This week was my first visit to Bangkok since the floods in December. The city seems to have recovered and the economy is on the mend. After an estimated 0.1 percent growth in real GDP in 2011, the International Institute of Finance (IIF) is forecasting a robust 7 percent growth recovery in 2012, helped by a multi-year fiscal stimulus that would bring the fiscal deficit to an estimated 5.5 percent of GDP for the fiscal year 2011-2012.

The package of fiscal stimulus included a 40 percent hike in minimum wages from April and an aggressive cut in corporate income tax rate from current 30 percent to 23 percent and a further cut to 20 percent for 2013. This would put Thai corporate tax rate closer to those of its neighbours.

The combination of increase in minimum wage rates and generous price support programme for rice mean that the government is serious about tackling income gaps and pushing consumption.

The purpose of the Bangkok trip was to debate the future of Asian banking business models. The central question is how to recycle Asian savings within Asia. Because of its demographics and prudence in consumption, East Asia has always run a net current account surplus, with its accumulation in savings placed largely in the advanced markets. Why can't some of these savings be used to fund much needed infrastructure within the region?

In 2003, Dooley, Folkerts-Landau and Garber named the current cross-Pacific arrangement Bretton Woods II, where Asia funded the US current account deficit by reinvesting its savings back in the advanced markets. This arrangement can also be called the Grand Bargain.

Basically Asia swapped dollars for jobs for the youth entering the labour force and the exploitation of its natural resources. The Grand Bargain is ending as Asians realise that their holdings of dollars may be exposed to future depreciation and that Asian labour force and natural resources should not be cheap forever.

The Grand Bargain had implications for the advanced country banking business models. A deficit country will very soon find that its banking system must have loans/deposit ratios running higher than 100 percent, because the excess consumption has to be funded by credit.

In Asia, the average loans/deposit ratio is lower than 100 percent, because savings are larger than debt. The American banking system had to shift from retail banking into a wholesale banking system, relying on securitisation of its assets (mortgages and loans) and selling them into the global market to fund its loan book.

Quite a lot of AAA-rated securities ended up in European portfolios, because the prudent Asians stuck mostly to Treasuries. Thus, when the subprime crisis erupted in 2007, the European banks were one of the bigger victims.

There are good reasons why US and European banks evolved into leveraged wholesale banks turbocharged by derivative markets. Ninety percent of OTC derivative trading in the US are dominated by five large banks. Europe as a region accounts for 70 percent of total global interest rate derivative trading.

The Atlantic banks went into proprietary trading and financing engineering because by the 1980s, under competition from the Japanese banks, net interest margin business (basically the margin between lending rate and deposit rates) became less and less profitable.

This shift out of traditional retail banking business was also due to the free market ideology to reduce market friction to zero by lowering transaction costs (such as transaction taxes and commissions). In the old days when brokers made money from fat commissions, they were willing to provide research for their customers.

When margins became near zero with computerised trading, securities firms engaged more and more into proprietary trading and leveraged trading in order to make money. Good quality research became scarce. Banks made more money from “pushing” derivative products to their retail investors, because they could earn more fees up-front and from granting credit to their customer from leveraged trading.

The combination of proprietary trading and leveraged derivative financial engineering morphed banking business away from being a trusted agent of the real sector into a competitor or principal that may trade sometimes in conflict against the interest of its customers. The financial sector became a principal in its own right, with total assets larger than the real sector and therefore Too Big to Fail.

This change in culture was exemplified by the remarkable Op-Ed by Greg Smith, a former executive director in Goldman Sachs, published in the International Herald Tribune on March15, 2012, which I read on the plane back to Hong Kong. He basically highlighted the debate whether one should be making money for the bank or making money for the client.

Because Asia as a whole did not run into deficit, the banking system has not strayed from its retail banking roots. After the painful lessons of the 1997-98 Asian financial crisis, Asian regulators have been much more cautious in allowing Asian banks to go the derivative route.

The game is changing dramatically because Asian interest margins are also beginning to be squeezed as competition intensifies. Some Asian banks are already being rapped on the knuckles for not paying enough attention to client suitability in selling inappropriate wealth management products to customers. So the debate on whether Asian banks should make more money from capital market business is very much on the table.

This raises a fundamental question which the current global regulatory reforms have not addressed. I have gone on record to say that if green engineers are paid less than financial engineers, will we expect a green economy to emerge before asset bubbles? Similarly, if banks are to serve their real sector customers better, what policies are required to induce them to make more money from real customer service than leveraged proprietary trading?

This means that regulators need to pursue less what banks should not do, but what business models are appropriate for the banks to serve the real sector better? This obviously requires the regulators and the industry to have a better conversation than the current lines of engagement.

The Daily Star/Bangladesh/ 18th March 2012