If capital requirements are increased significantly, but only on some activities, banks may re-classify assets to switch their business into forms where the capital requirements are no higher than today. To me that is an argument for thinking about very substantial rises in required bank capital pretty much across the full range of their activities. Of course if this is very costly it will create two problems: it would create big incentives to avoid them and potentially big costs to the wider economy, because of the impact on the price and availability of bank loans. Two issues are important. First, the scale of the impact on bank funding costs from higher capital requirements. Higher funding costs would push up on the cost of bank loans to households and non-financial companies and affect lending and investment, which in turn could require a monetary policy response; those costs will also affect the incentives to avoid (or evade) capital requirements. The second issue is how much more robust the financial sector, and banks in particular, become with different amounts of extra capital. Several estimates of the cost of higher bank capital exist. The Institute for International Finance (IIF) suggest that proposed regulatory reform which could be part of the Basle III system could reduce the path of average annual GDP growth in the US, euro area and Japan by 0.3pp for the next ten years 2. This implies that the level of GDP would ultimately be around 3% lower.
Should Asia continue to grow by an average annual rate of 7% over the next ten years, it is estimated that Asia’s share of the global GDP will increase to 40%. Let me further elaborate on these two developments, namely the strengthening of domestic demand in Asia and the intensification of regional economic and financial integration, that are mutually reinforcing in sustaining Asia’s economic growth prospects. A more recent phenomenon supporting this trend is the strengthening of regional financial cooperation not only to preserve regional financial stability but also to enhance the prospects of the region. Strengthening domestic demand The strengthening of domestic demand is part of the structural changes taking place in Asia to diversify its sources of growth. Growth in most of the Asian economies was previously export-led. While several measures have been taken to promote domestic demand, the favourable demographic structure, the low levels of unemployment, the relatively low level of household debt and the policy flexibility to implement supporting monetary and fiscal policies have contributed to higher consumption. Other measures initiated are the social safety nets in the form of schemes and programmes for unemployment benefits, healthcare, education and retirement that have been put in place to reduce the need for high savings. The consequent increase in consumption demand has not only resulted in a significant expansion of the retail trade sector but Asia is also increasingly becoming an important consumer in the global economy.