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While Asian nations focus on rebuilding economies battered by the recent financial crisis, observers are divided on the question of how to avoid a recurrence. Is the global financial system overdue for an overhaul? Josie Gibson investigates.

The former Thai property magnate now selling sandwiches to passing Bangkok motorists is the optimistic face of Asia's financial meltdown. Tough times, he concedes over grinding truck gears and car horns, but with luck and hard work he'll be back.

But not so for many across the region. The financial crisis heralded by the nosedive of the Thai baht in mid-1997 has left a legacy of social, political and economic problems. In a contagion that spread quickly to other parts of Asia, big investors lost badly, small investors were destroyed, and governments were pushed to the brink of collapse.

The factors behind the meltdown have been well documented. Professor Michael Skully, chair of banking in the Accounting and Finance department at Monash University, recites them without a pause: cheap investment funds fuelling unnecessary development, worsening balance of payment figures, dubious banking and accounting standards, and a rapid drop in investor confidence.

In the high-octane world of global finance, this last factor is vital. When confidence plummets, investors want their money out as fast as possible to minimise losses. Capital flight is disastrous for a country's currency, putting pressure on the exchange rate, which in turn pushes confidence even lower. Banks find themselves suddenly unable to cover bad loans. The results: widespread insolvencies and a lot of half-built shopping centres and golf links.

Banks unprepared

According to Professor Skully, the Asian crisis was evidence not so much of the lack of an effective international regulatory framework as of the absence of local political will and bureaucratic resources to make the rules work.

"Central banks were not prepared for the rapid economic expansion," he explains. "They were overwhelmed. In the case of Indonesia, the banking sector expanded from fewer than 100 banks to 200 in a couple of years. The financial sector lacked the necessary regulatory experience because experienced staff left for the private sector."

Earlier this year, billionaire speculator/philanthropist Mr George Soros released a book titled The Crisis of Global Capitalism. Criticised as a key player in the Asian financial crisis, Mr Soros is now gloomy on the subject of unchecked market forces, arguing for greater national controls on capital flows and warning that the Asian crisis was simply a harbinger of an imminent worldwide collapse. His comments seem ironic, given the amount of wealth he has managed to accumulate from this very system. However, he is not alone: a number of Asian leaders have also urged greater political and bureaucratic controls on capital flow.

There are also those who advise strongly against such intervention, arguing that the existing framework can be strengthened to at least minimise the effects of a future crisis.

The global financial system is loosely regulated by a handful of international institutions, among them the Bank of International Settlements (which oversees central banks), the World Bank, the International Monetary Fund, and, more recently, the World Trade Organisation and APEC. These bodies work to develop agreements and standards on banking and investment for adoption by member nations.

Mr Roger Love, a lecturer in finance at Monash University, is among those who believe this cooperative approach has worked reasonably well in the past, although he agrees the lack of enforcement powers makes it difficult to punish renegade behaviour. "We are sovereign countries," he says. "Without a world parliament, how do you actually enforce these agreements? But I believe the high degree of cooperation between central banks has achieved great things, by working to contain contagion and prevent another world depression."

Mr Alan Oxley, chairman of the Australian APEC Study Centre based at Monash, is firmly against greater intervention by politicians and bureaucrats in financial markets. Since the onset of the Asian crisis, APEC finance ministers have been working on programs to strengthen banking and corporate governance in Asia. "APEC has a critical role to play to keep governments in the region focused on policies that use the market to promote growth," Mr Oxley says.

That isn't to say that the world financial system doesn't need changing. Australia's treasurer, Mr Peter Costello (LLBHons 1980, BA 1982) is among those calling for improved transparency and crisis management in the wake of the Asian crisis.

The Governor of Australia's Reserve Bank, Mr Ian Macfarlane (BEcHons 1968, MEc 1971), has found himself in an uncustomarily defensive position after supporting calls for the international financial system to be reviewed.

System unstable

"I have been asked whether we no longer believe in markets, and whether we have become proponents of capital controls," he says.

Mr Macfarlane says it is unfair to blame the current plight of some Asian countries solely on their policy shortcomings. In his view, the root cause of the Asian crisis was not simply the inadequacy of some Asian nations' financial infrastructure and governance: the international financial system itself is unstable.

To help reduce this instability, Mr Macfarlane has suggested that hedge funds ­ "the privileged children of the international financial scene" ­ be subjected to similar disclosure and supervision regimes as other investment and commercial banking activities. He also urges greater realism about the rate at which emerging markets, with their underdeveloped financial infrastructures and regulatory frameworks, can handle the pressures of integration into the international scene.

And when all else fails and a crisis develops, he says, better crisis management could help to avoid exacerbating a loss of confidence. Mr Macfarlane says the recent case of Brazil, where the IMF and Brazilian authorities held behind-the-scenes negotiations on a financial aid package, was infinitely preferable to the public tug-of-war between national authorities and the IMF that occurred in Thailand and Indonesia.

In any case, a return to unilateral restrictive controls is not the answer, he warns. "It would be tragic if our failure to reform an unstable international capital market resulted in a return to inward-looking policies, and that may yet happen."

Reserve Bank Governor Mr Ian Macfarlane.

Monash researchers Professor Michael Skully, left, and Mr Roger Love, believe the high level of international cooperation shows the current global financial framework can be effective.

A new Master of Applied Finance, offered by the Faculty of Business and Economics, will begin in July. For details, contact Professor Michael Skully on (03) 9903 2407.