Singapore’s economic growth has been heavily dependent on factor accumulation during the past three decades. Attempts to gauge productivity growth in Singapore and other East Asian countries has led to the widely publicized debate on whether the East Asian “miracle” was driven by factor accumulation or productivity growth. According to the most recent study by the authorities, Singapore’s productivity growth was indeed very low until the 1980s, but has improved significantly to a level comparable to the Organization for Economic Co-operation and Development (OECD) average in the 1990s.


Singapore’s economic growth has been heavily dependent on factor accumulation during the past three decades. Attempts to gauge productivity growth in Singapore and other East Asian countries has led to the widely publicized debate on whether the East Asian “miracle” was driven by factor accumulation or productivity growth. According to the most recent study by the authorities, Singapore’s productivity growth was indeed very low until the 1980s, but has improved significantly to a level comparable to the Organization for Economic Co-operation and Development (OECD) average in the 1990s.

III. Singapore—Financial Sector Development: a Strategy of Controlled Deregulation 1

A. Introduction

1. For a city state with scant domestic resources, Singapore’s development has been nothing less than remarkable. In the three decades since it gained independence, Singapore has built itself up from a small trade entrepot to a leading international financial center, ranking fourth in the world behind London, New York and Tokyo in foreign exchange trading, and fifth in derivatives trading. Singapore has played a pivotal role in channeling capital to Asia, largely through the Asian Dollar Market, the Asian counterpart to the Euromarket and is now one of the world’s largest offshore financial markets. Conservative banking and regulatory practices, an open market and solid economic fundamentals have created a vibrant and healthy financial sector. Based on overall balance sheet soundness, Singapore banks were ranked seventh in the world and first in Asia by Moody’s Investor Services in 1999.

2. Despite these strengths, Singapore’s position as a leading financial center is being challenged by changes in global finance. Sophisticated financial innovations are reshaping financial markets worldwide, and institutional investors and capital markets are becoming the chief vehicles for raising money and channeling savings. Singapore’s main advantage is as an international banking and foreign exchange center; its capital markets—fixed-income and equity markets and the fund management industry—are less developed and have played a smaller role in contributing to Singapore’s financial growth. Furthermore, a broad worldwide trend toward financial deregulation that began in the OECD countries in the 1980s and has sharply accelerated in Asia since the 1997 financial crisis, is spurring competition and will likely result in consolidation of activity in fewer centers. Technological advances are also eroding Singapore’s geographic advantages as a financial center—a favorable time zone and its location in one of the world’s fastest growing regions. Indeed, all financial centers are facing a difficult transition to a “digital age” of global markets, in which national boundaries are being blurred and mobile capital means that traders can manage money from just about anywhere.

3. The Monetary Authority of Singapore (MAS) has long been aware of these challenges. In early 1997—before the full-fledged outbreak of the Asian crisis—the authorities undertook a fundamental regulatory review of the financial industry, and in early 1998 unveiled a comprehensive set of reforms to be phased in over five years targeted at lifting impediments to the development of Singapore’s capital markets and to promote Singapore as a full service international financial center.

4. A key question—especially in light of evidence that size and “critical mass” matter for capital markets—is whether Singapore, with its small domestic economic base, can develop the depth and liquidity in its capital market to attract issuers, intermediaries and investors beyond its borders. Singapore is also competing against other regional centers. Singapore’s chief regional rival has been Hong Kong SAR, where the authorities are also undertaking efforts to deepen capital markets and attract foreign issuers and investors.

5. This paper addresses issues relevant to Singapore’s continued development as a financial center. Section B provides brief background on the development of financial sector activities. Section C discusses major trends that have swept through the financial industry, including securities market developments and the increasing dominance of institutional investors, and highlights several weaknesses in Asian capital markets exposed by the financial crisis. Section D reviews the government’s efforts to promote the capital market and other parts of the financial industry. Section E contains concluding remarks on Singapore’s prospects as a global financial center.

B. Development of Singapore’s Financial Center

6. The development of the financial sector was gradual and carefully controlled, guided by conservative prudential practices, and strict government guidelines regulating of financial activity. Beginning in the late 1960s, the government undertook a deliberate policy of shaping the financial industry to become a global force, employing a host of fiscal and regulatory measures combined with prudent macroeconomic policies to induce financial institutions to operate out of Singapore. These policies succeeded in putting Singapore on the map as one of the premier international offshore financial centers. Singapore’s carefully controlled strategy helped win credibility and market integrity—vital to any financial center—but the approach has not been without costs. The government’s heavy control has slowed capital market development and hampered financial innovation.

What makes a financial center?

7. A financial center consists of a high concentration of financial institutions and underlying markets that allow transactions to take place more efficiently than elsewhere.2 Typically, the clustering of financial services and institutions at a particular site is fomented by a host of factors—affecting both demand and supply—such as market openness, low cost of funds, geographic location, a well-developed infrastructure, and an ample supply of skilled labor that can be tapped quickly when financial markets are in a cyclical expansion.3 Financial activities also tend to be drawn to locations with high volumes of information flow from trade or other commercial activities. As such, larger cities provide a critical mass for information flows, including face-to-face contact that expedites exchange of news. Path dependence and scale economies have been identified as key determinants that allow financial centers with an early comparative advantage to sustain it over time and achieve critical mass4. These centers attract related services such as accountants, lawyers and computer specialists. The larger the market grows, the greater the efficiency, liquidity and information flow. This in turn attracts more market players and more liquidity.5

8. Singapore reached its current stature through a unique confluence of geographic, historical and economic factors. In the colonial period, its central location and its deep-sea port made it the trade and transportation center for commodity-rich Southeast Asia.6 Growing trade and commerce attracted foreign bankers, trade finance and foreign exchange operations. Before World War II, Singapore bank branches acted as the regional headquarters for neighboring areas. Singapore’s time zone allowed same-day trading with financial centers in United States, and centers in Asia and Europe, an advantage that later helped spur Singapore’s foreign exchange market. Singapore also boasted a modern communications and transportation infrastructure, along with a skilled labor force. Like Hong Kong SAR, Singapore inherited from British colonialism stable political institutions and a legal system that attracted European and United States financial institutions familiar with British law (Box III.1). By the early 1960s, Singapore’s bank centered financial system was already more advanced and open than most of its neighbors, putting it in an ideal position to take advantage of Southeast Asia’s spectacular growth and the capital needs that would develop a decade later.7

9. Still, Singapore’s future was not necessarily secured. Several political and economic events threatened its prospects. In 1965, Singapore separated from the Federation of Malaysia and became an independent nation state.8 With this separation, Singapore lost a key trade market and income source. In addition, in 1967, Britain began withdrawing its military forces that had accounted for roughly 15 percent of Singapore’s GDP. Both these events left Singapore with a markedly smaller economic base. Singapore also had limited natural resources. Most of its energy, raw materials and food had to be imported.9 Political risks were looming as well, with large neighboring countries threatening open hostility.

Singapore and Hong Kong SAR as Financial Centers

Singapore’s chief rival in the region for the large part of the past three decades has been Hong Kong SAR. Although Tokyo would have seemed the more natural regional center, onerous regulations and controls discouraged international capital and allowed Singapore and Hong Kong SAR to fill the vacuum. It was not until the 1980s, when the government slowly began deregulating the financial industry, that Tokyo developed into the global center it is today.

Singapore vs. Hong Kong as Financial Centers, 1998

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Source: IFC, BIS, HKMA, and MAS.For Hong Kong, (*) data for 1994 and (**) for 1995.

Singapore and Hong Kong SAR share several common characteristics: they are city states, although Hong Kong SAR’s GDP and population is at least twice that of Singapore; their business and physical infrastructure (telecommunications, transportation, and clearing and settlement system etc.) are considered first class; they function as transportation (air and sea) and financial hub for the region; they operate in the same time-zone; they are English speaking and inherited British-based legal and political institutions; they lack a sufficiently large industrial base or “hinterland” to feed their own financial center, and instead have relied on attracting external funds and intermediating them via the center to regional users. China is considered Hong Kong SAR’s extended hinterland and Southeast Asia Singapore’s.

What sets them apart from other regional countries is their sound and open financial system, characterized by: high credit ratings and capital adequacy ratios (in excess of 18 percent), strong accounting practices, capable management, no deposit insurance, large presence of foreign institutions, and strong regulators.

However, there are several areas where the two differ, reflecting in part the different political routes they followed starting in the 1960s. Following independence, the authorities in Singapore adopted a proactive approach towards developing the economy, and introduced tight controls and conservative prudential standards. By contrast, Hong Kong SAR—under British protectorate—continued its laissez-faire approach, with minimal controls and government interference. Its tax rates are the lowest in the region. Unlike Singapore, onshore and offshore banking are fully integrated, with domestic and foreign currency activities and resident and nonresident activities being treated the same.

As for the regulatory approach, banks in Hong Kong SAR are not subject to reserve requirements. For years, Hong Kong SAR had no central bank and was reluctant to introduce prudential standards. However, banking sector problems in the 1980s, the stock market crash in 1987 and various financial scandals threatened Hong Kong SAR’s reputation, leading to the gradual introduction of prudential regulations and the establishment of the Hong Kong SAR Monetary Authorities (HKMA). In contrast, Singapore began with high prudential standards and gradually relaxed them to establish a level playing field for local banks.

Under intense competitive pressures, HKMA like MAS is undertaking several efforts to improve the functioning of the local capital market. For instance, HKMA has listed Exchange Fund Notes on the Stock Exchange to enhance liquidity; established a Mandatory Provident Fund that will go into effect at the end of 2000 and will channel more long-term funds to the capital markets and enhance fund management industry; and launched an asset-backed securities market for mortgage loans.

Policies to promote Singapore’s financial center

10. Recognizing these economic and political uncertainties, the government adopted an aggressive outward oriented development strategy. For the financial sector, this meant reaching well beyond Singapore’s own borders to overcome comparative disadvantages relative to London, Tokyo or New York, all of which drew on industrial establishments that provided a vast pool of funds for financial intermediation. Singapore’s practical response to its shortage of natural resources, limited size, and relatively large stock of educated workers was to develop a modern and sophisticated financial center that would serve needs well beyond its own economy and immediate region.10 A strong domestic financial sector would also serve to finance the government’s industrialization drive.

11. Over the next three decades, the authorities introduced an array of financial-sector reforms, launched new markets and used regulatory and fiscal incentives to attract financial institutions to Singapore. Well ahead of most Asian countries and in line with its export oriented development strategy, the government liberalized the capital account, deregulated a large part of domestic financial sector and completely lifted all exchange controls by late 1970s, helping Singapore’s financial center stay ahead of other competitors in the region and progressively improve market efficiency.11 Beginning in the 1980s, the government’s efforts shifted to broadening the financial system and promoting the domestic capital markets.

12. Three core tenets characterized the government’s strategy: (i) fiscal and regulatory incentives to lure financial activities to Singapore and jumpstart activities such as the Asian currency market; (ii) the creation of a separation fence to insulate domestic financial intermediation from international banking activities; (iii) strong emphasis on controlled and regulated development of the financial sector.

The Asian Currency Market

13. The government’s first move to promote its financial sector was to try to emulate the remarkable success of London’s offshore center—the Eurocurrency market—by introducing its regional counterpart in 1968, the Asian currency market, commonly known as the Asian Dollar Market because most of the transactions are denominated in U.S. dollars.12

14. The Eurodollar market developed because of onerous banking regulations in developed countries and a large supply of U.S. dollars emanating from oil-producing as well as countries with noncovertible currencies who maintained dollar deposits in order to finance international trade. The Eurodollar market proved highly competitive vis-à-vis the United States financial market and other advanced financial markets.13 Free of national controls and regulations, offshore markets enabled international banks to engage in more profitable international transactions under favorable regulatory and fiscal treatment. Countries hosting offshore markets in return enjoyed positive externalities as financial institutions established offices, hired local workers, imported technology and information, raised the tax base and attracted new business opportunities.14

15. To jumpstart the Asian currency market, Singapore authorities introduced tax and regulatory incentives to induce international commercial and merchant banks to locate their regional business operations in Singapore. These included exemptions for nonresidents from withholding tax on interest income; zero reserve requirements; no deposit insurance premiums; and a 10 percent concession on taxable income. A liberal employment policy was also adopted to attract skilled foreign workers. With these measures, the government also hoped foreign financial institutions would attract new business activities and have positive spillovers on the domestic economy through more efficient mobilization of savings and better risk management techniques so as to create a strong financial system which in turn is a key contributor to economic growth.

16. The government also exhibited flexibility and pragmatism, responding quickly to emerging market trends and competitive threats by aggressively broadening fiscal and regulatory incentives. The authorities eliminated the 20 percent liquidity requirement on foreign currency deposits that had put the Asian Dollar Market at a disadvantage to the Euromarket in the early 1970s. Following Euromarket trends, the Asian Dollar Market widened its product ranges in the 1970s by introducing money market products and longer term securities such as the Asian dollar bonds. Tax incentives encouraged the establishment of international money brokers to intermediate sales and purchases of foreign exchange.

17. All told, the creation of the Asian Dollar market was a success and Asia’s rapid economic growth fueled its explosive expansion in the 1970s and early 1980s.15 It played an important role in channeling savings from Europe, the United States, the Middle East and Japan to the fastest growing countries in Asia. The Asian dollar market together with special tax incentives helped lure multinational corporations to establish their regional headquarters for regional treasury and financing operations in Singapore, buttressing demand in the foreign exchange market.16 Regional central banks also flocked to Singapore’s foreign exchange market because of strict prudential and supervisory standards, which restricted participation to only the most creditworthy and strongest financial institutions.17 Interbank lending, largely to finance trade, accounted for roughly two-thirds of the Asian Dollar Market’s business, with the remainder going to nonbank customers (Figure III. 1). Most of the lending was denominated in foreign exchange and was short-term and unhedged, with maturities averaging less than three months.

Figure III. 1.
Figure III. 1.

Singapore: ACU Market

Citation: IMF Staff Country Reports 2000, 083; 10.5089/9781451834185.002.A003

Sources: IMF, World Economic Outlook; CEIC Database: and Monetary Authority of Singapore.1/ Comprises Hong Kong, Indonesia, Korea, Malaysia, Philippines, and Thailand.

18. The rate of expansion of the Asian dollar market slowed in the mid 1980s, and contracted in the 1990s when Japan—a large provider of interbank offshore funds—went into a recession, forcing Japanese banks to consolidate their international positions. Deregulation in OECD financial markets also caused a gradual shift toward securities-based lending in the home markets and the Eurobond market. Still, the Asian Dollar Market remains one of the largest offshore markets, with total assets reaching US$503 billion at end-1998 more than 600 percent of Singapore’s GDP.

The “separation fence”

19. The second major initiative was to introduce financial legislation that would separate domestic financial intermediation from international banking (the Asian currency market).18 Separate accounts were introduced for international and domestic transactions. Banks were required to record their international transactions in the Asian currency market through so- called Asian Currency Units (ACUs), while Singapore dollar transactions with residents were booked through domestic banking units (DBUs).

20. The bifurcation served a threefold aim. First, the government wanted to discourage the Singapore dollar from being traded internationally (known as the policy of “non-internationalization of the Singapore Dollar”) to stem currency speculation and preserve control over domestic monetary policy.19 Second, the government also wanted to nurture the local banking industry. With the large influx of foreign banks interested in establishing ACUs it feared that the domestic banking sector would quickly become overbanked. The government introduced protective barriers, restraining the retail banking activities of nonresident banks.20 Restrictions were not imposed, however, on banks wanting to access the rapidly expanding Asian Dollar market. Third, for prudential reasons, the government wanted to maintain some control over the allocation of domestic savings and insulate domestic financial intermediation from international banking which was subject to less stringent regulations.

21. Under this two-system regime, ACUs could carry out international transactions under favored regulatory and fiscal treatment, while the DBUs were subject to stricter liquidity and reserve requirements and higher tax rates. Singapore residents were not initially allowed to transact with ACUs. However, these restrictions on residents were fully relaxed by the late 1970s when capital and foreign exchange controls were completely removed. Singapore residents are now free to lend and borrow from ACUs in foreign currencies. Nevertheless, although restrictions imposed on Singapore dollar denominated financial activities by nonresidents have progressively been liberalized, several remain in place, covering credit lines, derivatives such as options, swaps and forward agreements in Singapore dollars. These restrictions form part of the government’s policy to “not encourage the internationalization of the Singapore dollar.” In essence, most of the restrictions are aimed at limiting speculative trading activities taking place in the Singapore dollar.

Conservative prudential practices and controlled deregulation

22. The third feature has been the pursuit of orderly and controlled development and the conservative regulatory approach adopted by the Monetary Authority of Singapore (MAS)—which is charged with supervising and promoting the financial industry. This approach sets Singapore apart from other financial systems. Highest priority was given to protecting the soundness and resilience of Singapore’s financial system and the interests of depositors and investors. Every effort was undertaken to minimize risks, banking failures and financial scandals so as not to undermine Singapore’s market credibility.

23. Indeed, prudential standards (capital, cash balances and liquidity standards) have been far more conservative than most anywhere.21 Foreign banks are allowed in primarily on the strength of their home regulation. Comfort letters are required stipulating that head offices will meet liquidity or capital shortfalls of their offshore affiliates. Strict consultative procedures with MAS have guided financial transactions and activities, which issued notices stipulating which activities were permitted. MAS would regularly monitor bank loan files, accounts and transactions and internal controls. Furthermore, the authorities were unwilling to allow untrammeled competition and growth in the financial sector. New types of financial activities typically required MAS approval.

24. As financial activities tend to be attracted to centers with a low regulatory burden, including light handed prudential supervision, the authorities have had to walk a fine line between ensuring financial soundness and credibility while not overly hampering financial innovation and market development. The twin objectives have sometimes been at cross purposes. The MAS has been criticized for being heavy handed, imposing burdensome monitoring of financial activities and complex consultative procedures. In many cases, financial institutions have not undertaken activities to avoid time consuming prior consultations with MAS. Likewise, the high prudential standards have come with a cost, having been identified as a constraint to capital market development and imposing a high regulatory cost on domestic banks.

25. Recognizing that previous attempts to develop capital markets had not borne fruit and that issuers and investors were still attracted by the more liquid Eurobond market, the government began shifting in the early 1980s its focus to promoting the capital markets and broadening the financial system. This was also in part a response to emerging international financial trends toward securitization (see Section C).

26. To kick-start the local capital market, the government launched various initiatives, including (i) opening in 1984 a futures and options exchange—the Singapore International Monetary Exchange (SIMEX); (ii) establishing a new Singapore Government Securities market in 1987 to offer a wider range of Singapore dollar government debt instruments; and (iii) establishing in 1987 a new stock exchange catering to smaller companies—the SESDAQ.

27. Despite these efforts, Singapore’s financial center has remained largely an international banking center with a well developed foreign exchange market. It benefited from “first-mover” advantage in the region with the Asian currency market. By contrast, its bond, equity and futures markets remained relatively underdeveloped. The securities markets were marked by thin liquidity, lack of issuers and instruments, and low trade volume. Several key features were holding back capital market development:

  • Government bond issues were not a source of government funding. Typically chronic government deficits have helped create highly liquid markets for government securities, especially in OECD countries. Singapore’s government, by contrast, has run surpluses and has had no need to issue debt. Further, large public sector infrastructure funding requirements were largely tax revenue financed. The government securities market has consisted largely of primary issues to meet bank reserve requirements and to soak up excess funds in the Central Provident Fund (CPF), Singapore’s mandatory pension system.

  • Corporate bond issuance has not been a source of corporate funding. Corporations relied instead chiefly on bank financing, or as is the case of multinational corporations, on their parent company. Statutory boards and government linked enterprises also relied on the government budget as a source of funding.

  • An unintended consequence of the authorities’ policy of controlled deregulation and limits on internationalization of the Singapore dollar has been to thwart the development of Singapore’s capital markets by limiting trading activity and product development. Until recently, government restrictions on borrowing Singapore dollars by nonresidents forbid corporations and supranational borrowers from issuing Singapore dollar denominated debt. Restrictions on foreign listings as well as on investment choices of CPF members have likewise constrained the development of the securities markets.

C. Trends in Global Finance and the Effects of the Asian Crisis

28. Asia’s financial crisis exposed significant shortcomings both in the region’s financial systems and in corporate financial structures. Although most Asian countries have a high degree of financial depth (measured by ratios to GDP of broad money, total banking assets and private credit), their financial systems have been largely bank-centered, heavily regulated, and closed compared to most OECD countries (Figures III.2, III.3 and III.4).22 A heavy reliance on bank debt along with substantial institutional weaknesses—inadequate supervision, substandard corporate governance practices, weak accounting and disclosure standards and poorly defined legal rights—are widely cited factors contributing to the crisis. Risks were heavily concentrated in the banking system.23

Figure III.2.
Figure III.2.

Singapore: Financial Indicators

Citation: IMF Staff Country Reports 2000, 083; 10.5089/9781451834185.002.A003

Sources: IMF, International Financial Statistics; and WEFA.
Figure III.3.
Figure III.3.

Singapore: Indicators of Stock Market Development

Citation: IMF Staff Country Reports 2000, 083; 10.5089/9781451834185.002.A003

Sources: International Finance Corporation; and CEIC database.
Figure III.4.
Figure III.4.

Singapore: Indicators of Bond Market Development

Citation: IMF Staff Country Reports 2000, 083; 10.5089/9781451834185.002.A003

Source: Bank of International Settlements.

29. An important but widely overlooked reason for Asia’s heavy reliance on bank financing may have been the underdevelopment of local capital markets. Financial market deregulation in Asia lagged behind most OECD countries. Little use was made of more sophisticated and longer term financial products such as bonds, convertible bonds, asset–backed securities or derivative products to hedge exposures to interest–and exchange-rate risks. Indeed, in several countries, including Singapore, the domestic bond market was more a placement market than an active trading market. Price discovery was limited by the lack of liquid benchmarks to price credit risks and credit ratings for most corporations. Most financial systems (except Hong Kong SAR and Singapore) were protected and relatively closed to foreign competition and investors. Securities market development was also retarded by lack of transparency, including poor disclosure and weak governance practices and heavy regulation. Institutional investors played only a marginal role in providing long-term capital and developing sophisticated hedging products.

30. The Asian crisis spotlighted the advantages of open, broad and deep financial systems. More liquid bond and equity markets and reliance on longer-term fixed income securities by corporations may have lowered the real sector’s vulnerability to the weaknesses in the banking system. Alternative instruments such as asset backed securities and more liquid secondary markets could have mitigated the liquidity squeeze banks were facing. Thin and illiquid markets amplified asset price volatility and deepened losses in the severe downturn.

31. Studies show the importance of well developed financial systems for economic development.24 They reduce transaction and information costs, enhance price discovery, improve resource allocation and allow investors to trade, hedge, diversify and pool risks. Although empirical evidence so far does not suggest a clear-cut superiority between bank-centered systems as in Germany or Japan and market-based financing systems as in the United States or the United Kingdom, since the 1980s, global finance has been trending toward market-based systems, with capital markets taking over the function of channeling savings at the expense of banks.

32. Both supply and demand factors have supported this general trend toward securitization:25

  • Progressive deregulation in the banking and securities industries has heightened competition among financial service providers. The line between banks and nonbank financial institutions has blurred with banks competing with nonbank financial institutions for fee-and commission-based business, as well as savings intermediation.

  • The removal of capital and exchange controls also increased competition and cross–border flows, allowing companies and investors to tap international financial markets to find the lowest cost funding and highest risk-adjusted return. Corporations are now directly issuing debt, equity or hybrid securities and are increasingly seeking listings on large, liquid foreign exchanges, using these as a wider platform to raise funds and expose themselves to a broader and more sophisticated investor class. The same holds true for debt securities, with the growth of international bonds outstanding outpacing the growth of most domestic bond markets. In contrast, (syndicated) bank lending—the main vehicle for raising funds in the 1970s—has been on a declining trend since the 1980s.26 The recent upturn in such lending (which still remains below the levels of the 1980s and early 1990s) reflects an acceptance by borrowers of the higher prices and spreads as being rational, as well as some large cross-border M&A activity.

  • Institutional investors—pension funds, insurance companies and fund managers—have had a profound impact on capital market development and are now the key suppliers of long-term funds and risk capital. They have spurred the development of new risk products and have led the movement to improve corporate governance and disclosure practices, as well as bankruptcy procedures and legal protection of creditor and investor rights. The proliferation of new financial products is enabling investors to better manage and tailor risks so that each counterparty can match their own risk and return profile. Market activity in derivatives and securities trading has surged as a result.

  • Advances in information technology and telecommunications are lowering transaction costs, fueling product innovation and erasing the advantages of geographic location. With round-the-clock and around-the-world electronic trading, investors now have the capability to move across markets rapidly, arbitrage price opportunities almost instantaneously, and manage money and access markets from just about anywhere. As a result, financial institutions have begun consolidating their trading operations in fewer financial centers. National exchanges, in the face of intense competition, are looking to attract more listings, investors and wider product ranges by seeking alliances with other exchanges, as in the recent merger of the London Stock Exchange and the Deutsche Bourse. Several stock exchanges, including Australia, Hong Kong SAR, Singapore and Toronto, have demutualized to encourage broader membership and brokerage participation, while providing the exchanges more flexibility to enter new alliances.

  • As for demand factors, households have begun to shift from bank deposits to performance-based financial instruments such as money market or equity funds.27 Moreover, an aging demographic profile in OECD countries has boosted demand for higher-yielding retirement products, channeling more savings into longer-dated securities products such as equities and fixed income products. Tax incentives and a shift from defined benefit to defined contribution plans in many countries has raised demand for capital market products and asset management services.

33. The Asian financial crisis has accelerated Asia’s adoption of these global trends. The pace of financial deregulation in the region has sharply accelerated as governments have moved to strengthen and diversify their financial systems. Many are deregulating their domestic capital markets and introducing a wider range of products. Several countries are focusing on developing deeper securities markets and upgrading their corporate governance and regulatory practices. Inevitably, more emphasis will shift to capital markets to satisfy the large capital funding needs of banks, corporations and public infrastructure projects. Asia also needs to prepare for the transition towards an aging population, which will raise demand for higher yielding investment instruments. Institutional investors will play an increasingly dominant role in channeling and managing capital, forcing greater competition and allocation efficiency in capital markets.

D. Singapore’s Recent Capital Market Reforms

34. The authorities in Singapore have long recognized that trend changes in global finance and intense global competition could threaten Singapore’s position as a leading financial center. This recognition is exemplified in the following statements by Deputy Prime Minister (and Chairman of the MAS) Lee Hsien Loong:

“Increased competition and globalization have encouraged consolidation of financial activities in fewer major centers…. A similar consolidation can happen in our time zone. We cannot tell how many centers the Asia Pacific will have. But whatever the final count, we want to be in that number.” (November 1997).

“Financial innovation has continued unabated, institutions are rationalizing and consolidating, and transactions and services are rapidly going on line. Singapore has been directly affected by these global trends. These trends mean that institutions will increasingly prefer to centralize their activities in one single center.... In Asia, this will pose a strong challenge to Singapore.” (April 2000).

35. Key barriers to the development of Singapore’s capital markets are that its financial sector lacks a large domestic “hinterland” that would naturally feed its capital markets. As noted earlier, countries in Southeast Asia, that have, in the past, used Singapore as a financial service center, are aspiring to develop their own financial centers and are in the course of liberalizing their financial systems. Its other advantages—a favorable time zone, infrastructure and legal system—will be less critical as globalization and technological advances proceed.

36. Driven by concerns that Singapore may not fully benefit from the rapid changes in global finance in 1997, the authorities began a fundamental review of their approach towards regulating and promoting the financial industry, in close consultation with the private sector. An important aim was to identify potential new business opportunities as well as those regulations and market structures constraining the financial sector.

37. Within a year, MAS unveiled a comprehensive package of reforms with essentially a fivefold aim: (i) bring regulatory and supervisory practices in line with current best practice, shifting the emphasis from regulating to supervision and from rules-based to a risk–management approach, with improved disclosure practices; (ii) remove remaining entry restrictions in domestic banking and insurance to fully open the financial industry to foreign competition; (iii) develop deep and liquid fixed-income and equity markets; (iv) promote the asset management industry; (v) and gradually liberalize the use of the Singapore dollar by nonresidents.

38. The reforms to the regulatory framework constitute a break from the past policy paradigm focused on tight and conservative government control and, at times, onerous regulatory guidance of the financial industry. The new emphasis is on allowing market participants more freedom to assume their own risk profiles, promoting transparency, and introducing more competition.28

39. At the same time, however, the authorities indicated that they will only proceed very gradually in easing their policy of non-internationalization of the Singapore dollar. Several changes have recently been announced to relax limits on the use of the Singapore dollar. But (as discussed below), there remain substantial restrictions on borrowing and trading by nonresidents that are limiting the development of a more active and deeper capital market. Prudential concerns about destabilizing speculative capital flows and the ability of speculating to launch an attack on the Singapore dollar will continue to determine the pace of reforms in this area.

40. The authorities recognize the importance of deep and liquid financial which allow market participants—especially large-volume traders such as institutional investors—to transact large volumes rapidly with minimal effect on prices and at low transaction costs. Accordingly, a high priority has been assigned to enhancing market liquidity.

Government and corporate bond market reforms

41. The authorities have undertaken several market structure reforms aimed at enhancing the efficiency of government and corporate bond markets. A core aim is to improve market liquidity in the government securities market, establish a benchmark yield curve and increase issuance activity in the corporate bond market.

42. To establish a benchmark government bond yield for longer-dated issues, the government established a pre-announced auction schedule, auctioning issues at key maturities.29 These efforts have had a noticeable impact on market size and trading volume (Table III.1). The amount outstanding of Singapore Government Securities (SGS) increased markedly, from S$23 billion at end-1997 to S$36 billion at end-1999. Average daily trading turnover in SGS has increased to S$602 million in 1999 from S$534 million in 1997. Bid-ask spreads have narrowed on on-the–run issues.30

Table III.1.

Net Funds Raised in the Domestic Capital Market

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Source: MAS Annual Report.

Government registered stocks and securities, excluding Treasury bills.

Singapore dollar – denominated bonds listed on the SES.

Refers only to Singapore dollars reserve-free NCDs issued during the year.

43. Several reforms are aimed at developing the corporate bond market by stimulating more corporate issuance, broadening the issuer and investor base and credit spectrum:

  • The government took the first important step in August 1998 with Notice 757, for the first time allowing nonresident foreign corporations to raise money in Singapore dollars through bond and equity issues. However, if the funds are not used to finance activities in Singapore, proceeds must be swapped out to a foreign currency. The aim of this restriction was to maintain some disincentive to the internationalization of the Singapore dollar.

  • While Notice 757 originally applied only to corporations with high credit ratings, it was extended a year later to unrated foreign corporations in order to expand the issuer base and credit spectrum, and especially to attract lower grade Asian companies to the Singapore dollar bond market.

  • The government also encouraged local corporations, government-linked enterprises and statutory boards to tap the local capital markets.

  • Finally, tax incentives were introduced to promote issuance, underwriting, and origination out of Singapore.

44. The results have been positive. Corporate bond market activity rose sharply in 1999, with active bond issuance by high grade foreign companies and statutory boards. The breadth of issuance rose and attracted banks, multinationals and corporations with very high credit grades while lower grade corporations have yet to enter the market. Since the third quarter of 1998, Singapore dollar bond issuance by nonresident firms has totaled S$4 billion. Local firms issued SS9 billion in 1999, compared to S$7 billion in 1997 and S$4 billion in 1998 (a year affected by the Asia crisis). Most notably, while most issues before 1998 were private placements, they are now public issues, enhancing price discovery and liquidity.

Promoting institutional investors and the asset management industry

45. The second major reform area targets institutional investors, including asset management, insurance companies and pension funds. Institutional investors are to play a more active role in channeling both foreign and domestic savings to Singapore capital markets and in pushing for wider selection of capital market products, including diversifying the range of retirement products. The authorities envisage Singapore becoming the home base for private sector fund managers and a major regional funding center for fixed-income and equity products.31

  • Several measures have been implemented to catalyze the fund management industry. Tax and regulatory incentives include relaxing the criteria to obtain an investment advisor license; making regulatory requirements for unit trusts more transparent; and expediting processing time for applications to launch a unit trust.

  • The decision has been taken to farm out the management of part of government assets to qualifying private sector fund managers based in Singapore. A total of S$35 billion is expected to be farmed out over the next three years (1999–2001) to private managers.32

  • The investment limits on CPF approved unit trusts have been increased, so that fund managers have more room to improve the risk-return rewards of their funds.

46. These measures are expected to increase the size of the fund management industry, which has already grown markedly. Assets managed in Singapore rose from S$18 billion at end-1990 to S$112 billion at end-1998, while the number of fund companies tripled to 157.

Equity market

47. Equity markets are a third key focus of the capital market reforms. In terms of market capitalization, Singapore’s equity market is already well advanced. However, the issuer base remains narrow and liquidity low. The exchange also has been slow in developing online trading. The authorities’ aim is to make the Singapore Exchange the leading stock exchange for the region, with several reforms targeting this objective:

  • As noted earlier, the Singapore Stock Exchange was demutualized in 1999, creating a stock-company structure. This will allow the exchange to pursue more broadly the interests of investors, fund managers, and traders rather than just member brokers.

  • Following demutualization, the Stock Exchange of Singapore and SIMEX merged in late 1999. The merger is expected to spur the development of complementary products, reduce overhead costs, and improve the stock exchange’s leverage to pursue cross-border alliances with other exchanges.

  • To expand the issuer base, listings of SMEs and foreign companies are being strongly encouraged, although they are subject to Notice 757, which requires them to swap the funds so raised out of Singapore dollars if they are not earmarked for activities in Singapore.

  • To attract investors, disclosure and other corporate governance practices are being upgraded.

  • Broker commissions, now fixed at high rates, will become fully negotiable at the beginning of 2001, and brokers will be allowed to compete with banks by offering money market funds and advisory services. All told, the measures are expected to lower transaction costs, increase trading volume and improve market liquidity.

Remaining constraints

Statutory liquid asset ratio

48. Despite these encouraging developments, several market structures remain as constraints to bond market development. First, the statutory liquid asset ratio is considered very high compared to other countries with similarly developed financial systems. Banks are presently subject to a liquid asset ratio requirement of 18 percent of their liability base, of which they are required to hold a minimum of 10 percent in SGS. As a result, banks have been holding roughly two-thirds of the S$36 billion in total outstanding SGS at end–1999. Since banks typically hold these securities until maturity, their large holdings for statutory purposes are severely constraining the development of an active secondary market in SGS.

49. Experience has shown that liquid asset ratios are misleading and do not necessarily provide an adequate protection of financial institutions’ soundness. The ratios may not take into account banks’ maturity profile, off-balance sheet activities, marketability of the assets, including availability of sufficiently deep secondary markets, or the ability of banks to access market or credit lines. The authorities are therefore reviewing these regulations with a view to adopting a maturity ladder system to allow banks more flexibility in managing their liquidity requirements. The maturity ladder approach compares cashflows and outflows short-term (day-to-day) and over an extended period, and attempts to construct an analysis of banks net funding requirements as well as cumulative net deficits of funds at selected maturity dates.33

Accounting regulations

50. Second, the present accounting regulations require that financial institutions value their SGS holdings at the lower of cost or market value. This has had an adverse impact on secondary trading as banks in their role as dealers have been reluctant to trade in part due to the valuation effect this could have on their bond holdings which are held for regulatory purposes. In line with international best practice standards, the authorities are considering introducing amortization cost accounting for SGS holdings for liquidity requirement purposes so to isolate the valuation impact from trading activities.34

Repo market

51. Third, regulations of repos continue to constrain the development of more active repo and secondary markets. In repo transactions, securities are exchanged for cash with the agreement to repurchase the securities at a future date. The securities thus serve as collateral for what is effectively a short-term cash loan. Repos can be used for such activities such as hedging, leverage and securities lending.35 MAS does not allow government securities obtained through a repo trade (so-called term repos) to be counted toward bank liquidity requirements. Only overnight repos can be counted towards bank minimum liquid asset ratios (up to a maximum of 5 percent), which could account for the much higher liquidity in the overnight repo market.

52. In this context, several recent initiatives suggest that the authorities are prepared to move rapidly in this area. First, the S$20 million consultation limit on repo transactions with nonresidents was lifted in November 1999. Banks can now, without prior consultation with MAS, enter into a repo transaction in SGS and any other Singapore dollar denominated bonds with any party and for any amount, on the condition that there is a full delivery of a collateral.36 Second, in May 2000, the authorities announced that government securities obtained through a repo transaction could be counted towards bank liquidity requirements and that longer dated government securities would be used more actively to influence market liquidity. Third, also in May 2000, the authorities announced the issuance size in benchmark issues would be raised from the present S$1.5 billion to SS2.5 billion. Further, the authorities announced that offshore banks will be allowed to transact in repos with nonbank customers.

Derivative products

53. Markets for hedging products, such as options, futures and forward contracts, on government securities still remain to be developed. These instruments play an important role in attracting trading activities by permitting the pooling and trading of risks. The availability of futures markets would also foster price discovery in the cash market.

Swap market

54. The swap market is not considered adequately liquid, especially farther out the maturity spectrum. As a result, corporate issues have been limited to 3–5 year maturities. Average daily volume in Singapore dollar interest rate swaps is around S$100–200 million while cross-currency swap trading volume is more variable with periods of inactivity.37 Several restrictions, especially on nonresidents, are limiting liquidity in the swap market. Interest rate swaps (IRS) are restricted to Singapore corporates and banks. Other counterparts may trade IRS only if a Singapore denominated asset is underlying the trade, but prior approval for such a transaction is required from MAS. Liquidity in the swap market is, however, important; foreign corporate bond and equity issuers are required to swap out their proceeds from issuing Singapore dollar denominated debt if the proceeds are not used to finance economic activities in Singapore.

55. As in the case of the repo market, recent measures have been aimed at addressing these problems. The MAS has lifted the requirement that longer bonds obtained via a swap transaction be subject to the minimum liquid asset requirement. This should help lower the cost of a swap transaction. In addition, banks may now transact with nonresidents all interest rate derivatives products, including interest rate swaps, without prior consultation with MAS. As part of the banking liberalization the government has established a new category of banks—the Qualified Full Banks—which would receive the same rights as fully licensed banks. QFBs will be allowed to lend up to S$ 1 billion (from currently S$300 million) and engage in Singapore dollar swaps without any restrictions on the purpose of the swap and will not require prior approval by MAS.

Policy of Discouraging Internationalization of the Singapore dollar

56. The most critical hindrance to the development of deeper and broader capital markets is the numerous remaining regulatory restrictions on trading activities in Singapore dollars by nonresidents. Experience in other financial centers suggest that markets for short-sales of securities hedging products and access to domestic currency credit lines by residents and nonresidents are essential to deepen liquidity and encourage trading. Although the restrictions have been eased over the years, they continue to limit potential trading activity and development of market liquidity. For instance, nonresidents still face a S$5 million consultation limit in the amount they can borrow to finance trading activities, including derivatives, in Singapore dollar denominated financial assets. This has deterred traders from taking short positions in Singapore dollar securities (borrowing bonds and selling them in the hope interest rates will rise) since the trader may run into the risk of not being able to settle when payment is due. These restrictions restrain a large number of financial institutions with presence in Singapore from more actively lending in Singapore dollar financial instruments and thus limit market depth.

57. Moreover, although it is unlikely that the Singapore dollar will emerge as a medium of exchange outside the region (in the same way as the dollar or the yen have become), there is the potential for the Singapore dollar to be used more widely as a store of value given its political stability and high degree of credibility of its government. This would allow Singapore to reap the seignorage gains from issuing domestic currency to nonresidents.

E. Conclusion

58. Like other financial centers, Singapore faces considerable challenges in keeping its competitive edge. Capital market development, including the promotion of complementary services such as fund management, are vital for Singapore’s financial center to stay competitive. Given that critical mass in capital markets is essential to attract more investors, intermediaries and issuers, and to lower the cost of funding, Singapore must find ways to overcome the “size problem.”38

59. The first step has been taken by allowing foreign companies to issue debt and equity in Singapore dollars. Yet, even here Singapore may run into limitations because of the “home bias” factor, with evidence indicating that equities, especially, are traded most actively with exchanges where companies have their primary listing. To expand its currently narrow trading platform, the Singapore Exchange is reviewing possibilities of forming alliances with other exchanges, both in the region and globally.

60. Singapore’s policy approach has been to lift restrictions gradually to minimize systemic risks. But, the authorities are fully aware of the potential inconsistencies that can arise from this approach. As Deputy Prime Minister Lee Hsien Loong said in April 2000, “the liquidity of the Singapore dollar market, and MAS rules to discourage the internationalization of the Singapore dollar, constrain the growth of the bond market.” At the same time, however, Deputy Prime Minister Lee also said that the authorities “are not likely to change our basic stance against S$ internationalization, but we have relaxed the specific restrictions, and will continue to review regularly how much further we can safely go”

61. However, as global competitive forces are speeding financial innovation and capital flows faster than regulations can keep up, and when capital market size and liquidity have grown so critical, Singapore may no longer be able to afford this gradual approach.

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Prepared by Jeanne Gobat (x34413), who is available to answer any questions on this paper.


Funding cost may be affected by factors such as domestic regulations, taxation and efficiency of payments and settlement systems. If these are more onerous in one center versus another, then the cost of funds will be higher as well.


However, history also shows that centers can rise and fall in importance in part because of changes to the political systems or other factors. Until the mid 1960s, Beirut was a leading banking center for the region spanning from the Middle East to Asia. Further, Shanghai was thought to have the most developed financial center during the interwar period between 1910–39.


Davis (1990) and Porteous (1995).


For a detailed description of Singapore’s development as a financial center, see Bryant (1985 and 1989).


By the mid–1960s, roughly two–thirds of the 34 licensed banks operating in Singapore were foreign owned. Other financial institutions such as finance companies and insurance firms existed, although on a more modest scale. The Post Office Savings Bank, originally established in the 19th century to promote savings by low–income individuals, operated roughly 39 branches and counters by end–1965. The Central Provident Fund was formed in 1955 as a compulsory savings scheme to provide retirement benefits for workers


Singapore gained full internal self–government in 1959 from the British government, although the British retained control over defense and foreign affairs. In 1963, Singapore joined together with Malaya, Sabah (North Borneo), and Sarawak to form the Federation of Malaysia.


Agriculture, fishing and quarrying accounted for less than 4 percent of GDP. Singapore’s land area is very small. Its total land has grown somewhat through the government’s efforts to reclaim land. Yet, to put its size in perspective. Luxembourg has a land area four times that of Singapore but a population only one sixth as large. London is 2½ times larger than Singapore and its population three times as large (Bryant, 1985).


The Monetary Authority of Singapore, 1980 and 1989.


By the mid 1970s, a bank cartel system of exchange–rate quotations was abolished and the Singapore dollar was floated; credit guidelines were lifted and the interest rate setting cartel dismantled. (Bercuson, 1995).


Asian currency market and Asian Dollar Market are used interchangeably.


The Euromarket offered attractive deposit rates because it had no reserve requirements, deposit insurance premiums or interest–rate ceilings (regulation Q); its lower lending rates reflected the absence of entry restrictions and cartel–like structures that characterized United States banking. (Sarver, 1988).


For fuller discussion on the development and role of international offshore financial centers, see Cassard (1994).


For a detailed account of the development of the Asian currency market in the 1970s, see Hudjera (1978).


Currently more than 5,000 multinational corporations have made Singapore their regional headquarters for treasury and financing operations.


Roberts (1994).


For the purpose of this policy, Singapore residents are defined as: (i) Singapore citizens; (ii) individuals who are Singapore tax residents and (iii) companies incorporated in Singapore or overseas which are jointly owned or majority owned by Singapore citizens.


The authorities introduced a three–tier banking system in the early 1970s. Established local and foreign commercial banks received a full banking license, allowing the full range of domestic and offshore activities, while new foreign entrants could only obtain a restricted or an offshore license. No restrictions on offshore activities were imposed. Restrictions on domestic retail banking varied with offshore license having their activities severely curtailed.


Claessens and Glaessner (1997 and 1998).


For a fuller discussion of the causes of the financial crisis, see Lindgren and others (1999) and Harwood et al. (1999).


Most of the information in this section was drawn from “Institutional Investors in the New Financial Landscape," OECD (1998) and various IMF Capital Markets Reports (1997–99).


See Annex V, International Capital Markets, IMF 1998.


In the United States, bank deposits as a share of total financial assets of the household sector has fallen to 59 percent in 1995 from 63 percent in 1980. By contrast, in Japan the ratio rose to 65 percent in 1995 from 55 percent in 1980.


For further information on the reforms aimed at changing the regulatory and supervisory framework and improving bank disclosure practices, see SM/99/53.


The government launched in September 1998 its first 5Y bond issue, followed in October 1998 with a 7Y bond issue, and a 10Y bond last year. As a result, the government has now a regular pre–announced issuance schedule of 91 and 364 day t–bills and 2,5, 7 and 10Y bonds


On-the-run issues are the most recently issued securities of a given maturity class. On-the-run issues turn into off-the-run when a new security of the same maturity class is issued.


Outside of Tokyo, Hong Kong SAR is the leading center for asset management in the region.


In selecting Singapore-based fund managers, GIC requires the fulfillment of four sets of criteria: (i) a minimum 3–year track record; (ii) the investment team in Singapore should comprise at least three fund managers who also have to meet minimum standards of qualifications and experience; (iii) the size of funds under management should be at least S$500 million in Singapore or S$5 billion at the group level; and (iv) the fund management firm is required to commit resources to training.


For a full discussion on developments in sound practices for managing bank liquidity and trends in supervisory practices, see BIS (February 2000).


Commonly, all financial assets are measured at fair value. There are exceptions to this rule, however. Amortization cost can be applied to securities such as bonds that are held to maturitiy.


For more on repos see MAE OP/97/3 and BIS (1999)


This means that financial institutions can borrow Singapore dollars through a repo transaction but have to first buy a Singapore dollar asset.


The Singapore Bond Market, Deutsche Bank, August 1999.


Recent empirical evidence indicates that size may matter and can lower the cost of capital Hardouvelis et al. (1999) find that the average saving in the cost of capital from market integration in Europe for the period between 1992 and 1998 amounted to around 200 basis points. Stulz (1999) also finds that financial integration encouraged by globalization has lowered cost of capital.

Singapore: Selected Issues
Author: International Monetary Fund