Zeti Akhtar Aziz: Building financial systems for sustainable development
Speech by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia (Bank Negara
Malaysia), at the Global Ethical Finance Forum "Building Financial Systems for Sustainable
Development", Edinburgh, 1 September 2015.
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It is my distinct pleasure to speak at the Global Ethical Finance Forum here in Edinburgh. I
would like to warmly thank the Scottish Government and the Middle East Global Advisors for
the kind invitation for me to speak at this forum. It is a privilege to be here in the company of
this distinguished and diverse gathering of professionals from the various fields that are
prioritising ethical finance for sustainable development.
The discussion on ethical finance that supports sustainable development is timely. In this
recent decade, we have had to deal with a financial crisis of unprecedented global
proportions that has stemmed in part from the prevalent ethics and culture in the financial
services industry. In this period, we have also witnessed significant occurrences of
misbehaviour and ethical lapses surface in the financial services profession, including the
manipulation of reference rates and deliberate compliance failures. Since the global financial
crisis, we have now had several years to reflect on these weaknesses and to institute the
much-needed reforms that have prioritised resilience and stability. Having made important
progress on this front, it is timely to direct our attention to developing more enduring solutions
that will place the financial sector firmly back in the service of society. This calls for a closer
examination of the fundamental character of modern finance - where ethical and responsible
finance that is strongly anchored to the real economy has a more significant role.
My remarks today will begin with some observations on the evolution of financial systems
and the trends that have increased the vulnerability to financial crises, highlighting some of
the key issues that have contributed to the breakdown of financial systems. Finally, I would
like to take this opportunity to discuss some possibilities for the future of finance.
Financial systems, then and now
The development of finance has historically been a positive and inseparable part of
world economic growth and prosperity. There is a large body of research that points to
the significant benefits of financial development, recognising the economic value in financial
intermediation that mobilises savings, catalyses investment, enables an efficient allocation of
resources, reduces information asymmetries, and facilitates the management of risks. The
transformative role of finance in economic progress is evident throughout history. The
intrinsic power of finance essentially lies in its linkage to the real economy - that finance
exists to serve the real economy. As has been described, "where enterprise leads, finance
follows". This can be seen in the early financial innovation and growth of financial systems
around the world. In the 17th century in the Netherlands, the establishment of the
Amsterdam Exchange Bank and the availability of instruments such as bills of exchange
contributed towards financing their extensive domestic and international trade. This became
the bedrock upon which the Netherlands evolved to become the foremost maritime and
economic power in the world during the Dutch golden age. It was also the financial revolution
of pre-modern Britain that provided the foundation for the industrial revolution to take effect in
the 18th to 19th centuries.
A more recent observation unfolding is the experience of China, where the process of
financial intermediation has been key for the infrastructure development that has propelled
China's economic growth story that began in the 1980s. In the process, it has lifted millions
from extreme poverty. Though these are distinct experiences separated by chasms of
geography and history, finance was a common and powerful component of the overall rise of
these economies. More recently, this transformative role of finance can also be observed in
the many emerging economies in different parts of the world in the 20th century as they
transitioned to becoming a significant and important component of the global economy.
Further, as the regional and international dimension of finance increased, this globalisation of
finance facilitated greater cross border trade and investment activities.
In this recent two decades however, finance has progressively evolved from being a
means to an end, to being an end itself. The role of finance shifted from being an enabler
of growth to an engine of growth in its own right. In the more globalised world economy,
financial centres also flourished to become an important source of national income and
wealth. These trends however saw the start of the erosion of the linkage between finance
and the real economy, sowing the seeds of financial activity that would become inherently
unsustainable. In several parts of the world, finance progressively deviated from long-term
value creation towards the pursuit of short-term returns. Banks' trading and fee-generating
activities became much more lucrative than traditional lending activities. This in turn spurred
innovation in financial services that became more and more removed from the service to
society and the economy. During the period just prior to the global financial crisis, domestic
credit provided by the financial sectors such as in Iceland and the US, which had previously
averaged 48% and 149% of GDP respectively, had become decisively decoupled from, and
had far outstripped real economic activity. Domestic credit by the financial sectors in Iceland
and the US had by 2007, risen sharply to 299% and 236% of GDP respectively.
The experience of the global financial crisis highlights the potential for the benefits of
finance to be dramatically reversed, resulting in destructive rather than constructive
effects of finance. Several studies have shown that the marginal returns to growth from
finance diminish at high levels of financial development. In other words, there can be "too
much finance" where the costs to growth and stability outweigh the benefits of financial
development. Similar to other booming industries, the financial sector at the height of its
exuberance showed an overinvestment of resources in terms of capital including human
capital which only became apparent after the bust. With the benefit of hindsight, it has
become clear that in the lead up to the global financial crisis, many financial systems were
close to, or had long surpassed, the point where bigger was better.
The breakdown of financial systems
The gradual severance of the link between finance and the real economy, in my view,
represents the foremost factor that has weakened the positive role of finance and increased
the potential for financial instability. As witnessed during the recent crisis, the degradation of
finance eventually rendered its noble economic function of intermediation as ineffective,
causing greater harm than good to the economic growth process. The various factors
contributing to the recent crisis have already been extensively researched and discussed,
highlighting that in most cases finance had become highly disconnected from real, productive
economic activity. Additionally, is the role that it had in altering the relationship between the
growth and distribution of risks created distortions in which the gains from excessive
risktaking were privatised among the few while the losses were socialised among the many.
The abuse of securitisation and the "originate and distribute" model was a particularly telling
display of this malaise, severing the link between risk-taking agents and those who ultimately
bore the risk. While intended to facilitate better risk management by transferring risk from the
banks to a diversified set of investors, this distancing gave rise to problems in the incentive
structure and in the availability of information. There was a clear breakdown in the
relationship between creditor and borrower. Banks were essentially incentivised to focus on
aggressively originating loans which were of compromised quality due to lowered
underwriting standards. Investors of such bundled risks had then become far removed from
their origins. Information was no longer transparent and risks could no longer be fully
understood. Economic agents seeking larger returns were in turn encouraged to achieve
them through greater leverage, thereby amplifying the vulnerabilities of the financial system
and wider economy.
Much attention has also focused on the misaligned incentives of financial services
professionals as reflected by the compensation structures that rewarded short-term
performance and inadequate reprimand for overzealous risk-taking. This, I believe, was also
symptomatic of the growing disembodiment of finance from its consumers and the wider
economy. When social bonds are reduced to just profit measures, it provides a weak
foundation for sustainable finance. Outcomes for finance need to be measured based on end
services to the real economy, reflected for example, by an entrepreneur's successes or the
financial well-being of retail clients. The detachment of finance from its function in serving the
economy, results in clients being viewed as opportunities for extracting value and
transactions as bets on financial outcomes. The prevalence of mis-selling of complex
financial products exemplifies this shift in trend.
Future finance: re-anchoring finance to the real economy
Allow me now turn to some of the imperatives for re-anchoring finance to the real economy.
Firstly and most critically, future finance needs to have stronger links to the real
economy by effectively having an intermediation role that is in the service to society.
Financial systems have to be both value-adding and value-based - value-adding, in that
they contribute meaningfully by intermediating and facilitating real economic activity, and
value-based in that they aim to benefit society. Such finance that is value-adding and
valuebased is deeply needed in the global economy. Many parts of the world, notably the
developing world, require large amounts of funding to address infrastructure development.
Financial inclusion also remains an important agenda to uplift the living standards of the
marginalised segments of society in our global community.
Secondly, a functioning regime practising value-adding and value-based finance
needs to be built on a set of universal principles that will create a sustainable model
for mainstreaming such positive finance in the global financial system. A regime that is
deep-rooted in genuine productive activity that discourages excessive leverage that
emphasises transparency, and that strengthens financier-client relationships would
cumulatively be a positive force for the global financial system. Indeed, these are some of the
core underpinnings of Islamic finance which has already garnered significance in many parts
of the world. The central tenet in Islamic finance requires that financial transactions be
supported by genuine economic activity, reinforcing the link between finance and value
creation and aligning financial innovation to productive economic activity. Additionally, the
emphasis on risk-sharing in Islamic finance strengthens the incentives for participants to
screen and monitor transactions for economic viability and risks, and to institute the
governance process. In Malaysia, our efforts to widen the reach of such value-adding and
value-based finance include the development of a multi-bank platform to match funds from
potential investors with entrepreneurial ventures in the real sector.
Thirdly, the efforts to strengthen the supply and demand of value-adding and
valuebased finance would contribute significantly towards re-anchoring the global financial
system to the real economy. On the supply side, the focus on professionalism, ethics and
the quality of talent would contribute to drive for positive changes in the financial services
industry. In Malaysia, we have initiated the Financial Services Professional Board, launched
in 2014, comprising of an independent group of eminent experts from around the world is
currently refining a voluntary code of ethics that may be internationally applicable across the
financial services industry.
A meaningful change in the culture of financial institutions requires a true commitment from
the industry. A display of such commitment through the measurement and disclosure of a
financial institution's non-financial performance, such as its impact in social, environmental
and governance metrics, can be a powerful tool for change. In Malaysia, such a proposal is
being developed for Islamic financial institutions to disclose their Corporate Value-Intent, a
performance measure their commitment to value creation. Greater consumer activism and
demands for more consumer-focused corporate information reflects the increased demand
by consumers for institutions to account for their behaviour and values.
In terms of the demand for ethical and responsible finance, greater awareness among
consumers and investors on the availability and viability of such positive finance is also
needed, including among governments, corporates and the retail market. Education,
engagement, incentives and the alignment of legal and regulatory frameworks on the
utilisation of such finance will be important to achieve this.
Finally, is the need to foster strong leadership at the global level that can have an
advocacy and facilitative role in resolving barriers and bringing together different
stakeholders to work together in a coordinated and cohesive manner. The Responsible
Finance Institute, initiated as a think tank based in the United Kingdom, that brings together
responsible finance experts from around the world and has a unique role for this endeavour.
The focus on collaboration and convergence between the diverse fields of ethical and
responsible finance has great potential to harness the best practices of positive finance in its
various forms to collectively wield a powerful force in shaping future finance.
Moving forward, stable and sustainable development can be best served by re-connecting
the current gulf between finance and value creation that is reinforced by bringing benefit to
society. With the financial reforms by the international community now much in place, the
imperative for future finance is not only by becoming stable and resilient but also becoming a
deep anchor to its bedrock, the real economy and generating a positive benefit to the greater
society.
With that, allow me to wish you an engaging and productive forum. Thank you.