Zeti Akhtar Aziz: The mandate and roles of Asian central banks
Keynote address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the
Bank of Korea International Conference 2010 "The changing role of central banks", Seoul,
31 May 2010.
* * *
It is my great honour to be invited to speak at the "Bank of Korea International Conference
2010", held this year in conjunction with the 60th anniversary of the Bank of Korea. Let me
take this opportunity to congratulate the Bank of Korea on this special occasion. The Bank of
Korea can take great pride in its achievements during these six decades. From its
establishment in June of 1950, the Bank of Korea has devoted great efforts to provide a
stable and conducive macroeconomic environment and to build an effective financial system
that has facilitated the growth of the Korean economy and its long-term sustainability.
This recent decade has been the most challenging for policymakers, in particular, for Central
Banks. In the late 1990s, the Asian region was confronted with a severe crisis, and about a
decade later, the world was confronted with a financial crisis of unprecedented global
proportions. While Asia was adversely affected by these crises, there was a rapid return to
recovery, both during the Asian financial crisis and during this recent global financial crisis.
For the Bank of Korea, the courageous policy responses to some of the very tough
challenges presented during these episodes can be judged by the results that have been
achieved. There is now a cause for optimism in the present circumstance. Korea is
recognised as one of the economies that has been the fastest to recover from the crisis. The
exceptional work by the Bank of Korea has been an important element in this unwavering
resilience of the Korean economy.
As the nature of globalisation changes and as financial innovation intensifies, the world has
become more complex and less predictable. While the trend for greater trade orientation
continues, changes in comparative advantage and shifts in the direction of global demand
have transformed the trade patterns in the global economy. In addition, the financialisation of
savings and the increased diversification of these funds into financial markets have
increased the impact of these markets on the real economy as the performance of these
markets experience booms and bust. The greater integration of financial markets across
borders has also increased the potential for its effects to be rapidly transmitted from one
financial system to another market in another part of the world. In this new environment, the
greater interdependence arising from the stronger interlinkages between economies and
financial systems have thus significantly raised the risk for contagion.
At the same time, new economic growth centres have emerged that are shaping the
economic and financial landscape of the world economy. Emerging economies in Latin
America, the Middle East and Asia have become important centres in the global economy.
These trends have resulted in an increasingly multi-polar world in which the economic power
is more dispersed in the global economy. In Asia, the growing significance of domestic
demand, the enhanced quality of the workforce and the more developed and resilient
financial systems have all contributed to this strong growth performance. While the strong
global linkages continue to be an important element in this growth process, this decade has
seen the tremendous expansion in intra-regional trade in Asia. Intra-regional trade has
increased from 32% of total trade in 1995 to now exceed 50%. This trend has generated
mutually reinforcing growth in the region.
While this trend has reduced the extent to which external demand and supply shocks affect
the Asian region, the more recent phenomenon of greater international financial integration
has left no country insulated from the contagion of external shocks and from financial crisis
from other parts of the world. In this new environment of greater international financial
integration, developments in one asset class in a market in a distant country can spread to
other asset classes, markets and to other parts of the world. Financial exposure through third
markets are also becoming the new norm as liquidation of assets frequently occur in well
functioning and high performing markets to meet obligations in other markets that have
experienced disruptions or meltdowns. This was evident in the post-Lehman period which
saw massive outflows from the Asian region following the deleveraging by the financial
sector in several of the advanced economies. The increased connectivity of the world means
that systemic risk events will become more widespread and significant compared to
previously.
These fundamental changes in the national and international financial environment have
prompted the search for solutions that would reduce the prospect of such financial disasters
from happening in the future. This search has involved the reassessment of the role that
should be assigned to Central Banks. It is important to recognise however, that there is no
unique blueprint for the design of the institutional arrangements for a Central Bank and that it
needs to be relevant and suited to its own circumstances. Indeed, the roles of Central Banks
have varied considerably and have ranged from having a narrow mandate of maintaining
price stability to more broader mandates that have included maintaining financial stability,
undertaking the supervisory and regulatory function of the financial sector, maintaining
orderly financial markets, addressing financial imbalances, leading the financial resolution
initiatives in the management of a crisis and finally, driving the development of the financial
system. My remarks today will focus on the mandate and role of Central Banks from the
perspective of emerging economies, and more specifically, in the context of Asia.
National roles
This recent two decades, have witnessed radical reforms of Central Banks in several parts of
the world, generating widespread debate on two specific trends that have emerged. The first
relates to the shift in focus to the single mandate of price stability as being the core function
of Central Banks. This has been frequently accompanied by the adoption of the inflation
targeting framework. The second relates to the establishment of a separate entity to
undertake the supervisory function of banks, although more than half of the Central Banks
around the world still have the responsibility of the supervisory function. In the aftermath of
the recent global financial crisis, the search for the appropriate framework for monetary
stability and for the optimal institutional structure for financial sector regulation and
supervision continues, perhaps now with greater earnest.
Prior to the recent financial crisis, the predominant view was that Central Banks should
pursue "one tool and one target" policy strategy. Based on this view, the best role for the
Central Bank in pursuing macroeconomic stability and prosperity was to ensure that inflation
remains low. This recent crisis has changed this perception. Maintaining price stability and
financial stability is a means to an end. The ultimate goal is surely to achieve sustainable
economic growth and prosperity. Maintaining orderly financial markets has also now become
an important role for Central Banks given the implications it has on the functioning and
performance of the real economy.
For the emerging economies in Asia, ensuring orderly financial markets has always been an
important role for the Central Banks in the region. Given the stage of development of the
financial markets and its relative size in the international financial system, disorderly
conditions that do not self equilibrate generally threaten to undermine the performance of the
real economy. This was evident during the Asian financial crisis in 1997 and 1998. Ten years
hence, several financial reforms and initiatives have been implemented by the region. These
reforms include deregulation and instilling greater market orientation, the development of the
domestic financial infrastructure and the supporting legislation, increasing the range of
instruments at the disposal of the Central Bank and strengthening the surveillance
capabilities of the Central Bank.
These developments have yielded tremendous payoffs to the Asian region. The
strengthened resilience that has been achieved has enabled most financial markets in Asia
to absorb the destabilising implications of the recent global financial market turmoil. Most
importantly, there was no disruption to our financial intermediation process. This has not only
allowed the markets to facilitate the transmission of policy but it has also supported the
recovery of private sector economic activity.
Equally important has been the role of the Central Bank in addressing the build up of
financial imbalances which would not only have an impact on financial stability, but also on
macroeconomic stability. While interest rates have been an important tool to address the
build up of such financial imbalances, most Central Banks in Asia have placed greater
reliance on macroprudential measures. Prudential measures applied since the 1990s have
been successful in containing the build up of such financial imbalances, thus reducing the
risk to financial stability.
The world going forward is likely to continue to be affected by financial crisis. History has
shown that there have been more than a hundred distinct banking crises in these two recent
decades. The prospect of surviving such a crisis is not only about building resilience but also
having the capacity to manage it. The institutional arrangements for financial stability
continue to be a key area of debate. The main issues have tended to centre on the role of
the central bank in financial stability, and whether there should be a single or multiple
supervisory authorities. Given that the central bank is the lender-of-last-resort, the central
bank is invariably in the frontline of the actions to restore stability. While there is no general
agreement on the optimal structure for the supervision function, it is recognised that financial
systems have become increasingly complex and interconnected. Whether a country adopts
an integrated model or a model that is organized along sectoral lines, effective coordination
is critical to effectively safeguard financial stability.
As the entity responsible for monetary policy, the Central Bank undertakes surveillance on
macroeconomic conditions and in undertaking open money market operations and the
management of international reserves, the Central Bank has direct contact with the financial
markets. The Central Bank is thus able to gain valuable insights that contribute towards a
more informed financial supervision, including in the design and implementation of
macroprudential policy measures. The Central Bank is also best positioned to evaluate the
tradeoffs should conflicting objectives arise. In such situations, a fragmented institutional
arrangement frequently results in delays and compromises in policy responses. In addition,
there would also be a lack of clarity of the accountability for the decisions.
Finally, the Central Bank also performs a critical role in crisis containment and management,
in particular, to provide liquidity, to prevent disruptions to the functioning of the financial
system and to restore stability and confidence to the financial system. To avoid a piecemeal
approach by any individual agency in the system and to ensure a comprehensive response
to the financial crisis, the institutional arrangements for greater coordination across agencies
is essential to allow for prompt action that may include a range of measures such as capital
injections, debt guarantees and asset purchases in the effort to contain and manage the
crisis.
Regional roles
At the regional level, the role of the Central Banks in East Asia has in this decade,
transitioned to a new level of collaboration and cooperation. Following the Asian financial
crisis, efforts have focused on five main areas, namely, to enhance the effectiveness of
regional economic and financial surveillance, to improve the arrangements for regional
crisis management that is reinforced by regional support mechanisms, to develop the
regional financial infrastructure including the bond market and the payments and
settlement system, to strengthen regional financial stability, and finally, to pursue capacity
collaboratively, so as to enhance the effectiveness of the Central Banks in the
building
region.
The priority for Asia going forward is to accelerate regional financial integration. To ensure
this takes place in an environment of regional stability, strengthening cooperation is also
aimed at managing the risks and vulnerabilities of the region. In 2006, the East Asian Central
Banks have established a monetary and financial stability committee as a forum to discuss
the risks to regional macroeconomic and financial stability. In addition, the ASEAN+3, a
subset of this group, has already taken concrete steps to multilateralise the Chiang Mai
Initiative into a more advanced and robust framework for the effective pooling and utilisation
of liquidity support in the region. While the Asian region is highly diverse, in these key areas
of cooperation and collaboration, the Asian region has demonstrated its cohesiveness in
coming together to deal with the challenges that the new environment presents to us.
Conclusion
Let me now conclude. The world has changed and will continue to change. To remain
effective in the new environment and to have the capacity to respond to the new challenges,
Central Banks also need to undertake its own transformation and modernisation. Moreover,
in preserving the independence of the Central Bank and to be able to stand our ground in
performing our responsibilities, Central Banks need to be standing on solid ground. This
requires continuous capability enhancement and capacity building so as to be well positioned
to have the ability to rise to the challenges of the new environment. This may involve
significant changes to the governance arrangements, the empowering legislation, the skills
required, the role of communications, the human capital management and development and
the organisational culture. Indeed, capacity building is a further robust area of collaboration in
the Asian region.
Going forward, Asia's participation in the global economic and financial system is set to
increase exponentially. As the countries of the region connect with each other and the rest of
the world, there is every reason to hope for a better future of sustained stability and
enhanced growth prospects for the benefit of the regional and world economy.