Zeti Akhtar Aziz: Current challenges confronting central banks
Opening and keynote address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of
Malaysia, at the SEACEN-BNM Banking and Financial Law School 2009 "Current
Challenges in Central Banking - Legal Perspective", Lanai Kijang, 24 September 2009.
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It is my great pleasure to speak at the 5th Banking and Financial Law School 2009, jointly
organized by the South East Asian Central Banks (SEACEN) Research and Training Centre,
the Institute of Bankers Malaysia and Bank Negara Malaysia. The theme for this year's
Banking and Financial Law School on "the legal perspective of the current challenges in
Central Banking" has particular relevance in the present environment. Indeed, global
attention is now focussed on an overhaul of the financial architecture in the efforts to address
the fundamental weaknesses that have surfaced in this recent global financial crisis.
The current policy debates cover a wide ranging set of issues that include far-reaching
regulatory reforms to strengthen the foundations for financial stability, institutional
arrangements to achieve more efficient functioning of financial markets, effective
coordination of financial stability measures and greater clarity of central bank mandates in
promoting monetary and financial stability. The theme of this conference also has special
relevance to us at Bank Negara Malaysia, as our new Central Bank of Malaysia Act 2009 will
come into force later this year. We are very honoured to host the conference for this year and
are pleased to welcome so many distinguished members of the legal fraternity, in particular,
from other parts of the world to join us at this forum.
My remarks today will focus on three key challenges confronting Central Banks, and how the
legal aspects impact the effectiveness of Central Banks. The first relates to building the
capacity to manage the increasing uncertainties generated by financial innovation, the
increasing prominence of the non-regulated sector and the increasing interconnectedness
between financial institutions and markets. Such developments have not only resulted in the
emergence of new risks to the financial system but have also changed the dynamics of how
risks in the financial system are transmitted to the real economy. In this environment, it is
vital to have a legal and regulatory framework that is robust and dynamic enough to
enable the central bank to respond to these developments.
The second challenge concerns the effective implementation of financial safety nets and
the effective coordination of the different components of the safety net to maintain public
confidence and to support continuous financial intermediation. Appropriate legislation and
regulations that ensure credibility and integrity of the safety nets are an essential part of
maintaining financial stability.
The third relates to the increasingly and highly
complex financial and economic
integration associated with globalisation. This has resulted in a significant expansion
in cross-border financial activities and introduced new sources of risks to domestic
financial systems. The recent crisis raised many issues for which clear solutions, or even
consensus, have yet to emerge, including on the propensity for home bias in the policy
responses, suitable approaches to cross-border resolutions, and the significant challenge of
coordinating policies across different legal and institutional frameworks. This is an area
where the legal framework remains highly fragmented. A sustainable solution will require
legal reforms in particular, to provide certainty and clarity in dealing with crises.
As events in the current global environment have demonstrated, central banking has become
significantly more challenging. The issues confronting central banks today are far more
diverse and complex, prompting the re-examination of the role of central banks, the capacity
to manage and contain risks to monetary and financial stability, and the governance
arrangements and the policy instruments that are needed to support the effectiveness of
central banks.
The new Central Bank of Malaysia Act 2009 which was passed by Parliament in July this
year represents the culmination of more than two years work to address the issues and
challenges that are confronting Central Banks in this rapidly changing environment. The Act
elaborates extensively giving greater clarity on the mandates for which we are accountable
and providing enhanced powers to undertake these mandates. In the principal objective of
promoting monetary stability, it is recognised that price stability is to be achieved in an
environment of sustainable growth of the economy. Consideration is thus given to the
sustained implications of monetary stability measures on the real economy. The law
therefore requires the Bank to take a balanced view to avoid the adoption of rigid frameworks
that may result in strong biases that would lead to a fundamental and sustained damage to
the economy. This balance is also extended to the explicit role of the Bank in developing an
inclusive financial system in its responsibility to develop a sound and progressive financial
system. These considerations are particularly important for emerging market economies so
as to ensure balanced economic progress and development.
The new Central Bank of Malaysia Act 2009 also institutionalises the autonomy for the
formulation of monetary policy, thus providing for the integrity and credibility of the decisions
made. It also provides for greater flexibility in monetary policy implementation, allowing for a
diversified range of instruments that can now be deployed for the implementation of
monetary policy. As financial markets trend towards greater sophistication and demonstrate
periods of extreme volatility, central banks must have commensurate capabilities to conduct
monetary policy operations in order to maintain price stability. Equally important is the
mandate to provide oversight over the money and foreign exchange market to ensure the
orderly development and functioning of the markets. These necessary powers are however,
combined with a system of checks and balances to enable the Bank to act decisively, but yet
having in place safeguards so as to enhance transparency and accountability.
More extensive powers to achieve financial stability
In the area of financial stability, our new Central Bank Act incorporates an explicit mandate of
the Central Bank for financial stability. This mandate is articulated in terms of the risks to
financial stability that includes risks that disrupts the financial intermediation process
(including the orderly functioning of the financial markets), or which affects public confidence.
The Act also provides comprehensive provisions for heightened surveillance, pre-emptive
actions and expanded resolution powers to facilitate the swift and orderly resolution of
financial crises. The Bank may also take appropriate intervention actions to avert risks that
stem from unregulated entities.
The Act further acknowledges the importance of coordinated policy measures across
different agencies whose actions can affect financial stability. Accordingly, the new Act
provides for cooperation arrangements with other supervisory authorities and the ability of
the Central Bank to make recommendations to such authorities on measures or safeguards
for promoting financial stability. These new powers are complemented by strengthened
institutional arrangements in the form of the establishment of a Financial Stability Executive
Committee that will be formed to ensure the effective coordination of regulatory authorities in
financial resolution.
Enhanced governance and accountability framework
With these enhanced powers, the governance and accountability framework in the Act has
also been strengthened considerably. This relates to the enhanced role of the Board of
Directors' in the oversight of the management of the Bank. In providing enhanced powers to
the Central Bank to address financial stability issues and the strengthening of the oversight
function of the Bank, correspondingly, focus has also been given to governance, internal
controls and risk management by the Bank. For this purpose, the Central Bank of Malaysia
Act 2009 empowers the Board to establish three specific committees, namely the Board
Governance Committee, Board Audit Committee and Board Risk Committee that are chaired
by a non-executive director, to ensure the independence of the oversight on the functioning
of the Bank.
A comprehensive financial system safety net
Let me now turn to the second key area confronting central banks, namely the need to have
in place an effective financial safety net. The global experience in these recent two decades
has shown that crises have continued to plague the world and have resulted in massive
costs to the economy. Financial safety nets serve two primary purposes, that is to avert risks
to financial stability and to reduce the costs to the financial system and economy in the event
of a crisis. They also serve an important social purpose of protecting savers and investors.
The first component of the financial safety net is the existence of an effective regulatory and
supervisory system to ensure the sound management of financial institutions and the ability
to deal with problems affecting financial stability. This includes adequate powers and
instruments to mitigate losses to the system in the event of a crisis, restore stability and
ensure the continuity of the financial intermediation process. The second is the lender of last
resort facility that is provided by central banks to address liquidity stresses faced by financial
institutions. Thirdly, is the deposit insurance scheme that provides a guarantee on deposits
to protect the savings of small depositors and reduce the prospects for disruptions that could
threaten the stability of the financial system.
The effectiveness of the financial safety net depends on several factors. They include the
capacity of central banks and supervisory authorities to assess risks, the effective
coordination between the different components of the safety net, clear communication
strategies and a strong and comprehensive legal framework that supports the operation of
the safety net. In Malaysia, the Malaysia Deposit Insurance Corporation Act (MDIC Act)
which establishes the Malaysian Deposit Insurance Corporation (MDIC) provides
comprehensive intervention powers for the protection of depositors. This is complemented by
an extensive operating framework developed between the Central Bank and the MDIC which
clearly sets out the responsibilities and obligations of both agencies in promoting financial
stability and in financial resolution. In the area of consumer protection, amendments to
Malaysia's financial services legislation are also being put in place to provide for the
establishment, roles and functions of a financial ombudsman to deal expediently and
efficiently with disputes concerning financial services between consumers and the financial
institutions.
Let me now turn to the challenges arising from greater financial globalisation and the growing
importance of international cooperation in ensuring sustainable economic and financial
integration across national borders. In this environment regulators are confronted with the
challenge of adapting regulatory and legal norms from a nation-centric system to norms that
are more reflective of international business and finance. The issue is how to complement
the domestic agenda and the international agenda. Regulatory problems arise not only
because of the need for domestic regulators - operating within diverse national regulatory
norms and cultures - to cooperate and coordinate in the domestic environment but also
across jurisdictions.
Operational and legal issues in cross-border resolution arise where the regulatory
frameworks of different countries do not provide for a common solution in areas such as the
unwinding of financial transactions and the enforceability of secured parties' rights to
collateral in the foreign jurisdiction. Failure to address such resolution issues promptly,
generally within a matter of days, can lead to increased uncertainty and potential
crossborder conflicts. Authorities must also have access to information that is not regularly
exchanged in the normal course of supervisory cooperation. This needs to be supported by
consistent requirements for the coordinated execution of regulatory actions. Equally
important is an effective legal infrastructure for the mediation of claims against insolvent
institutions with international operations
Concurrence among regulatory authorities on key elements of effective resolutions would be
an important step forward. Greater harmonization and clarity about the triggers for action, the
tools to return insured funds quickly to depositors, the authority to implement a quick
resolution, and the legal powers to restructure and continue key banking functions would
allow for more effective crisis management. Hence, it is not just about opening our borders;
we need to examine how our domestic regulatory framework interfaces with that of other
countries.
International cooperation
The regional cooperation among central banks in East Asia have advanced significantly in
this recent decade in the aftermath of the Asian Financial crisis. The focus of cooperation
has been in the areas of financial stability, financial markets and payment and settlement
systems. The participation in the working, technical and high level committees have
contributed towards efforts to facilitate the adoption of international standards for banking
supervision and financial stability taking into consideration the regional perspective. It has
also contributed towards identifying supervisory priorities and areas of concern that will have
an impact on financial stability, and towards improving techniques relating to supervision and
surveillance. Challenges pertaining to cross-border issues such as regulatory arbitrage,
competition laws, regulatory harmonisation are, however, yet to be fully resolved.
The new Central Bank of Malaysia Act 2009 gives Bank Negara additional flexibility and the
mandate to engage in international cooperation. The Act allows for the Bank to engage with
foreign supervisory authorities to coordinate and cooperate on financial stability measures.
The new constituent law also incorporates a specific provision for the Bank to participate and
provide appropriate resources in arrangements, schemes, programmes, or initiatives with
any other central banks or international financial institutions or authorities to promote
bilateral, regional and international monetary, financial or economic co-operation.
Conclusion
In conclusion, the supporting legal framework for central banking and the financial system is
a key element to addressing the challenges faced by central banks. I have highlighted three
areas which are currently very relevant in the current global financial system. Central banks
in the advanced financial systems have resorted to unorthodox measures to prevent a
systemic collapse of the global financial system. While action has been based on the sense
of urgency and to avoid a total collapse of the system, in the aftermath of the crisis, an
extensive review of the legislation needs to be made. The more challenging part is to
effectively address cross-border issues facing national financial systems. Regardless of
whether we are in a state of crisis, these challenges will continue to be relevant given that
conditions will continue to be dynamic and the trend towards a more globalised world will not
reverse.
On this highly complex subject, this two day conference will likely generate highly engaging
discussions. I wish the Banking and Financial Law School a highly productive outcome and
hope that your stay in Malaysia will be enjoyable and memorable.