On Nov. 15, 2009, the Asia Pacific Economic Cooperation (APEC) again accentuated its commitment to boosting Asia-Pacific integration. APEC currently accounts for almost 50 percent of global GDP.
India is not yet included, since the debate over India's position is still ongoing. ASEAN meetings only involve China, Japan and South Korea.
At the same time, the East Asian Summit, formed in 2005, involves India, Australia, New Zealand, China, Japan and South Korea. Regarding the strong cohesion among Asian countries, regional integration into the APC (Asian Pacific Community) is relevant for discussion.
The main objective of the APC is to create a competitive group of countries that is more resistant to global shocks due to financial market and/or economic uncertainty.
In the Asian context, the 1997 fiscal crisis has provided a valuable lesson. Unlike previous crises characterized by government policy failures, the problems in the 1997 Asian crisis originated from three channels: corporate sector vulnerability, financial liberalization in the 1980s resulting in excessive bank risk taking, and the lack of global coordination in blocking financial turmoil.
Relating to the first channel, problems were due to low governance quality. While shareholders are the core of governance, their role in firms is weakened if their rights are not effectively protected and enforced by the legal system. The quality of corporate governance can be captured by, among others, rule of law and corruption perception index (CPI).
The World Bank revealed that during the period 1999-2008, Indonesian rule of law did not change much, albeit showing an upward trend.
Instead, its position during the last decade was always below the 30th percentile, hence making it too early to say that there is now an improvement in the rule of law.
Meanwhile, the CPI score for Indonesia recently increased by 0.2 points to go to 2.8. On the other hand, the CPI score for Singapore, Thailand, Brunei and Malaysia respectively were 9.2, 3.3, 5.5 and 4.5.
Hence, compared to neighboring countries in Southeast Asia, the CPI score for Indonesia is relatively low. It indicates that Indonesia is not yet free from corruption that hinders good governance.
For the second channel, banking sector reforms consisting of recapitalization and/or mergers and acquisitions (M&A) suffer from moral hazards. Recapitalizations implemented from 1998-1999 became polemic until today due to unprevented corruption. The similar moral hazard indication also happened recently when the government rescued Bank Century.
By parallel, the effectiveness of M&A among Indonesian banks after the 1997 crisis remains questionable. Despite restoring the financial viability of distressed banks, these M&A have created larger banks and a more concentrated banking market. Currently, more than 70 percent of the banking system's total assets are ruled over by 15 banks.
The four biggest banks - Mandiri, BCA, BNI and BRI - have total assets of more than 44 percent of the banking system's total assets.
As banking market concentration increases, the banks are likely to offer higher interest rates on deposits, hence increasing the cost inefficiency.
Cost inefficiency can be captured by the ratio of operating expense to operating income. Until June 2009, this ratio was at 87.77 percent, relatively high for Southeast Asia.
In such a situation, Indonesian banks should then increase loan interest rates in order to maintain profitability.
However, an increase in loan interest rates during a period of global instability and market pessimism due to the 2008 global crisis may lead to an increase in bank fragility.
This is due to the possibility that borrowers who are willing to pay higher loan interest rates can be the ones who are likely to take risky projects in order to cover their loan interest rates. This is known as the "entrepreneurs' moral hazard".
Financial integration as one of the elements of Asia-Pacific integration plays a pivotal role in alleviating those potential problems.
Financial integration eases the entry and exit of foreign capital, financial assets or the operation of foreign financial institutions within a country.
While financial integration needs stronger macro governance in protecting investors and enforcing laws, stronger motivation among Asian countries in boosting financial integration becomes a key point for improving governance in countries with weaker macro governance environments.
Those countries will be supported by neighboring countries with stronger macro governance.
Nevertheless, the possible consequences of an increase in bank competition should be prepared for. Instead of leaving competition unsupervised, we should now rethink the mechanism of global supervision.
The 1997 crisis also revealed there was no coordinated approach in blocking financial turmoil, while the restructuring policies left to national governments failed to restore confidence that was missing in the global economy.
For such a reason, the Asia Pacific needs an effective international institution, like the European Central Bank, as a global watchdog for regional integration.
The effective international institution needs global leadership and ownership. The recent G20 summit and APEC meetings are good starting points to establish such an international institution.
Just as France, Germany and the United Kingdom were the leaders of EU integration, it is time for Indonesia, India, China, Japan and South Korea as a part of the G20 to act as global leaders in Asia-Pacific integration.
Indonesia, as one of the countries hardest hit by the 1997 Asian crisis, is the one that should have more incentive for Asia-Pacific integration, since endemic instability from both the corporate and banking sectors still lurks even now.
The writer is a PhD candidate in banking and corporate finance at the University of Limoges, France, and a lecturer at the School of Economics, Sebelas Maret University, Surakarta.
