documentation. Recently, banks have
come to rely upon negative pledges, which may confer proprietary rights
upon the lender. To overcome this equitable lien, rms will prefer to
issue securities if it is cost- e¬ective to do so. However, this may de-
pend upon the relationship between the rm managers and the main
group of shareholders. Nonowner managers may resolve the information
asymmetries between family and nonfamily owners by the issuance of
debt securities or through stock listings. Whether owner-managers would
be reluctant to do so is an outstanding empirical question. However, this
would heavily rely on the funding costs (loan rates and bond rates).
Loan rates in crisis countries have, until recently, tended to be lower
than bond rates, discouraging bond issues.
The capital structure of smaller rms, which are in a majority in all
the crisis countries except the Republic of Korea, also varies over time,
suggesting that at an aggregate level, rm nancing preferences may be
a function of the business cycle. Thus small innovative startup rms
(high-risk, high growth) are mostly reliant upon the entrepreneurs (or
familys) equity. As these rms become larger they are able to obtain a
variety of loans from nancial institutions and suppliers. Occasionally,
some rms obtain equity participation called angel nance from wealthy
individuals or venture capital rms not related to the entrepreneur. Alter-
nately, lower risk, lower growth rms tend to access debt. Without collateral
or a nancial track record, information opacity will prevent these lower

growth rms from obtaining nance from bond markets.
B. Major Obstacles to Bond Issuance
The general negligence of the bond market is a broad factor in the

underdevelopment of the corporate bond market. Several technical ob-
stacles are discussed below.20
Lack of a Benchmark Yield Curve
A major impediment to the development of corporate bond mar-

kets in the crisis countries has been the lack of interest rate benchmarks
for bond pricing. 21 When benchmarks are present, there may be an in-
ability to strip these benchmark government bonds to zero coupon bonds.
Usually, benchmark yield curves are constructed by market participants
from the suite of outstanding government bonds across a range of matu-
rities. Mathematical interpolation enables a continuous curve to be
constructed, which then serves as a benchmark for the revaluation of
existing portfolios and also for the pricing of corporate issues. Market
convention is to add a time-varying spread to the risk-free government
rate to establish the yield of a corporate security. This form of construc-
tion requires accurate bond prices to be available in liquid secondary
bond markets. Where markets for government securities are not liquid,
or where certain maturities of bonds are not available, then market par-
ticipants must construct these curves from a variety of alternate securities,
such as implied yields in long-term forward markets or the rates implied
by the xed rate leg of an interest rate swap.
Given the implied parity relationships between di¬erent nancial
products it is essential that deep over-the-counter (OTC) or exchange-
traded markets co-exist with bond markets to ensure pricing accuracy.
Daily turnover in foreign exchange and interest rate derivatives markets
in the Asia-Pacic region is described in Table 11.1 and 11.2, which is
based on BIS survey data. No interest rate derivative data were collected
for Indonesia or Thailand, although other market sources suggest that
20. See Kim (1999).

21. In the 1950s the corporate bond market in the US was able to develop
without the presence of government benchmarks. However, in those circumstances
lesser credit issuers were priced over prime name corporate issuers instead of
governments.
turnover, albeit very small, does exist. The Republic of Korea and Malaysia
also display very small levels of daily turnover even relative to small,
developed economies such as New Zealand. Another method of zero-
curve construction is through the implied zero rates from long-dated
forward contracts or currency swaps. The daily turnover of these instru-
ments is also very small, with Indonesia, Republic of Korea and Malaysia
having approximately US$1 billion of daily turnover, while Thailand
has US$2.3 billion. This volume in total is less than daily turnover in
New Zealand. It is clear that the use of alternate sources for the con-
struction of benchmark curves will be di¹cult, due to the lack of liquidity
in the underlying instruments.
TABLE 11.1
Foreign Exchange Derivatives Daily Turnover in
Selected Asia-Pacic Countries, April 1998
Local Turnover
Total Share to
Country Turnover Amount Total
(percent)
Australia 28.75 16.50 57.4
China, Peoples Republic of
Hong Kong, China 48.94 13.53 27.6
Indonesia 1.04 0.76 73.08
India 1.29 0.90 69.8
Japan 91.65 77.04 84.06
Malaysia 0.80 0.54 67.5
New Zealand 4.97 3.75 75.5
Philippines 0.40 0.28 70.0
Singapore 85.40 5.23 6.1
Korea, Republic of 1.05 0.32 30.4
Taipei,China 1.52 0.37 24.3
Thailand 2.28 1.93 84.6
UK 468.26 77.07 16.5
US 235.37 220.02 93.50
Note: 94.47 percent of World Average FX Derivatives Turnover is specied against the
US$. Turnover includes OTC forwards, FX swaps, currency swaps, and options.
Source: BIS Survey
TABLE 11.2
Interest Rate Derivatives Daily Turnover in
Selected Asia Pacic Countries, April 1998
Interest Rate Swaps

Total Share of
Country Turnover Amount Total
(percent)
Australia 2.830 1.272 44.9
China, Peoples Republic of
Hong Kong, China 2.437 1.939 79.5
Indonesia
India
Japan 31.623 17.612 55.7
Malaysia 0.001 0.001 100.0
New Zealand 0.421 0.101 24.0
Philippines
Singapore 5.347 4.183 78.2
Korea, Republic of 0.007 0.007 100.0
Taipei,China 0.116 0.115 99.0
Thailand
UK 122.928 68.754 55.93
US 58.441 31.368 53.67
Note: 58.5 percent of World Average IR Derivatives Turnover are swaps, 28.1 percent
are FRAs, and 13.4 percent are options. Turnover includes OTC, FRAs, swaps and
options.
Source: BIS Survey.
Attempts have been made by the crisis economies to solve these

problems, however. In Indonesia, a market for short-term Central Bank
securities (Sertikat Bank Indonesia) has existed since 1983,22 but it has
not played any meaningful role in providing a useful benchmark for
long-term debt securities. Therefore, various proxies have been attempted:
(i) the rates of 36 month time deposits plus a premium (generally 14
percentage points per annum), and (ii) a yield curve with maturities of
up to 30 years from the Indonesian swap o¬er rate (IRSOR) quoted by
investment banks on the Yankee bonds issued by the Government of
Indonesia (GOI). However, none of these could be a perfect substitute for
a government bond-based yield curve. A major reason for the GOIs dis-
interest in developing the government bond market was its strong preference
for a balanced budget policy.
22. In 1983, Indonesia took several measures to liberalize the nancial

sector, including interest rate deregulation and initiation of the Central Bank
certicates.
In the Republic of Korea, three-year bank-guaranteed corporate bonds

have been used as benchmark facilities for the entire bond market. Gov-
ernment bonds present a range of problems, including arbitrarily set low
interest rates and mandatory purchase requirements in some cases (e.g.,
housing bonds and telephone bonds), and lack of coordination between
government ministries concerning issuance and administration of their
bonds, which prevent the bonds from becoming benchmark facilities.
Besides the guaranteed corporate bonds, a few other low-risk bonds,
such as the Type I National Housing bond, ve-year Regional Develop-
ment bond, three-year Land Development bond, and 364-day Monetary
Stabilization bond, also serve as quasi-benchmark bonds. A reliable yield
curve cannot be established, however, because these bonds all involve
di¬erent types of problems. Even the guaranteed bond faces the possi-
bility that guaranteeing banks themselves may go bankrupt, while banks
are increasingly reluctant to provide guarantees since the Asian crisis.
Also in early October 1999, the Thai Bond Dealers Club (BDC)
developed the Thai Government Bonds Benchmark/Yield Curve. It is
derived from average bid prices quoted by nine counterparties of the
Bank of Thailand. The Thai BDC publishes the yield curve at the end
of each trading day. Benchmark bonds must have remaining maturities
of approximately 1, 2, 5, 7, or 10 years, and amounts outstanding of at
least B 20 million.
Narrow Investor Base
The investor base is narrow in most countries. This is associated

with (i) the restricted, overregulated contractual savings system; (ii) under-
developed mutual funds; (iii) overregulation of the asset management
industry, and (iv) a limited role for insurance companies in capital markets.
Subjecting bond markets to nonmarket forces, such as the practice of
forcing captive investors to purchase bonds at below-market yields, also
restricts demand. In the bank-dominated nancing system, major clients
of banks are also inclined to put their surplus funds into bank deposits
rather than bond markets. Such a bank-client relationship has contributed
to the narrow investor base. Lack of understanding of bonds by investors
is another factor. High savings have been channeled mostly into banks
in those countries that provide only short-term nancial instruments.
Limited Supply of Quality Bond Issues
The limited number of quality bond issues impedes the liquidity

and construction of benchmark instruments. These benchmark issues also
require su¹cient spacing between maturities to ensure that the curve is

extended to a reasonable maturity in line with market expectations and
needs.
There are few viable debt instruments because of (i) the poor credit
standing of issuing corporations; (ii) statutory restrictions and nancial
regulations on the issuance of bond instruments; (iii) repressive regula-
tory processes; and (iv) a reluctance to issue when there is a scal surplus
or near surplus. Most corporations in these countries experienced exces-
sive leverage through bank loans and foreign borrowing, which resulted
in poor nancial status. Poor corporate governance, in particular the
lack of transparency in nancial transactions and unsatisfactory account-
ing practices, further reduced investor condence in corporate bonds. In
most of the countries surveyed, laws governing the bond markets can
barely cope with the demands of trading and regulation of sophisticated
nancial transactions. Where laws do appear to be adequate, regulators
are unable to enforce them. This renders investments in the bond mar-
kets yet more uncertain, reduces overall demand for such investments,
and makes the markets even shallower. Finally, while there is clearly
reluctance on the part of governments to borrow when they have a scal
surplus, there are regional examples (e.g., Singapore and the Govern-
ment Investment Corporation (GIC) where the process of debt and
investment management and maintenance of the benchmark bond infra-
structure successfully coexist.
Continued deterioration of the credit standings of issuing corpora-
tions as a result of the Asian crisis also reduces the supply of quality
bonds. Governments must also be aware that undue legal restrictions on
the amount of bonds that corporations can raise, or on the number of
eligible issuers, interfere with the proper operation of market forces in
bond markets (and hence unduly limit supply).
Inadequate Bond Market Infrastructure
The inadequate bond market infrastructure in the DMCs is due to

the absence of (i) competitive auctions; (ii) a secondary market trading
system where real-time price and volume information is readily avail-
able; (iii) an advanced clearing and settlement system for bonds; (iv) a
stronger role for credit-rating agencies; and (v) hedging instruments for
long- and short-term interest rate risk. High transaction costs are also a
major impediment.
For the bond market to be developed, mechanisms are needed to
ensure that the market value of securities reects correct market percep-
tions of relative borrower risk and other fundamentals. For this purpose,
bond markets should be competitive and all participants should have

access to information to help them value securities correctly. To this
end, an economy must have a stable, consistent, and accessible frame-
work for the timely and accurate analysis and interpretation of information
about issuers and securities. Exhaustive, objective, and independent re-
search by credit rating agencies, investment banks, and other nancial
service institutions is also essential for bond market development. Some
countries, such as India, Republic of Korea, and Malaysia, have allowed
the establishment of credit rating agencies to foster competitive ratings.
However, with low demand for ratings due to shallow bond markets, the
e¹cacy of such a step is questionable.
High transaction costs resulting from such factors as stamp taxes,
which curtail liquidity in both primary and secondary bond markets,
may also hold back bond market development. Most of the countries
levy transaction taxes, such as stamp taxes and capital gains taxes, on
the trading of bonds and other securities in the nancial markets. To
stimulate liquidity in their domestic bond markets, Malaysia and Thai-
land have eliminated stamp taxes to lower transaction costs and encourage
the trading of securities. Regulations that require institutional investors
(especially banks or insurance companies) to set aside a proportion of
their investments in bonds as regulatory capital or reserves also increase
bond market transaction costs. Such requirements, though essentially
prudent in nature, impose an opportunity cost on investors that reduces
the demand for bonds and other securities.
V. Strategies for the Development of Domestic Corporate

Bond Markets
The development of viable corporate bond23 markets calls for con-

tinued and consistent policy e¬orts over a sustained period. These should
deal with both demand and supply side impediments as well as infra-
structure problems. Banks account for up to 80 percent of nancial assets
in Asia, compared with less than 25 percent in the US. This suggests
that capital markets, including bond markets, have a promising future in
Asia if proper policies are pursued. The following are the most impor-
tant issues that require governments vigorous policy e¬orts.
23. In terms of medium- to long-term industrial nancing, corporate bond

and medium-term notes (MTN) may be comparable. However, an MTN is differ-
ent in that it is issued directly to investors without the use of an agent, and there
is no secondary market for MTNs.
A. Supply-Side Strategies
Providing an Enabling Environment: Financial Liberalization, Main-

taining Adequate Exchange Rate Policy and Regulatory Standards. The
capital regime in most Asian economies has been signicantly liberal-
ized, allowing ows of foreign funds across countries. This trend will
accelerate due to the ongoing process of globalization and rapid develop-
ment in information technology. As a result, domestic industrial sector
and nancial institutions will increasingly seek the funds with the cheapest
interest rate at home as well as abroad. In this situation, domestic interest
rates and foreign exchange rates will play a critical role in determining
the real e¬ective price of those funds. If the local currency remains
overvalued, ceteris paribus, foreign borrowing will become attractive,
and vice versa. As discussed earlier, crisis countries historically maintained
overvalued currencies, providing a signicant incentive to foreign bor-
rowing. Financial liberalization needs to be continued and an adequate
exchange rate policy must be put in place in order to facilitate both
development of domestic nancial markets, including bond markets, and
to achieve other macroeconomic goals.
Also, while governments must provide an environment conducive
to nancial liberalization, Central Banks are duty bound to maintain
tight regulatory standards and enforcement procedures to ensure investor
condence in the nancial system. Critical to this process is the inde-
pendence of the Central Bank, its success in monetary policy management,
and the risk management practices of nancial rms.24 Recent examples
of regulatory improvement include (i) improvements in the supervision
of nance companies in Thailand; (ii) improved asset-quality norms in
the Republic of Korea (Korean banks accrue interest on loans due for
only one month whereas international standards are three months); (iii)
general acceptance that Central Banks subscribe to the Special Data
Dissemination Standard (SDDS),25 which details what data can be pub-
lished and when. (The Bank of Korea and the Korean Ministry of Finance
now publish material through a webpage, though the quality and timeli-
ness of the data from the Bank of Thailand is poor.)
24. Note the Institute of International Finance Task Force on Risk Assessment
Report (2000:January) that species best risk management practice for the private
sector.
25. Note the Institute of International Finance report (1999:March): Report
of the Working Group on Emerging Markets Finance also recommended that this
information include the o¬-balance sheet positions of reporting institutions. See
this report for further details on data transparency and disclosure.
Any public sector bond should not receive privileged treatment

such as lower prices or rates. Market forces should determine the prices
of all bonds. In some developing countries, governments issue a large
amount of bonds to nance special projects and budget decits at lower
prices through forcing nancial institutions to purchase, or by providing
tax incentives to investors. Such practices distort the overall bond mar-
kets, while discouraging the corporate bond market.
Reforming Corporate Governance. Good corporate governance helps

to protect the legitimate interests of all stakeholders, including the holders
of corporate bonds. Many Asian corporations have been accused of weak
and unsatisfactory corporate governance in the areas of anticorruption,
lack of transparency in nancial transactions, and accounting methods
and ownership structures which fail to satisfy international standards.
These problems have caused, among others, the erosion of investor con-
dence in corporations nancial documents and the bonds issued by
them.
Before the crisis, in the Republic of Korea, mutual payment guar-
antee arrangements between companies inside the group of chaebol were
frequently made, and chaebol-a¹liated nancial institutions provided
loans to their associated corporations in a manner lacking transparency,
undermining condence in the nancial documents of the concerned
corporations and nancial institutions. In many countries, accounting
methods were changed in an ad hoc manner. While the crisis countries
have redressed these practices, reforming accounting methods to adopt
best practice should be expanded to other areas. Improved corporate
governance will enhance the quality of corporate bonds. Investor per-
ceptions of intangibles such as corporate integrity, prevention of
asymmetric availability of corporate information, and enforcement capa-
bilities of securities market regulators, are a key factor determining the
quality of corporate bonds and capital market dynamism.
Although corporate systems di¬er from country to country, they
can be grouped in two contrasting models: outsider and insider mod-
els. 26 The UK and the US are adopting the former, other countries the
latter. The former may be termed as a market-based model, and the
latter a board-based model. In the case of outsider models, widely
dispersed investors own and control the company. If management ne-
glects shareholder value, investors react by selling the shares. In the
board-based model, members of the board represent the interests of
26. Thompson (1999).

identiable groups, and are in charge of disciplining management. The

general trend in Asia is for countries to shift from the board-based to a
market-based model. However, the market-based model requires su¹cient
disclosures, a good ow of information, rigorous trading rules, and well-
developed investor protection systems.27
B. Demand-Side Strategies
Strengthening the Role of Institutional Investors and Mutual Funds.

The role of institutional investors (pension funds and insurance compa-
nies) and mutual funds is particularly important in terms of expanding
developing countries investor bases, because individual investors in these
countries are not very familiar with bond markets, resulting in reluc-
tance to invest in corporate bonds. In those economies which have been
successful in developing bond markets, the role of institutional inves-
tors and mutual funds is seen in the purchasing and selling of various
bonds and creation of attractive asset portfolios utilizing those bonds.
In Asia, the Republic of Korea and Malaysia are relatively success-
ful in this context. In the Republic of Korea, establishment of mutual
funds was signicantly deregulated in 1998. The provision of tax ben-
ets to foreigners investing in domestic xed income securities is also
being considered. In Malaysia, tax exemptions on bond market gains
only apply to individual investors and not to institutions. However, there
is still a strong need to strengthen the capacity of institutional investors
by increasing pension funds (e.g., corporate and banking sector employ-
ees) and mutual funds, broadening funding sources, and improving fund
management skills. Providing consistency in the tax exemptions avail-
able to investors and the encouragement of purchases of bonds by other
nancial institutions28 will also assist the development of this market.
In Indonesia, only institutional investors, the banking sector, and
the newly emerging mutual funds purchase domestic bonds (including
government bonds). Before the crisis, foreign investors holdings of ru-
piah bonds accounted for 1020 percent of new bond issues, concentrated
in highly liquid ones with good credit standing such as PLN (the state-
27. Specic policies concerning the enhancement of the governance struc-

tures in crisis economies have also been analyzed by a number of ADB studies.
Also see the discussion of La Porta et al. (2000) on agency problems and legal
regimes.
28. The manner in which Indonesian banks hold their reserves is specied
under the Banking and Financial Institutions Act. Procedures could be established
which facilitate the holding of bonds as bank reserves.
owned electricity company) and BTN (a state bank). The makeup of

pension funds investments before the crisis was about 5055 percent in
time deposits; 1015 percent in stocks; 1015 percent in bonds and
promissory notes, and 1530 percent in others, including real estate.
The makeup of insurance companies precrisis investments was about
4550 percent in time deposits, 46 percent in stocks, 1215 percent in
money market instruments (SBI), 810 percent in bonds and promissory
notes, and 1930 percent in others, including real estate. Bondholding
of these companies was negligible.
The mutual funds, which emerged in 1996, grew fast. Prior to the
crisis in 1997, their investment portfolio assets reached a record Rp7.2
trillion, comprising 25 percent money market instruments, 15 percent
equities, 50 percent bonds and promissory notes, and the balance in
cash. This clearly exhibits the large investment of mutual funds in do-
mestic bonds. Indonesia needs to expand the role of institutional investors
and mutual funds by developing pension funds and mutual funds, de-
veloping human resources, and broadening funding sources.
International investors have also been encouraged to purchase Asian
bonds following the establishment of broader benchmark indices, which
o¬er the advantage of risk diversication. For example, JP Morgan has
updated the Emerging Market Bond Index (EMBI Global) to be slanted
more towards Asian issuers, and now includes three of the crisis
economies.29
Robust legal frameworks for perfecting and enforcing security in-
terests are also needed to encourage investors. In Thailand, new bankruptcy
legislation is hoped to lift bank lending to businesses by ensuring that
banks are able to recover future bad debts. However, Senate amendments
set the minimum threshold level at double the proposed levels (debts
need to exceed B1 million for individual bankruptcy, and B2 million
for corporations) with bankruptcy status able to be lifted after three
years instead of the proposed 10 years. These developments appear to
have helped secondary market bond turnover with more than half of
total turnover now due to corporate bonds30 .
29. EMBI Global has a weighting of Republic of Korea 7.5 percent,

Philippines 2.9 percent and the new additions of Malaysia 2.5 percent, Peoples
Republic of China 1.6 percent, and Thailand 0.4 percent (Source: Asiamoney,
September 1999). Other examples include the Strategic Income Fund of Chase
Manhattan.
30. The Nation (11/1/2000) reported that in December 1999 B18.6 billion
of B35.4 billion was attributable to corporate bond turnover.
Private Placement. Private placement of corporate bonds has advan-

tages, particularly in developing countries where the overall bond market
is underdeveloped. Securities privately placed are exempt from registra-
tion with the SEC because their issuance does not involve a public
o¬ering. Corporations themselves and investment banks may nd poten-
tial buyers of bonds through various means and decide on issuing
conditions without resorting to o¹cial procedures. This shares some
characteristics with bank loans.
In case of the US, the trading of privately-placed corporate bonds
has been allowed since the 1990 adoption of SEC Rule 144A, which has
brought about major changes in the market. Consequently, there are now
two types of private placement markets: the market for 144A bonds and
the traditional market that includes non-144A bonds. Rule 144A private
placement is now underwritten by investment banks on a commitment basis
similar to publicly o¬ered securities. Table 12 indicates the importance of the
private placement of bonds in the US, as a source of corporate nancing.
TABLE 12
Issuance of Publicly O¬ered and Privately Placed Bonds by Non-Financial
Corporations in the US, 1975 to 1991
(US$ billion, annual rate)
19751980 19811985 19861991

Type of Bond
Amount % Amount % Amount %
Public 21.0 58.8 35.6 64.3 87.6 57.4
Private 14.7 41.2 19.8 35.7 64.8 42.6
Total 35.7 100.0 55.4 100.0 152.4 42.6
Source: Frank Fabozzi and Franco Modigliani (1996), Capital Markets (second edi-
tion), Prentice Hall, page 530.
From the 1970s to the early 1990s, privately-placed corporate bonds

accounted for about 40 percent of all corporate bonds issued in the US,
a very signicant gure. Particularly noteworthy was the increase in
privately-placed bonds between 1986 and 1991, partly due to the adop-
tion of SEC Rule 144A in 1990.
C. Developing Infrastructure
Reliability in Credit Ratings. Each country has a few domestic credit

rating agencies that provide rating services free of charge or for a ser-
vice fee. In Indonesia, PEFINDO was established in 1994 by the Ministry
of Finance and Bank of Indonesia along with a technical assistance
agreement from Standard & Poors (SP). Another new agency, Kasnik,
Du¬ and Phelps, was licensed in 1997 and has recently become opera-
tional. PEFINDO has rated some 200 companies involving about 250
debt securities (including commercial paper-CP). Requirements for rat-
ing of listed bonds and CP have increased the demand for the services.
PEFINDOs relationship with SP has clearly helped it gain international
credibility. In the Republic of Korea three local agencies are in opera-
tion: Korea Management Consulting and Credit Rating Corporation
(KMCRC), Korea Investors Service (KIS), and the National Information
and Credit Evaluation Corporation (NICE). All publicly issued
nonguaranteed bonds must be rated by at least two credit rating agen-
cies and those corporations rated A or higher may issue nonguaranteed
bonds.31 However, postcrisis nonguaranteed bonds now make up the bulk
of the market, illustrating the development of rating services.
In general, however, local rating agencies are not particularly reli-
able, because of poor rating skills and techniques, limited sources of
information, and inadequate accounting practices of corporations. Part-
nership agreements with internationally reliable agencies such as SP or
Moodys, as in the case of Indonesia, will signicantly increase the reli-
ability of local rating agencies. In small countries, it would be advisable
to use these international agencies rather than to set up local agencies
in view of large xed operating costs.
Creating a Benchmark Yield Curve. The establishment of benchmark

yield curves is essential for the pricing of nongovernment securities,
since investors traditionally price these securities based on a spread over
the equivalent risk-free or government security with the same maturity.
A number of regional governments have recognized this (e.g., Australia;
Hong Kong, China; and Singapore), and have committed themselves to
maintaining the benchmark curve infrastructure despite the absence of a
funding need. These curves also facilitate the development of deriva-
tives markets, and provide additional risk transformation capability to
nancial market participants. Specically, normal procedure is to inter-
polate the yield for a particular corporate bond maturity based on spread
over a stripped benchmark yield curve derived from a series of on-the-
run government bullet bonds.
31. The rating categories of these agencies are similar to Standard & Poors.
Excepting a few economies such as Hong Kong, China and Malaysia,

mid- and long-term benchmark government bonds have not previously
existed in Asias developing economies. There are only short-term bench-
mark government bonds (including Central Bank issues) or quasi-benchmark
bonds such as guaranteed corporate bonds in the Republic of Korea.
However, nothing can substitute low risk government bonds. Tradition-
ally, the rapidly developing countries of Asia have maintained balanced
or surplus scal positions, which discouraged the issuance of any gov-
ernment bonds to nance current scal expenditures, although various
special purpose government bonds were issued. There was also opposi-
tion to creating benchmark Treasury bonds because of fears of accumulating
government debts.
By contrast, Hong Kong, China, one of the economies successfully
minimizing the impact of the Asian crisis, has made continued e¬orts
both before and especially since the crisisto develop Exchange Fund
Bills (EFBs) and Exchange Fund Notes (EFNs) (termed hereafter as Ex-
change Fund paper or EFP). As Hong Kong, Chinas scal status has
generally been in surplus, the main objective of the EFP program was to
help develop the local debt market by increasing the supply of high
quality bonds and creating a reliable benchmark yield curve for Hong
Kong dollar debt instruments. The EFP program was introduced in March
1990 with the issuance of 91-day bills. Since then, the program has
expanded in both size and tenor, with 182- and 362-day bills being
launched in October 1990 and February 1991, respectively, followed by
2-year notes in May 1993, 3-year notes in October 1993, 5-year notes in
September 1994, 7-year notes in November 1995, and 10-year notes in
October 1996. The EFP has been very well-received by the market and
provides a reliable Hong Kong dollar benchmark yield as a result of
regular issuance of EFP with varying maturities, thus developing an e¬ec-
tive market-making mechanism.
The case of Hong Kong, China may o¬er a good example for de-
veloping a benchmark government bond market in developing economies,
despite the fact that it has experienced comparatively much better nan-
cial and economic conditions. Recently, the Republic of Korea and Thailand
has also initiated a benchmark government bond program. The benets
of a benchmark bond market are much larger than the costs incurred
from government debts, which justies the need to create a government
bond-based yield curve. It is essential that benchmark government bonds
be highly liquid through the o¬ering of su¹cient government bonds
across a range of maturities. This facilitates the correct interpolation of
yields for nonbenchmark maturities and also helps to prevent distortion
of the yield curve through illiquidity-induced volatility.
Considering these issues, Thailand has identied the establishment

of a benchmark yield curve as a priority policy area in its overall bond
market reform package. Since there is now an ample supply of govern-
ment bonds arising from the nancing of scal decits and the restructuring
and recapitalization of nancial intermediaries, it has now been possible
to establish a market yield curve. Two curves are currently available:
the market yield curve based on same day trading provided by the Thai
Bond Dealing Center, and a yield curve based on yields as of settlement
date provided on the Bank of Thailand website.32
Regulatory Framework.33 Although regulatory authorities should make

best e¬orts to avoid discouraging market innovation through their regu-
latory measures, it is crucial to have an e¬ective and sound framework
to regulate and supervise a bond market, intermediaries, institutional
investors, and other market participants. This is both for adequate inves-
tor protection and to fulll sound business practices or codes of conduct
that reduce systemic risks. This requires a set of clearly dened market
rules, a high degree of transparency, and rigorous prudential standards
and principles of governance. It is also essential to ensure a combina-
tion of internal and external checks and surveillance to monitor compliance
with the regulatory framework. There are other responsibilities concern-
ing the role of government as a debt manager that must also be addressed.
Briey, these responsibilities center on the separation of duties between
debt management and other Treasury functions.
Transparency and clarity in the regulatory authorities responsibilities,
roles, and objectives is also essential for maintaining a high level of e¬ective-
ness and public condence, as well as to avoid gaps and duplications. To
this end, it is important to ensure clear legal denitions of supervisory actions,
close coordination and cooperation between di¬erent regulatory authorities,
and precisely dened regulations for various market participants (diversity
of bank and nonbank participants) and nancial instruments.
Settlement Systems. The transaction costs associated with trading and

issuing securities are subject to economies of scale and scope. Technol-
ogy improvements and the establishment of Asia-wide settlement systems
32. op cit. Meecharoen (1999).

33. APEC Collaborative Initiative on Development of Domestic Bond Markets
(August 1999), Guidelines to Facilitate the Development of Domestic Bond Markets
in APEC Member Economies.
Europe is emerging as a signicant alternate high-yield debt market with
approximately US$45 billion in outstandings in 1999 (Standard & Poors gures).
would assist the long-term viability of domestic bond markets. The es-
tablishment of uniform procedures would provide a rst step in this
direction. At the specic country level, policy e¬orts are being made
which provide some idea of the challenges ahead. For example, in Thai-
land the real-time delivery versus payment project (DvP) was started in
April 1998 and is due to be completed by the third quarter of 2000. A
real time bond price quotation system to newswire services has also
been established to improve information ows and pricing mechanisms.
Thailand also has a Master Plan to serve as an internal guideline for
policy implementation and coordination between agencies such as the
Thai Bond Dealing Center, Securities and Exchange Commission, and
the Ministry of Finance.
VI. Strategies to Tap International Bond Markets
A. Background
It is not possible to apply a uniform set of strategies to both do-

mestic and international bond markets, since the domestic strategies
identied in the previous chapter may not be relevant to international
markets. Notwithstanding this comment, concerns over governance, dis-
closure and pricing impede the development of both markets.
Also, given the generally low credit ratings that nonsovereign issuers
would achieve, with the exception of debt issues in the US and to a lesser
extent Europe, 34 the amount of access available in other international
markets is low. Debt issues in US markets are, however, subject to the
scrutiny of the SEC, which imposes a high level of nancial account-
ability. Thus the focus should be on the further development of sovereign
or quasi-government issues, which could enter these markets with their
sovereign status, adding to investor appeal, and on credit ratinga nec-
essary requirement for public issues in the US. However, there are clear
benets to nonsovereign issuers in domestic markets, largely in the form
of better pricing of existing issues, should benchmark yield curves of
government securities be available in international markets. Thus govern-
ments or their instrumentalities should pursue a strategy of continually
issuing bonds in international markets across a range of maturities to
maintain the infrastructure that has been previously established. Note
that given the cost of establishing domestic bond market infrastructure
it may be prudent for some developing economies to focus their e¬orts
on tapping international markets (such as the yankee market). Such issuers
should begin to build a market for their bonds by providing bonds that
are attractive to international investors in both maturity and pricing.
B. Major Issues to be Addressed
Enabling a Regulatory Environment. Policymakers in crisis econo-

mies must achieve a low net regulatory burden by achieving economies
of scale and scope, ongoing deregulation, and the avoidance of taxes on
external transactions. Doing so will facilitate nancial market develop-
ment across a broad spectrum of nancial products (including derivatives)
and services. This involves developing unied strategies that provide
measurable outcomes for currency stability and maintaining the pace of
nancial reform. A key feature is the removal of any withholding taxes
on loans to nonresidents. Transaction-based economies of scale and scope
may be achieved in selected areas, such as through a unilateral approach
to settlement procedures.
Providing further access to foreign intermediaries in retail invest-
ment and banking markets will both further encourage the development
of infrastructure, and enhance the demand in domestic markets for in-
vestment products. Another advantage of greater foreign access is the
potential transfer of technology to other domestic nancial participants,
though expected outcomes should also be clearly dened and measured.
Corporate Governance, Transparency and Disclosure. Regulatory re-

form is necessary to strengthen the legal process for protection of foreign
investors. Key areas of concern include the governance structures of cor-
porations where founding families maintain managerial control, and the
transparency and level of disclosure of nancial statements. Policy in
these areas has been articulated by a number of international studies by
the BIS and the Institute of International Finance (IIF).
Benchmark Yield Curves. One cannot separate concerns over the lack
of corporate and government benchmarks, as corporate pricing is based
on a spread over the government bond of equivalent maturity. Therefore,
governments in crisis economies also need to pursue strategies which
establish benchmark yield curves in o¬shore markets if inadequate infra-
structure and the lack of demand from domestic investors prevents them
from immediately doing so in domestic markets. Examples such as the
Philippines global bond issues in 1998 and 1999 serve as a benchmark
for other sovereign issues.
Institutional Investors and Mutual Funds. Risk management and regu-

latory supervision should also be benchmarked to international standards
to inspire investor condence, though regulation must be carefully ap-
plied so as not to impede innovation in nancial markets. While strategies
that facilitate the private placement of securities may be pursued, this

would defeat the purpose of providing liquid secondary market pricing.
Thus private placements may be appropriate for illiquid corporate issues
but not for benchmark sovereign issues.
Opportunities for private placements may arise through the recy-
cling of bank loans through securitization processes (which are common
in the US), but these securitized loans may need to be selectively sourced
from the outstanding stock of loans to make them attractive to investors.
VII. Conclusions
Asian crisis countries, in the postcrisis period, should pursue the

diversication of industrial nancing methods to increase nancial re-
sources for development projects and accelerate nancial sector
development. The industrial nancing in these countries has long been
excessively bank-based, which has revealed several dangers, such as an
extremely inexible nancing mechanism, a dominant portion of short-
term nancing, and vulnerability to external shocks. Bank disintermediation
has already been emerging in terms of the extremely guarded lending
policy of commercial banks in Asian developing countries. To diversify
funding methods, bond markets, which have been neglected, should re-
ceive a policy priority. The negligence in the past was due to the cheaper
nancing of overseas borrowing, bank-dominated domestic nancial sys-
tems, and agency problems arising from family-owned corporations.
This paper makes several policy suggestions to develop bond mar-
kets in the crisis countries, covering supply and demand-side policies
and infrastructure development issues. These include (i) providing an
enabling environment; (ii) reforming corporate governance; (iii) ensur-
ing reliability in credit ratings; (iv) creating a benchmark yield curve;
(v) strengthening the role of institutional investors and mutual funds;
(vi) expanding private placement; (vii) providing a real-time delivery
system; and (viii) strengthening the regulatory framework. The paper has
also discussed strategies on how to tap international bond markets: the
Asian countries need to provide an enabling regulatory environment,
ensure corporate governance, establish international benchmark yield
curves, and have risk management and regulatory standards at interna-
tionally acceptable levels.
However, all these requirements require a substantial period of
time to be satisfactorily implemented. Therefore, the crisis countries should
take balanced and consistent steps under a well designed mid- and long-
term bond market development strategy. It is also advisable to increase
bond issuance in international nancial markets to ensure nancing di-
versication and minimum funding costs.
Appendix
International Bank Financing by Asian Crisis Economies
1. Indonesia
The level of international lending to Indonesia peaked in 1997 (US$58 bil-

lion), but fell 25 percent to US$43.8 billion by June 1999.
Indonesias share of total lending to Asia has been relatively constant (around
15 percent).
The average maturity of bank lending has been rising, so that by June 1999,
49.6 percent of loans had a maturity of less than one year.
Lending to the nonbank private sector has been consistent at around 70 per-
cent of total loans, though the balance reects a reallocation to the public
sector and a withdrawal from lending to banks.
While Japan stills remains a signicant lender (31.9 percent in June 1999),
European banks have increased their share of total loans from 30 percent in
1996 to 40 percent in 1999.
TABLE A.1
Summary of International Bank Lending to Indonesia
(19961999)
Dec Dec June Dec June

1996 1999 1997 1998 1998
Total Asia (US$ billion) 367.1 378.8 319.6 299.4 287.0
Total Indonesia (US$ billion) 55.5 58.0 48.4 45.0 43.8
(TI/TA)% 15.1 15.3 15.1 15.0 15.3
Maturity
Less than 1 and 1 year (%) 61.7 60.5 54.1 52.8 49.6
Over 1 year (%) 34.1 36.2 42.6 43.5 46.6
Sector
Banks (%) 21.2 19.8 13.7 11.8 10.1
Public Sector (%) 12.5 11.8 15.7 14.8 21.0
NonBank Private Sector (%) 66.2 68.4 70.7 73.4 68.8
Nationality of Reporting Banks
Euro-Area Banks 30.4 39.6
UK Banks 6.9 7.8
US banks 9.5 8.5
Japanese banks 39.7 31.9
Others 13.5 12.2
Note: Maturity and Sector percentage does not add up to 100%.
Sources: BIS Consolidated International Banking Statistics for End-June 1999 No-
vember 1999 and BIS The Maturity, Sectoral and Nationality Distribution of International
Bank Lending: Second Half 1996, Basle July 1997.
2. Republic of Korea
The level of international lending to the Republic of Korea peaked in 1996

(US$100 billion) but fell 36.5 percent to US$63.5 billion by June 1999.
The Republic of Koreas share of total lending to Asia has fallen from 27.2
percent in 1996 to 22.1 percent in June 1999.
The average maturity of bank lending has been rising that by June 1999 53.7
percent of loans had a maturity of less than one year.
Lending to the bank sector has been reduced from 65.9 percent of total loans
in 1996 to 57.4 percent in June 1999, although the balance reects a realloca-
tion to the public sector and a withdrawal from lending to the nonbank private
sector.
While Japan still remains a signicant lender (23.7 percent in June 1999),
European banks have increased their share of total loans from 28.8 percent in
1996 to 31.9 percent in 1999.
TABLE A.2
Summary of International Bank Lending to Republic of Korea
(19961999)
December December June December June

1996 1997 1998 1998 1999
Total Republic of Korea
(US$ billion) 100.0 93.7 71.6 65.6 63.5
(TSK/TA)% 27.2 24.7 22.4 21.9 22.1
Maturity
Over 1 year (%) 20.0 23.4 39.4 38.2 28.7
Sector
Banks (%) 65.9 59.3 56.6 57.0 57.4
Public Sector (%) 5.7 4.2 6.8 8.3 8.2
UK Banks 5.6 7.3
US Banks 9.4 10.1
Japanese Banks 24.3 23.7
Other 31.9 27.0
3. Malaysia
The level of international lending to Malaysia peaked in 1997 (US$27.3 bil-

lion) but fell 31.9 percent to US$18.6 billion by June 1999.
Malaysias share of total lending to Asia has been reduced slightly from 7.2
percent in 1997 to 6.5 percent in June 1999.
Lending to the nonbank private sector has been increasing slightly from 61.7
percent of total loans in 1996 to 64.3 percent in June 1999, though the bal-
ance reects a reallocation to the public sector and a withdrawal from lending
to the bank sector.
While Japan stills remains a signicant lender (32.5 percent in June 1999),
UK banks have increased their share of total loans from 6.4 percent in 1996
to 11.1 percent in 1999.
TABLE A.3
Summary of International Bank Lending to Malaysia
(19961999)

1996 1997 1998 1998 1999
Total Malaysia (US$ billion) 22.2 27.3 22.8 20.9 18.6
(TM/TA)% 6.1 7.2 7.1 7.0 6.5
Maturity
Over 1 year (%) 36.1 37.8 41.9 44.0 45.8
Sector
Banks (%) 29.3 35.3 30.8 27.7 21.7
Public Sector (%) 9.0 6.4 6.6 8.8 13.8
UK Banks 6.4 11.1
US Banks 10.5 5.7
Others 11.0 15.3
4. Thailand
The level of international lending to Thailand peaked in 1996 (US$70.2 bil-

lion) but fell 50.6 percent to US$34.7 billion by June 1999.
· Thailands share of total lending to Asia has been reduced from 19.1 percent
in 1997 to 12 percent in June 1999.
Lending to the nonbank private sector has increased signicantly from 59.6
percent of total loans in 1996 to 74.4 percent in June 1999, though the bal-
ance also reects a reallocation to the public sector and a withdrawal from
lending to the bank sector.
Japan remains a signicant lender (52.7 percent in June 1999), though Euro-
pean banks have increased their share of total loans from 22.3 percent in 1996
to 30.9 percent in 1999.
TABLE A.4
Summary of International Bank Lending to Thailand
(19961999)

1996 1997 1998 1998 1999
Total Thailand (US$ billion) 70.2 58.5 46.4 41.2 34.7
(TT/TA)% 19.1 15.4 14.5 13.8 12.0
Maturity
Over 1 year (%) 30.2 30.7 36.5 37.1 39.4
Sector
Banks (%) 36.9 29.9 26.1 22.0 19.4
Public Sector (%) 3.2 3.1 4.3 4.7 6.2
UK Banks 4.5 4.3
US Banks 7.2 3.6
Others 12.5 8.5
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Part 1

Theme Paper and Special

The Asian nancial crisis suggests many policy tasks to be ad-

mismatches: a maturity mismatch and a currency mismatch. The maturity

3. Best international practice, as well as some banking laws, suggests that

While the crisis economies must maintain their ongoing restructur-

4. From 1996 to 1999, the levels of international bank lending to Asian

II. Trends of Industrial Financing in the Asian Crisis Economies

Industrial nancing comprises new equity and debt nancing through

A. Domestic Debt and Equity Financing

Outstanding Bank Outstanding Equity Market

The crisis economies heavy reliance on bank intermediated nance

Country December 1996 December 1997 December 1998

6. Given the large di¬erence in historical backgrounds and underpinning frameworks

The three-year trends from 1996 to 1998 shown in Table 2 suggest

B. International Bank Financing

The levels of international lending (by BIS reporting banks) to the

Dec Dec June Dec June

Total Developing Countries (TDs) 692.6 891.7 860.7 842.7 809.6

7. In June 1999, Japanese banks only accounted for 26.1% of US$287

C. International Bond Issues

Recent Trends. International bond issues comprise bonds issued in Eu-

8. Details of international bank nancing to each of the crisis economies

Country Mar 94 Mar 95 Mar 96 Mar 97 Mar 98 Mar 99

Australia 42.1 50.1 53.7 88.5 80.4 86.9

have to be registered,10 borrowers have been encouraged to bypass na-

and is also largely a US-denominated market.12 From the borrowers per-

Standard & Poors Sovereign Long-Term Debt Rating

International bond issues by the crisis economies were also under-

Change in Levels of Bank Change in Levels of

Risk transformation capability is crucial when the bulk of both

international promotion or roadshow prior to the actual issue arranged

The replacement of intermediated nance with international bond

di¬erent, the reduction in funding by international lenders is part of a much

1996 1997 1998 1999

O¹cial Flows, Net 7.6 38.9 52.8 11.9

III. An Overview of Domestic Bond Markets in Crisis Economies

While crisis economies have historically relied on intermediated

secure and maintain e¹ciencies. The objective of the next section is to

B. Recent Trends of Bond Financing

A comparison of bond markets in the Asia-Pacic region is provided

IV. Major Obstacles to Development of Domestic Corporate

A. Traditional Negligence of Domestic Bond Markets

The traditional negligence of domestic corporate bonds by the in-

Mar 95 Sep 95 Mar 96 Sep 96 Mar 97 Sep 97 Mar 98 Sep 98 Mar 99

Cheaper Financing through Overseas Bank Borrowing. For a long

1993 1994 1995 1996 1997 1998 Oct

Table 10 shows the purchasing power parity (PPP) indices of the

1990 1991 1992 1993 1994 1995 1996

Bank-Centered Domestic Financial Systems. These countries have gen-

Agency Problems Arising from FamilyOwned Corporations. Industrial

17. Jensen and Meckling (1976) originally investigated agency problems.

Many emerging countries lack the nancial and technical infra-

within family owners, on top of the well-documented asymmetries that

or a nancial track record, information opacity will prevent these lower

B. Major Obstacles to Bond Issuance

The general negligence of the bond market is a broad factor in the

Lack of a Benchmark Yield Curve

The Asian nancial crisis suggests many policy tasks to be ad-

Industrial nancing comprises new equity and debt nancing through

The crisis economies heavy reliance on bank intermediated nance

8. Details of international bank nancing to each of the crisis economies

and is also largely a US-denominated market.12 From the borrowers per-

Standard & Poors Sovereign Long-Term Debt Rating

international promotion or roadshow prior to the actual issue arranged

The replacement of intermediated nance with international bond

A comparison of bond markets in the Asia-Pacic region is provided

Agency Problems Arising from FamilyOwned Corporations. Industrial

Many emerging countries lack the nancial and technical infra-

or a nancial track record, information opacity will prevent these lower

22. In 1983, Indonesia took several measures to liberalize the nancial

23. In terms of medium- to long-term industrial nancing, corporate bond

identiable groups, and are in charge of disciplining management. The

27. Specic policies concerning the enhancement of the governance struc-

19751980 19811985 19861991

Considering these issues, Thailand has identied the establishment

The level of international lending to Indonesia peaked in 1997 (US$58 bil-

The level of international lending to the Republic of Korea peaked in 1996

The level of international lending to Malaysia peaked in 1997 (US$27.3 bil-

The level of international lending to Thailand peaked in 1996 (US$70.2 bil-

Governance in Asia: A Comparative Perspective, OECD, Seoul, 35 March