Zeti Akhtar Aziz: Fifty years of central banking - stability and
sustainability
Address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the Ceremony
for the 50th Anniversary of Bank Negara Malaysia: "50 Years of Central Banking - Stability
and Sustainability", Kuala Lumpur, 8 February 2009.
* * *
Bank Negara Malaysia opened its doors as a Central Bank on January 26, 1959, just over a
year after Malaysia gained independence in August 1957, reflecting the importance that was
being accorded by our founding fathers to the institution of Central Banking. At the very
outset, the Central Bank was entrusted to provide leadership in performing the traditional
Central Bank mandate of promoting monetary and financial stability. Equally important was
the mandate to develop the domestic financial system - a financial system that would
facilitate economic growth and development.
It is my very great honour to welcome distinguished guests that have come from different
parts of the world to join us on this special occasion to commemorate the fiftieth anniversary
of Bank Negara Malaysia. We also wish to express our appreciation to the Prime Minister of
Malaysia for his presence as the guest of honour at this occasion.
Introduction
Allow me to share our experience during these fifty years and our aspirations moving
forward. These five decades have been highly challenging but rewarding with many fulfilling
outcomes and there were also lessons learned. While the country has experienced great
prosperity during most of the period, our economic and financial progress has also been
punctuated by episodes that have tested our resolve. Rising to address these challenges, the
growth and economic transformation experienced in these fifty years have been achieved in
an environment of macroeconomic and financial stability.
During the five decades, Malaysia has experienced an average annual growth that has
exceeded 6 per cent and annual inflation that has been less than 3 per cent. The continued
increase in incomes and the low and stable inflation have not only promoted a high rate of
savings that has exceeded 30 per cent of GDP but it has also resulted in the financialisation
of savings. This has allowed Malaysia to rely on domestic sources of funding to finance our
growth and development during this period, thereby minimising our levels of external
indebtedness.
Monetary stability
Being a highly open economy, the sources of monetary instability have generally emanated
from external price shocks, which have occurred during periods of high commodity and
energy prices, and to a lesser extent, from periods of excess demand and overheating
conditions. There essentially have only been two episodes in our history in which overheating
conditions have generated inflationary pressures; the major period being prior to the Asian
financial crisis.
Since the 1990s, monetary policy has been further complicated by volatile capital flows. This
was evident in several periods, the early nineties, the mid-nineties, and the outflows during
1997-1998, and in the current period following the de-leveraging by financial institutions in
the advanced economies.
In the early days of the Bank, policy actions were focused on the management of liquidity in
the financial system through the imposition of statutory and liquidity reserve requirements,
and through prescription of interest rates and portfolio restrictions, including ceilings on
lending. Further progress and sophistication in the financial sector, the deepening of the
financial markets and the growing influence of capital flows, resulted in the reliance on
interest rate and other market-based instruments for monetary policy. Further, with the
increased role of expectations, greater clarity in policy signals became desirable. Thus in
2004, the New Interest Rate Framework was implemented, in which the Overnight Policy
Rate became the new policy rate, thereby enhancing the efficiency of the monetary
transmission mechanism. The new framework has also served as a catalyst for efficient
pricing of financial products and services by banking institutions.
A key issue for monetary policy in an open economy like Malaysia has been in maintaining a
flexible exchange rate and monetary independence in the face of increasingly large capital
flows. To better manage surges in capital flows which have become more prevalent, the
range of market-based instruments for monetary policy operations has been widened. The
rise in intra-regional trade and investment flows has resulted in greater importance being
accorded to stability of the exchange rate against regional currencies.
The monetary policy decision-making process at the Bank has also been redefined in which
the governance for monetary policy is based on the Monetary Policy Committee to achieve a
more optimal process for policy making. Monetary policy communication and increased
transparency have also become highly important in this framework.
Thus, while the Central Bank's responsibility towards promoting monetary stability conducive
to sustainable growth has remained unchanged since the inception of the Central Bank in
1959, the strategies, framework and instruments have evolved substantially to ensure its
effectiveness in delivering the desired objective.
Financial sector development
A key focus of the Central Bank during these five decades has been institutional building,
financial market development and putting in place the financial infrastructure. The evolution
of the financial system has seen its transformation from a rudimentary financial system that
was dominated by the banking sector to a highly diversified financial system, from a highly
controlled financial system to greater market orientation, from a highly fragmented system to
one that is more consolidated and rationalised, and to a financial system that is supported by
an extensive legal regime and regulatory and supervisory framework, and a financial system
that is more liberalised with stronger international linkages.
Part of the institutional building was the establishment of regulatory institutions that have
clearly defined mandates. These institutions join us today in celebrating the long tradition of
cooperation to meet the common purpose. Specialised development financial institutions
were also established to promote access to financial services to sectors that are not being
serviced by existing financial institutions. Financial inclusion, to ensure all economic activities
and all segments of society have access to financial services, has been a key priority.
Currently, about 80% of our population have some forms of banking accounts
Other financial infrastructure established by the Bank to support the intermediation process
includes the comprehensive centrally coordinated credit information system at the national
level which allows for better-informed credit decisions by financial institutions. In addition, the
Credit Guarantee Corporation was established to provide support for small businesses.
Cagamas, the national mortgage corporation, was established by the Central Bank to ensure
a steady flow of funds to the housing industry and develop a secondary mortgage market.
At the centre of the financial infrastructure is the payments infrastructure which has been
enhanced and modernised over the years to achieve greater efficiency and reliability of the
payments system. The payments landscape has evolved from one that was mainly
paperbased to include a range of new electronic forms of payment. Internet banking which was not
available in Malaysia as recent as 10 years ago is now widely used by the entire population
of internet subscribers in the country. The acceleration of the nation's migration to the more
efficient electronic payments continues to be an important agenda of the Central Bank.
Complementing institution building has also included the support given to the development of
talent in the financial services industry. The growth of the financial sector cannot be achieved
without adequate attention to the development of the professional requirements of the
financial services industry.
In the recent two decades, a comprehensive Islamic financial system has also evolved in
Malaysia, including the institutions, markets and supporting legal, regulatory and supervisory
framework. The Islamic financial system now offers the full breadth and depth of Islamic
financial services. Malaysia is the host to the secretariat for the Islamic Financial Services
Board in Kuala Lumpur that sets the international regulatory and supervisory standards in
Islamic finance.
Financial market development has also been central to building a robust financial system.
The Central Bank's efforts in this direction have included establishing the institutions and the
infrastructure to improve market efficiency of money, capital and foreign exchange markets.
The Securities Commission, the domestic rating agencies, Cagamas and the Cooperative
Commission were among the initiatives initiated by the Bank.
The development of a robust and vibrant foreign exchange market still remains an
outstanding area of development. As a highly open economy, this market is a vital part of our
financial system. The country exited from the Currency Board system in 1967 and introduced
the ringgit (known as the Malaysian dollar then). The changeover was successful. It was a
time when there was an absence of speculators. It was only in 1997-98 when the ringgit and
other regional currencies came under speculative attack. The volume of foreign exchange
transactions had become massive, far exceeding volume of trade and the normal financial
flows. This resulted in exchange rate volatility during the Asian crisis that occurred wave after
wave. Regional currencies continued to plummet during this period. After more than a year of
this turmoil and uncertainty in the foreign exchange market, Malaysia implemented selective
capital controls and de-internationalised the ringgit. This was instrumental in restoring
stability in the market. It acted very much like a circuit breaker. Offshore trading of the ringgit,
the major source for financing the speculative attacks, was effectively eliminated. Within a
year, all the controls that were imposed were removed. More than 10 years later, the ringgit,
however, still remains non-internationalised. An important precondition for the
internationalisation is the development of a robust foreign exchange market in our financial
system.
Financial stability
The events surrounding the current financial crisis has brought into sharp focus the role of
central banks in financial stability. As these events continue to unfold with great uncertainty
on the financial markets and broader economy, allow me to reflect on Bank Negara
Malaysia's own role in financial stability.
In addition to its functions as the lender of last resort, Bank Negara Malaysia has also had
the responsibility for the regulation of banking institutions. Since 1988, the Bank also
assumed responsibility for the insurance industry and in 2002, the development financial
institutions. The prudential regulatory and supervisory framework during these fifty years has
undergone significant change. The prudential framework and supervisory approaches
adopted by the Bank provided the flexibility to respond to the new developments and
challenges that have confronted the financial sector. Several factors have guided the
approach adopted by the Bank. The first is to recognise the limitations of the regulatory tools
and instruments. Second, is the acceptance that change is required in the context of the
changing environment, and the need to carefully assess the trade-offs that arise given the
different stages of development within the financial sector. And finally, is the need to take into
account the interlinkages within the financial system, and between financial systems across
borders.
Guided by these parameters, the Bank has evolved a prudential framework which at the start
comprised simple prudential rules that addressed capital, gearing, liquidity and portfolio
restrictions, to the now more differentiated and principle-based regulations that reflect levels
of risk taken by an institution. As a result, significantly greater flexibility is now accorded to
institutions that are able to demonstrate sound governance practices and risk management
capabilities. This flexibility has been accompanied by fundamental changes in the approach
to supervision that has shifted from a predominantly compliance-based approach, to one that
focuses on an assessment of the risk-taking activities of an institution and the effectiveness
of the control functions that are in place within the institution to manage the risks. The
supervisory tools have also been expanded to include more forward-looking assessments of
the risks to financial stability, supported by more dynamic stress testing approaches and
enhanced surveillance systems.
To a large extent, the preconditions for the shift to principle-based approach to regulation
have been strengthened through capacity building measures that have been pursued in the
period immediately following the Asian financial crisis. The development of the Financial
Sector Masterplan which was released in 2001 is a blueprint not only for comprehensive
financial sector reforms, but also provided the framework and strategies for the
modernisation of our financial system.
The financial safety net was also strengthened with the introduction of a comprehensive
deposit insurance system and the establishment of institutions to assist consumers in
managing their debt and resolving disputes with financial institutions. These measures have
contributed towards maintaining confidence in the financial system.
The crisis: a defining moment for the bank
In the 1990s, it became evident for emerging economies that new challenges to stability
arising from the international dimensions of financial activity had emerged. In particular,
highly volatile and potentially destabilising capital flows had become a dominant feature of
the international financial environment. Strong economic fundamentals alone proved to be
insufficient in containing instability in the domestic economy and financial system.
Many of us still vividly recall the Asian financial crisis of 1997-98 that significantly affected
several of the countries in the region. What started as a currency crisis turned into a financial
and economic crisis. During this period, the ringgit exchange rate depreciated by about 40%
at the peak of the crisis; the stock market declined by almost 80%. While the Malaysian
economy continued to expand in 1997, by 1998, conditions deteriorated significantly and the
economy contracted by 7.5%. An extensive set of measures were implemented. This
included a comprehensive restructuring programme for the financial and corporate sectors.
While still at the early stage of the crisis, an asset management company was established to
acquire and manage the non-performing loans of banking institutions. A special purpose
vehicle to recapitalise the banking system and a Corporate Debt Restructuring Committee
were also established to provide avenues for voluntary debt restructuring for businesses.
Within six months of the implementation of these measures, the problems in the financial
sector were addressed. This led to resumption in lending activities and the economy
expanded by 6.1% in 1999. Notably, the stakes taken in the financial institutions were
disposed back to the private sector with the costs of the exercise being more than covered.
The Bank's efforts to sustain stability did not end when the Asian financial crisis abated and
economic recovery was firmly in place. The lesson that the foundations for resilience are built
during good times was earnestly embraced. Therefore, once stability was restored, the Bank
embarked on a comprehensive restructuring and reform of the financial sector. This included
the consolidation of domestic financial institutions; the strengthening of corporate
governance, risk management and the institutional capacity of domestic financial institutions;
as well as the deepening of the bond market. These efforts have put the Malaysian financial
system in a much stronger position to weather the current global financial crisis.
Regional cooperation
From the beginning, the Bank has had an active engagement in the region and was from the
very beginning part of the SEACEN grouping which is the oldest and most inclusive regional
grouping. Starting in 1967, SEACEN has been a valuable regional forum. While it is a group
of highly diverse economies, this did not prevent it from being a cohesive grouping. The
permanent secretariat of SEACEN resides in Kuala Lumpur since 1979. The Bank is also
part of other groupings including EMEAP and the Asian Consultative Council (ACC) of the
BIS. Collaborative efforts in surveillance, regional financial market development and sharing
of information have been extensive. In Islamic finance, the Bank is a founding member of the
Islamic Financial Services Board to promote and enhance the soundness and stability of the
Islamic financial services industry.
Modernisation of the Central Bank
In the 50 years, the Central Bank has also been fundamentally transformed. At its inception,
the Bank started with 57 people with four departments. The Bank has grown in strength to
more than 2,600 staff to accommodate our expanded roles. The modernisation of the Bank
has involved change to the legal framework, our organisational and governance structure,
and the nature of human capital, to enable the Bank to become more effective in the
changed environment.
As we advance forward into the future, the Bank will be confronted with increased
challenges, and with many of the building blocks in place, the next phase of development of
the Malaysia's financial sector will involve greater market liberalisation and
internationalisation. These developments will intensify the demand for greater readiness,
capacity and capability from the Bank to best serve the nation moving forward.
This year, the Bank is in the process of submitting to Parliament a new Central Banking Act.
As the economic and financial landscape, both domestic and international, is now
significantly different from 50 years ago, the proposed Act involves a holistic review of the
Bank's mandate, governance, accountability and the present legislative framework to ensure
that the Bank remains effective in performing its functions. The institutionalisation of the
objectives and mandates of the Bank aims to provide greater clarity to the existing roles and
functions of the Bank. The proposed Act will also provide the Bank with the necessary
powers and instruments to perform the Bank's roles and functions effectively. The proposed
Act will also institutionalise many of the practices that have been introduced in this recent
decade which are deemed as critical in ensuring that the Central Bank has the necessary
authority and state of readiness to face future challenges.
In concert with these, the new Act will further reinforce the existing governance framework
with adequate mechanisms to ensure sufficient checks and balances are in place. The
governance framework will further facilitate and enhance high quality decision-making in the
Bank, institutionalising both existing and new procedures and processes to enhance
accountability, professionalism and transparency. The strengthening of governance and
accountability will form the prerequisite for the Bank to maintain our public legitimacy and
autonomy, as well as to ensure the integrity of the Bank as a public institution in serving the
nation's interests.
Conclusion
Bank Negara Malaysia's experience during these fifty years in preserving monetary and
financial stability and in supporting the sustainability of economic development has seen
many challenges. Throughout this journey, we remained focused on what needs to be
achieved and the vision of where we want to be. Key to our effectiveness is the internal
capacity of the Bank. At the heart of this are the people in the Bank. While the operating
environment has changed significantly and the policy focus has evolved, the values that the
Bank represents, of integrity, respect for diversity, professionalism and expertise, have been
enduring and reinforced over time.
Finally, the Central Bank could not have been successful in achieving our objectives and
policies if we did not have the support in our country - from the Government, the financial
and business communities, and the people of the country - for their confidence and trust in
us during these 50 years. The Bank, going forward, through our policy actions and in
discharging our responsibilities, will continue to uphold this trust that has been placed upon
us.