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Financial innovation can make it harder to identify and manage risk, Monetary Authority Chief Executive Joseph Yam says, adding everyone involved in the financial system must be vigilant.
In his latest Viewpoint article published on the authority's website today, he said the financial system has grown beyond the banks taking deposits and making loans, and earning a spread to cover the costs and the risks that occasionally materialise.
Due to the capital markets' development, the financial system now plays an important role in matching fund raisers' risk profiles and investors' risk appetite. Investors directly and increasingly assume the fund raisers' risks rather than leaving it to the banks, insulating them from the borrowers' credit risks.
More complicated system
But the modern financial system is even more complicated than this, making it even harder for the financial authorities to comprehend, Mr Yam noted.
"Financial innovation has enabled the credit risks of the fund raisers to be spread to outside the financial system and assumed by investors instead, through the use of tradable - at least under normal market conditions - financial products."
He said the financial system is so efficient at this that it has become rather difficult to identify what risks are involved, where they lie, and whether those assuming them are aware of them, let alone whether they are in a position to manage the risks in the first place. Therefore, there is a need for everyone involved in the system to remain vigilant.
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