Zeti Akhtar Aziz: Forces of change
Keynote address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the
Financial Industry Conference 2010, Kuala Lumpur, 3 November 2010.
* * *
It is with great pleasure that I welcome you to this year's Financial Industry Conference. One
year hence from our Conference in 2009, the world is still confronted with the same
challenge - achieving a self-sustaining economic recovery. The encouraging signs of
recovery that emerged a year ago have now given way to increasing uncertainties on the
sustainability of this global recovery. Considerable uncertainty also remains on how the
announced regulatory reforms will be implemented and on its consequential impact on
growth and on the financial intermediation process. In addition, market conduct challenges,
the uncertain outcomes of the unconventional and exceptional measures as well as the
considerable pressure on the public finances have added to the rising uncertainties on the
sustainability of global growth.
I. Economic outlook
As the effects of the massive policy support begins to wear off, growth in the advanced
economies is slowing, weighed down both by crisis originated factors and structural issues.
Unlike in the early part of the financial crisis, policymakers in the advanced economies now
have limited policy flexibility to undertake further measures to support growth. Amid these
increased uncertainties, there has been heightened volatility in the international financial
markets, arising in part from increased sovereign credit risks and, more recently, the sharp
movements in the major currencies in the foreign exchange markets.
In contrast, the recovery in the emerging market economies, in particular Asia, remains
robust, with the potential for relatively strong growth to be sustained. While most
Governments in Asia had an important role in stimulating the economic recovery, private
sector activity has been revived and is now having a greater role in driving the economy.
Also, with rising intra-regional trade, external demand from the region is providing additional
support to growth. Amid this favourable growth prospects, the region however is also
confronted by a number of challenges. As highly open economies, the weaker global
environment will, and indeed, has already resulted in a moderation in external demand. In
addition, the divergence in growth prospects between the advanced and emerging
economies, has precipitated surges of capital inflows, in particular, to Asia. This could in turn
lead to the risk in the build-up of destabilising imbalances in our economies.
Asia today, is however, in a better position to address these rising concerns. First, domestic
demand has steadily increased in importance since the beginning of this decade and is
contributing towards a more balanced growth. Second, is the diversification of Asia's export
markets towards increased intra-regional trade which now accounts for more than 50% of the
total trade in Asia. Third, the extensive financial reforms and development of the domestic
financial markets since the Asian financial crisis have significantly strengthened Asia's
financial systems to better manage the more volatile capital flows. In addition, rigorous
surveillance is being undertaken. This has allowed several economies to introduce
preemptive measures to preserve monetary and financial stability.
The near term outlook for emerging Asia going into 2011 remains positive. For Malaysia,
despite slower external demand, the overall growth is expected to remain strong, supported
by the continued expansion in private domestic demand. Favourable employment conditions,
firm commodity prices and an accommodative policy environment will continue to underpin
growth in private consumption. Meanwhile, the positive outlook on the domestic-oriented
sectors and the recently announced economic transformation programme has improved the
investment climate. Intra regional trade is also expected to continue to provide support to the
growth and development process.
Transition to high value-added high income economy
Beyond the near term horizon, the Malaysian economy is currently at a significant juncture in
its development. The economic future of our country depends on the success in our
transition to becoming a high value-added economy. For more than five decades, Malaysia
has demonstrated its economic flexibility to adjust to the changing environment and to
continuously enter into new areas of competitive advantage. The ability to continue to do this
as we advance forward into the future will however, become more challenging amidst the
rapidly changing global environment, characterised by increased competition and a higher
degree of global and regional economic and financial integration.
Fundamentally, the successful transition of Malaysia towards a high value-added, high
income economy will depend on several critical factors. The first is to achieve an orderly shift
towards new areas of growth and new areas of comparative advantage. This
transformation requires all sectors of the economy to be increasingly involved in higher value
added economic activity. In the manufacturing sector, existing industries need to move up
the value chain. This will be complemented by knowledge-intensive services sectors, such as
information and communication technology (ICT), education and health. While multinationals
and large domestic corporations will remain important in these sectors, the contribution of
small and medium enterprises (SMEs) have an important role in supporting these new
growth areas.
The second critical factor is that productivity improvements will become a critical
determinant of our future growth prospects. Continuous increases in productivity
characterised by greater innovation and efficiency in production and business processes, are
vital to achieve this transformation. Indeed, such productivity improvements are taking place
in the financial sector. The comprehensive efforts in capacity building and institutional
development in the early part of this decade have resulted in the opportunity to achieve
scale, and thus allow for increased investment in technology and in people. Increased
competition also facilitate this trend. The higher productivity levels and thus the value added
to the economy by the financial sector has increased to 11.7% of GDP in 2009, compared to
9.2% in 2000. Commensurate with the higher value added by the financial sector is also
reflected by the higher average wage in the sector which is about 70% higher than the
national average. This trend towards higher productivity levels needs to be generalised
throughout the economy.
For the successful shift to higher value added activities and for productivity to become an
important driver of growth, new talents are required to achieve this. Human capital
development is, at the heart of Malaysia's transition to become a high value-added
economy. Physical capital accumulation will no longer be sufficient for Malaysia to make the
transition into a more innovative and entrepreneurial society. A fundamental rethinking of our
education system is thus crucial for the effective development of talents with the necessary
skills and competencies required to achieve this. The cultivation of continuous learning is
needed for the constant upgrading of talents. In the financial sector, there is now a
comprehensive institutional arrangement to generate the supply of the right kind of talent
required by the industry - from pre-employment to leadership development not only to
focusing on the development of technical skills but also on the capabilities that practitioners
require in the context of an emerging economy.
The fourth critical factor is the extensive enabling infrastructure to facilitate private
sector economic activity. Malaysia already has in place high quality physical infrastructure
but considerably more is needed. Steps already being taken include the development of an
efficient urban public transportation system, reliable and seamless broadband connectivity
and energy efficiency-related infrastructure. This also needs to be reinforced by the
transformation of the Government machinery to support the transition to a high value added
economy.
The final and fifth factor is the ability to effectively participate in the economic and financial
integration with other emerging economies in particular with that of the region. Asia, in
particular, offers immense opportunities for increased participation by Malaysia. Indeed,
there is already rising investment into the region by Malaysian companies and this trend can
be expected to continue over the medium term. This is particularly pronounced in the
financial sector, where Malaysia's domestic financial institutions are now increasingly having
a greater presence in the region. Of importance, is that such ventures yield mutual benefit.
There must also be value added to the countries concerned so as to ensure the sustainability
of such ventures.
II. Financial stability and potential risks in the financial system
Let me now turn to the financial system and financial stability. The Malaysian financial
system has continued to perform well throughout 2010, with a high degree of resilience and
stability even under the more challenging conditions. The capital positions of both the
banking and the insurance sectors have remained stable, well above the regulatory
requirements. Asset quality in the banking sector have continued to improve, with the net
impaired financing ratio as at end September 2010 at 2% while the loan loss coverage ratio
is at 90%. The more favourable economic conditions and the positive outlook have also
resulted in strong profits being recorded by the industry.
While these developments affirm the underlying strength of the financial sector, there needs
to be greater vigilance on potential risks to the system. The first relates to the rising level of
household sector indebtedness. Debt accumulation by the household sector has expanded
rapidly, during the three year period leading up to 2009. Increasing at an annual rate of 9.3%,
household debts now account for 73% of GDP. While the household balance sheets at the
present remain healthy, household debt above prudent and sustainable levels would become
an area of concern. In addition, history has shown that excessive risk-taking practices by
banking institutions that involve indiscriminate lending practices with inadequate regard to
the aggregate debt obligations of borrowers would contribute to financial instability with its
consequences not only on the financial system but also on the economy.
This recent global financial crisis has shown that such irresponsible lending practices
contributed to the build up of excessive leverage among households, and that this in turn
sowed the seeds for negative consequences on both the financial system and real economy.
Banks and insurers are, therefore, expected to observe prudent underwriting standards and
responsible behaviours in their lending activities. Boards also need to be accountable and
ensure that the risks associated with consumer financing are well understood and being
effectively managed.
The second area that is being closely monitored is residential property prices. The aim is to
ensure affordable housing for the population and that imprudent financing to this sector does
not become a source of financial instability. Generally, the price levels of properties in
Malaysia have remained relatively stable, recording an annual increase of 5.6% in the first
quarter and 4.2% in the second quarter of this year. At the national level, residential property
prices have increased steadily in tandem with economic development and the rise in
household income levels. This aggregate growth trend of this sector has remained largely
manageable and residential property prices have not deviated from the long term trend. In
the more recent period, however, certain specific locations, particularly in the urban centres,
have experienced faster growth, both in house prices and the number of transactions.
Supporting this trend has been the increase in financing for multiple unit purchases by a
single borrower. This suggests investment activity that is of a speculative nature.
While Malaysia is not experiencing a general property price bubble, targeted pre-emptive
measures are appropriate to moderate the increases in property prices that are evident in
select locations arising from purchases that are speculative in nature. These measures aims
to support a stable and sustainable property market, and to ensure that prices of properties
remain affordable for the general public. Thus, with immediate effect, Bank Negara Malaysia
announces the imposition of a maximum loan-to-value (LTV) ratio of 70% that is applicable
from the third house financing facility taken by a borrower. Financing facilities for purchase of
the first and second homes will not be affected by this measure and borrowers will continue
to be able to obtain financing for these purchases at the present prevailing LTV level applied
by the individual banks based on their internal credit policies. This measure is expected to
moderate excessive investment and speculative activity in the residential property market
and to ensure affordability of homes for genuine house buyer. The objective of encouraging
house ownership among Malaysians continues to be an important national agenda.
As part of its continuous efforts to raise the level of financial savvy and sophistication among
Malaysians through the promotion of sound financial and debt management by individuals,
Bank Negara Malaysia also wishes to announce the introduction of the Financial Capability
Programme. This Programme will be offered by Agensi Kaunseling dan Pengurusan Kredit
(AKPK) through its nationwide establishments and will commence from January 2011. The
Programme is to equip individuals with practical knowledge and skills in money and debt
management. This is aimed at promoting sound household financial debt management.
Individuals, particularly new prospective borrowers and young adults, are strongly
encouraged to participate in this specially designed programme. The Bank will also issue
Guidelines on the Conduct of Business for Retail Financing for responsible practices in
consumer lending. The aim of these combined measures is to reinforce the conditions for
financial stability, promote a sustainable housing market and deliver socially desirable
outcomes through responsible lending and borrowing behaviours.
III. Financial regulatory reforms
These measures foreshadow our broader plans and priorities in the area of financial
regulatory reforms going forward. While banks and insurers in Malaysia have avoided the
pitfalls that have set back some of the largest and most successful global financial
institutions, our ambition to develop a dynamic and robust financial system demands that we
remain firmly focused on continuously strengthening the foundations for financial stability.
This will take into account our assessment of the domestic conditions, and the nature and
direction of risks in the financial system. The regulatory regime will be based on the
framework of international standards, specifically those set by the Basel Committee on
Banking Supervision, the International Association of Insurance Supervisors and the Islamic
Financial Services Board.
Following the global financial crisis, the most profound changes in the international standards
have been focused on the banking system. However, as a result of more prudent risk
management, a rigorous stress testing discipline and being subject to close supervision by
the Central Bank, banks in Malaysia are largely already operating at more conservative
capital levels than is being suggested under Basel III. While it is recognized that the global
reforms have been designed to address problems not faced in our financial system and are
guided by different value and incentive systems, it is still important that we embrace
initiatives that will enable us to avoid the same such mistakes. As more of our banks and
insurers venture abroad into the regional markets, financial institutions will also be assessed
by investors, analysts and market participants against these global standards.
Moving forward, after a consultative process with the industry, the following enhancements
will be incorporated to the Risk Weighted Capital Adequacy Framework for banking
institutions:

higher capital requirements to support risks in trading activities, securitizations and
counterparty credit exposures;

strengthened definitions and criteria for the recognition of Tier 1 and Tier 2 capital;
and

higher levels of common equity, Tier 1 and total minimum capital requirements
which also provide for capital conservations buffers.
The appropriate timing of transition to the new requirements, will be determined in 2011.
While the Basel Committee has set a generous timeframe for implementation of the new
requirements, we anticipate that given the current position of strength of our banking system
and together with other jurisdictions, including those in this region, we are in a position to be
on a faster track to adopt the new requirements. In this endeavour, an appropriate balance
will be maintained between our priority to substantially strengthen the capacity of the banking
system to absorb future shocks arising from financial and economic stresses, and avoiding
material competitive distortions that can arise from uncoordinated moves between countries
on specific elements of the framework.
Through the continued rigor of our stress testing requirements, the expectations are for
banks and insurers to operate at levels that remain sound even under stressed conditions.
This will be further reinforced with the implementation of Pillar 2 from 2011, which will accord
greater focus on the individual banks' own internal capital adequacy assessment processes
to determine the adequacy of capital against their specific risk profiles and capital
management strategies.
With respect to liquidity, our existing Liquidity Framework will be enhanced in 2011 to bring it
in line with the Basel III standard, while making appropriate customisations to take into
account the specific structural characteristics of our market. We will also issue additional
guidance to promote more stable funding structures that will increase the robustness of bank
liquidity positions, particularly during periods of stress in funding markets. These quantitative
liquidity standards will be further complemented by principles for sound and effective
management of liquidity risk.
While major agreement has been reached on most areas concerning capital and liquidity,
proposals in other areas including the non-risk-based leverage ratio, countercyclical capital
buffers and the supervision of systemically important financial institutions continue to be a
work in progress at the Basel Committee. It is important that bankers including board
members remain current on all these developments and understand their implications on our
domestic and regional financial landscape.
In the insurance and takaful industry, there have been continued improvements in corporate
governance practices and further strengthening of the capital positions of individual
institutions. These improvements have however, been uneven between institutions and
overall progress can be further accelerated. We will monitor closely the implementation plans
by insurers to meet and maintain internal capital targets that are above the regulatory
minimum level. Given the increasingly more complex and competitive environment going
forward, smaller insurers, particularly in the general insurance industry, need to strengthen
their ability to comply with the higher prudential standards. The option for mergers to form
stronger and more resilient institutions would accelerate this process.
In the critical area of corporate governance, we are well advanced in our concerted efforts to
strengthen the Boards of Financial Institutions through the Financial Institutions Directors'
Education (FIDE) programme which is now managed by the ICLIF Leadership and
Governance Centre. More than 200 directors have completed the programme.
Bank Negara Malaysia is also reviewing the need for boards of insurance companies to be
served by a dedicated head of risk to provide assurance to the board on the quality of risk
management within the firm. This is to promote better risk management systems and
processes among insurers and a more integrated approach to risk management and
oversight within insurers. The Bank is also reviewing the role of signing actuaries of general
insurers which may be expanded to support the more robust management of risks by
insurers, particularly with respect to underwriting and solvency assessments. The regulatory
framework for takaful operators will also be significantly strengthened with the issuance of
the Takaful Operating Framework by the end of this year.
These developments will further strengthen the preconditions for the wider adoption of more
principle-based regulations in the insurance and takaful sector. This will include our plans to
proceed with the liberalisation of operating cost control limits as set out under our Financial
Sector Masterplan. This move will usher in a more competitive environment within a stronger
framework of governance, market transparency and prudential safeguards that has already
been put in place.
Finally, the work on amagalmating and modernizing the existing legislation governing
financial institutions and intermediaries under the purview of the Central Bank is now in its
final stages. A key extension of the proposed new legislation involves putting in place a more
comprehensive framework for the effective regulation and supervision of financial
conglomerates. This will include proposals to cover financial holding companies under an
appropriate prudential regulatory and supervisory regime to ensure that the evolution of such
complex financial groups does not, over time, pose a threat to financial stability and the
safety and soundness of regulated institutions. The proposed new legislation will also provide
strengthened legal powers to support more effective market conduct regulation and
supervision.
IV. The financial sector blueprint
Let me now turn to our progress on the financial sector blueprint. While the fundamental
objective of this blueprint is to achieve a financial system that best serves our country as it
transitions to becoming a developed economy in 2020, the formulation of the plan has also
drawn from the important lessons of the recent global financial crisis. Most important, is that
growth of the financial system should ultimately be anchored to the growth in the real sector.
Based on the rate of growth of the economy projected for the next decade, the financial
sector is envisaged to increase in significance from 4.6 times of GDP currently, to between
5 to 6 times of GDP by 2020. Meanwhile, the contribution of the financial services sector to
GDP is expected to increase from 11.7% in 2009 to 14% by 2020. Following the increased
liberalisation in this decade, this expansion will be based on both domestic and foreign
financial business activity.
Also important, will be the changing structure of the financial system. Going forward, the
financial markets are expected to have a greater role in the intermediation of funds. Hence, it
is envisioned that there will be further deepening and increased liquidity in financial markets
as new players and a wider range of financial instruments combine to increase the efficiency
of the financial markets. Of increasing importance will be the intermediation of long-term
savings, such as insurance and pension funds, and long-term investments such as
investments in economic and social infrastructure.
The composition of financial institutions will also show much greater diversity: with banks,
insurers and takaful operators offering higher value-added services to serve the more
sophisticated customers, with more developed venture capital industry and angel funds
providing risk capital for innovative firms, and with development financial institutions stepping
up to widen the base of financial services to all Malaysians. In addition, new and existing
forms of financing that have thus far remained at the fringes of the financial system such as
factoring, leasing and credit companies are expected to become more significant. Spurred by
new technologies, such as greater adoption of electronic invoicing and receivables
exchanges, it will generate more competition to the traditional players while enriching the
product offering, particularly to the SME segment.
The evolution of the financial sector will also focus on the new growth areas that will catalyse
Malaysia's transition to a higher value added economy. These include areas of financing
such as for green technology, infrastructure development, education, and entrepreneurship
and innovation. These are key focal points that will yield increased national productivity, drive
innovation and stimulate the formation of businesses. It is anticipated that a significant
portion of new frontier industries will be spearheaded by young, innovative SMEs that would
require substantial investments in research and development, and for the commercialisation
of the research and development. To support these endeavours, a more diversified financial
structure, involving new financing modalities will be essential. The new funding ecosystem
will thus need to provide comprehensive and flexible financial solutions to Malaysian
consumers and businesses.
Recognising the importance of having a payment system that is comprehensive and efficient
to support the needs of the consumers and businesses in a high-income economy, the
payment system infrastructure would be enhanced and more inclusive, capitalising on the
advancements in technology as well as the high number of banking accounts and mobile
phone penetration in the country. The focus will be on infrastructure developments necessary
to provide the speed and efficiency while offering convenience to consumers and
businesses. Electronic payments should be the preferred medium for all economic
transactions. This includes having the infrastructure necessary for industry-wide mobile
banking and payment ecosystem, including an extensive outreach of the point-of-sale
terminal facilities. The pricing structure and a comprehensive awareness programme to steer
desirable payment behaviour are also key areas that will be addressed in our next phase of
the development of our financial system.
The blueprint will also seek to extend the reach to the potential untapped market represented
by the latent demand for financial services among the non-urban population and urban
residents in the lower income group. The blueprint will endeavour to develop a conducive
environment for the design of financial products and services and the utilisation of delivery
channels will effectively overcome the barriers to financial access, particularly cost
restrictions and physical accessibility. With greater regional integration, we also see
significant potential to leverage domestic strategies to create a strong regional footprint in the
provision of affordable and commercially viable financial products and services.
Beyond domestic borders, Asia's continued growth and prosperity offers significant
opportunities for the provision of financial services and productive investment prospects. An
important thrust of the blueprint will therefore be to develop the financial infrastructure to
enhance the linkages within the region. This will be facilitated through the continued process
of financial integration and increased connectivity within the region, with greater liberalisation
of the financial sector, the integration of payment and settlement systems, and greater
crossborder cooperation in maintaining regional financial stability.
Central to the development strategies for the next decade is the consolidation of Malaysia's
position as a leading international Islamic financial centre. Malaysia already has a strong
brand affirmed by the growing importance of our sukuk market and the higher level of foreign
participation in our Islamic financial markets. This is reinforced by the diversity of market
players and a comprehensive institutional framework for Islamic finance. Two landmark
initiatives achieved this year is the establishment of the Islamic Financial Stability Forum
(IFSF) and the International Islamic Liquidity Management Corporation (IILM). Moving
forward, Islamic finance is expected to further accelerate its pace of global expansion, having
a more significant role in facilitating the intermediation of international financial flows.
A critical factor that will determine the success of the financial services industry is the talents
in the industry. With increased international mobility of talent, the global war for talent will
intensify. Successful financial institutions will be those that are able to develop, attract and
retain talent. Financial services professionals also need to be regionally oriented and able to
integrate cross-border businesses effectively. The blueprint will also address this issue to
ensure that the sector will be well supported.
In charting the future for the industry, the foundation for financial stability will be
strengthened. The focus will be on addressing systemic risks and strengthening crisis
management capability. Regulatory cooperation will be enhanced in surveillance and in
capacity building for effective cross border resolution of problem institutions. Domestically,
significant supervisory attention will be directed towards achieving regulatory consistency in
respect to risk assessment for financial groups taking into account the trade-offs and the
need for safeguards.
Underpinning the more competitive and dynamic financial sector will also be a deep-seated
core value system, with financial service providers operating responsibly, with integrity and
offering financial products and services with dignity. More specific institutional arrangements
will be considered for market conduct and consumer protection.
In realizing this shared vision for the financial sector, of critical importance is the cumulative
participation of the public sector and the industry in the development of the Plan and its
implementation. This combined effort will ensure that the new blueprint is comprehensive,
relevant and realistic.
V. Conclusion
Let me conclude: Considerable uncertainty remains in the outlook for the global economy
and we must thus remain vigilant to emerging risks. Second, in a more complex and
interconnected environment, broader prudential and economic considerations must factor
more prominently in financial institutions' management of risks. Third, while we believe our
regulatory and supervisory system has served us well, we are not complacent and will
continue to work hard to place the financial sector on firmer ground so that our ability to
manage future shocks will be further improved. And finally, we are confident that with a clear
vision, focus and effective implementation, our strategies to bring the financial sector to a
new level in this next decade will deliver better outcomes for our financial system and our
overall economy.
Thank you.