Zeti Akhtar Aziz: Extending the boundaries in the new financial landscape
Speech by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the 10th Malaysian
Banking, Finance & Insurance Summit: "Liberalisation and Consolidation of Malaysian Banking &
Finance Sector: Enhancing Competitiveness & Resilience of Our Economy", Kuala Lumpur,
9 June 2006.
* * *
This decade has become one of the most dynamic periods in the development of our financial sector.
We have seen the dramatic transformation of the financial structure to becoming increasingly more
diversified, the industries becoming more consolidated and rationalized, and the system becoming
more internationally integrated. We have also seen the financial system transition into a more
competitive environment in which the institutional arrangements are more deregulated and liberalised.
The financial infrastructure has also evolved with fundamental changes to support this transformation.
Finally, the regulatory and supervisory approaches have also advanced to becoming more principled
and risk-based to improve the functioning and stability of the financial system.
The financial transformation has taken place in an environment of economic stability. Malaysia 's
economic performance has been characterized by sustained high quality growth and stable
fundamentals. The underlying growth in the Malaysian economy has been solid. Malaysia has
benefited from both the favourable external environment and the strong domestic demand. Malaysia
has also benefited from the globalization of production with the geographical relocation of the
production chain by an increasing number of both multi-national and local corporations across the
Asian region. This trend has leveraged on the respective comparative advantages in countries of the
region. Malaysia 's distinct capabilities in a wide number of areas has increased its participation in this
process. In addition, increased economic integration following the rise of intra-regional trade and
investment has brought mutually reinforcing benefits in terms of the expanding regional opportunities.
The strengthened corporate sector has also led to increased direct investment abroad by Malaysian
companies. Going forward, developments in the Malaysian economy will also benefit from the Ninth
Malaysian Plan.
A major strength of the Malaysian economy has been its economic flexibility. Significant changes in
the structure of the economy continues to take place. The manufacturing sector has continued to
move up the value chain while the services sector has gained increasing prominence, with its share of
GDP rising from 45% in 1995 to almost 60% today. The role of private consumption in the economy
has also been enhanced, supported by steadily rising incomes, low unemployment, and access to the
financial system. Of importance is the recovery of investment activity. In addition, the small and
medium-sized enterprises (SMEs) have increased their role in the domestic economy. New areas of
growth are also emerging, ranging from the shared services and outsourcing industry to
agrobusiness, biotechnology and Islamic finance. The flexibility of the economy to continually adjust to new
areas of activity has been an important factor contributing to the dynamism of the economy.
About a year ago, Malaysia took the opportunity to transition into a more flexible exchange rate
regime. This has been achieved in an orderly manner. Of importance was that the preconditions had
been put in place to ensure this orderly transition. The banking sector had been strengthened, the
bond market had been developed, and the capital account had been sequentially liberalised. These
developments were reinforced by the further deregulation and liberalization of the domestic financial
system, thus creating a more competitive financial environment. The successful transition to the new
regime following these developments has seen a two-way movement in the exchange rate that reflects
the underlying economy and the market conditions.
Monetary policy in this environment will continue to be conducted in a manner that will ensure that the
long-term growth prospects of the economy is achieved with price stability. As a small, open economy,
Malaysia is not insulated from the inflationary forces being felt globally. In this regard, decisions on
monetary policy will be determined by the Bank's assessment of a broad range of indicators of the
domestic economy. The Overnight Policy Rate (OPR) remains the signalling mechanism to achieve
the policy objectives. Interest rates, therefore, is not an instrument to influence capital flows or the
exchange rate.
The Bank continues to undertake initiatives to enhance communication to promote greater
understanding of the objectives, processes and conduct of monetary policy. Extensive deliberations in
assessing the latest domestic and global economic, monetary and financial developments are
conducted at the Monetary Policy Committee (MPC) meetings, which are held eight times a year. The
Monetary Policy Statement (MPS) remains the key monetary policy communication tool of the central
bank to provide the rationale for monetary policy decisions.
Given the pronounced changes in the economy and the significant changes taking place in the
financial sector, the industry would essentially need to respond to the new challenges arising from:
i. Greater linkages, integration and interdependence between nations. This trend is likely to
intensify as more countries embark on initiatives to promote closer regional economic and
financial integration, to enhance their level of economic performance.
ii. The challenge of intensified competitive pressures, arising not only from changes in the
financial environment, the technological advancements and financial reforms but also the
entry of new players, including the non-traditional competitors such as non-financial services.
iii. Consumers are increasingly confronted with a wide range of new and innovative products
and services that are delivered via new and more efficient delivery channels. As consumers
are becoming increasingly demanding and financially sophisticated, greater emphasis needs
to be given to the provision of the variety and quality products and services at competitive
prices through the most effective channels. Banking institutions need to anticipate and
rapidly respond to these new demands and expectations.
iv. Policymakers are also confronted by the challenge of maintaining overall financial stability
whilst at the same time, promoting efficiency in the financial system. Balancing the trade-offs
arising from meeting these objectives will be necessary to determine the best course of
action. This needs to be achieved while developing the financial infrastructure, in addition, to
allowing for the entry of new players into the system.
v. The emergence of international players that possess the competitive advantage of being
more technologically advanced with greater capability and capacity to offer more innovative
products and services through new delivery channels will further intensify the competitive
environment.
Despite its challenges, the changing economic and financial landscape also offers many opportunities;
i. New growth areas present new opportunities and financial institutions need to take
advantage not only of the potential return but also the options for further diversifying the
sources of income.
ii. Alternative sources of financing from the capital market, development financial institutions,
as well as from non-bank sources such as venture capital funds, have increased significantly
in recent years. Financial institutions need to develop new products and services that
reinforce these developments and meet the new requirements of corporate consumers. This
includes providing world-class financial advisory services and wealth management services.
iii. The emergence of new delivery channels such as the Internet and mobile phones have
significantly altered the traditional banking-customer relationship. Business can be
conducted seamlessly across borders. Technological developments have also transformed
the payment systems industry, with the introduction of new payment instruments and entry of
non-banks into payment services, facilitating the migration to e-payments. Market leaders
can capitalise on these developments in providing products and services to customers and
businesses.
The changing economic and financial landscape also brings about many opportunities for trade and
investment. With the accelerating pace of regional integration, financial institutions are presented the
opportunities to broaden beyond domestic borders to capture opportunities for the regional markets.
It has been more than 5 years since the Financial Sector Master Pan was launched. The strategic
focus has allowed us to promptly emerge from the crisis management mode and moved full steam
ahead towards developing the financial system, The initiatives undertaken have now laid a strong
foundation for the development of a strong and diversified financial system. Significant progress has
been achieved in building the capacity and capability of the financial sector and in putting in place the
necessary financial infrastructure including the supporting legislation and the domestic financial
markets.
The financial landscape and operating environment that is envisaged in Phase 2, where domestic
banking institutions would have built greater capacity and capability to compete, is also progressing as
planned. The level of competition in the financial system has increased significantly, fuelled by greater
expectations from customers and facilitated by a more flexible regulatory framework and increased
deregulation and liberalisation. This has resulted in improvements in the delivery of financial services
and more efficient pricing and risk management, all of which contribute towards raising the level of
economic performance.
The wide range of measures to improve efficiency and effectiveness of the financial institutions,
include initiatives on improving risk management practices, further developing the human capital and
building talents for the financial sector, as well as measures to elevate the level of consumer
awareness. These efforts have further enhanced the ability of the financial system to respond to the
changes that have occurred.
The banking sector recorded improvements on all fronts, enhancing the ability to compete effectively
and strengthening the resilience to weather any potential adverse developments in particular, any
external shocks to the system. The level of capitalisation remained consistently strong with the
riskweighted capital ratio of the banking system above 13% for the period concerned with quality of
portfolio continuing to improve further amidst sustained economic performance.
The banking sector also continued to record strong profitability performance despite the increasingly
competitive operating environment. In 2005, the banking system as a whole registered a pre-tax profit
level of RM12.4 billion with a higher component of the revenue originating from service related
activities such as the sale of wealth management products and remittance services, as well as from
trading and investment activities. With this stronger performance and enhanced capability to manage
risk exposures, several banking institutions have also taken the next step and moved forward to
expand in the regional market to reach new sources of business opportunities. On the domestic front,
there has been a narrowing of the gap as compared with the foreign banks.
Further initiatives undertaken include enhancing the operational aspects and delivery of services to
banking consumers through the rationalisation of the configuration within respective banking groups.
This has resulted in leaner and more effective entities where common functions and capabilities have
been pooled leading to more cost-efficient entities as well as allowing for greater focus in the
marketing and customer management. Following this rationalisation, the cost to income ratio of the
domestic banks have improved from 55% in 2003 to 51% in the first quarter of this year.
On the aspect of improving customer interface and improving time taken to conduct banking
transactions, branches have been redesigned with new business models. With this move, branch staff
now have greater opportunity to provide value-added consultations and interface with clients.
Increased investments have also been made to improve information systems - to be better positioned
to understand customers' profiles and needs, as well as enhance overall risk management.
Technologies such as data warehousing are now readily available to aid banking institutions to be
more customer-centric and thus be more focused in their approach. As a result, more institutions have
undertaken to offer greater product differentiation and value added services.
The robust growth in the Malaysian economy has also contributed to an increased demand for life
insurance coverage. The growth in premium income has continued to outpace economic growth. Over
the period 2000-2004, the market penetration rate increased from 31% in 2000 to 39% in 2005. The
per capita spending on life insurance products also increased at an average annual rate of 10% over
the same period. Notwithstanding this wider reach, life insurance coverage has remained relatively low
compared with the more developed markets in the region such as the Republic of Korea, Singapore
and Japan which reported penetration rates of more than 80%. Given the vast untapped market
potential and the increased product innovation and new distribution channels, the life insurance
penetration in Malaysia is expected to strengthen.
Demographic changes leading to a growing ageing population has been a growing concern in many
countries. Given the trends in rising life expectancy and falling birth rates, responding to the increased
challenges of retirement financing has been high on the nation's socio-economic development
agenda. Going forward, there will be greater interest in private pension schemes representing an are
of significant growth opportunities for life insurers.
The financial performance of the Malaysian insurance industry has also continued to be impressive
during the 2000 and 2005 despite the challenging underwriting and investment conditions, with growth
primarily driven by the life sector. Total insurance fund assets of the industry grew at an average
annual rate of 13.8%. The insurance industry also increased in importance as a component of the
economy and financial system. The ratio of total industry assets to nominal GNP rose from 16.1% in
2000 to 20.4% in 2005, while the ratio to total assets of the financial system continued on an upward
trend from 4.0% in 2000 to 5.1% in 2005.
Moving forward, the Bank will step up its vigilance of the industry's state of readiness to cope with the
changing environment. An orderly transition of the market-led adjustments is vital to ensure that the
adjustments does not destabilize the market or undermine public confidence. To this end, efforts will
continue to be directed towards building institutional capabilities and putting in place the necessary
supporting financial infrastructure to provide a firm foundation for orderly change. Initiatives in the area
of financial education for consumers will be intensified to further expand the coverage as well as to
promote the fair treatment of consumers.
With a strong foundation in place to meet increased competition, further deregulatory and liberalisation
measures will be introduced. This will include greater flexibility accorded to foreign insurers to
establish branch offices, the progressive deregulation of pricing for tariff-rated insurance products,
greater investment management flexibility and removal of limits on management expenses and
continuing improvements in disclosure standards to promote greater market discipline in the more
deregulated environment. On-going deregulatory measures will also further enhance the ability of
insurers to respond more proactively and speedily to changes in consumer demands and market
conditions. The prudential framework will also continue to be adjusted to establish principles of sound
financial and business practices in the changing environment, with a significantly stronger emphasis
on risk-based supervision and effective board and management oversight.
Further advancement towards greater international integration will be considered to provide Malaysian
consumers with greater access to world-class products and services, while further catalysing the
development of the domestic industry towards meeting international best practices and standards.
This will include the issuance of new licences in specialized lines and greater opportunities for
internationally-reputed insurers to acquire equity interests in, or forge strategic alliances with domestic
players, both in the direct insurance as well as re-insurance sectors. The progression towards further
deregulation and liberalisation will continue to be managed at an appropriate pace, taking into account
the development of the supporting infrastructure and the level of substantive progress achieved by
domestic institutions, in order to ensure market stability.
Next on the agenda in the development of the domestic financial system is the formation of investment
banks. This is aimed at further enhancing the delivery of financial services to the wholesale and
corporate sector. With this rationalisation, the business community will have a more streamlined
access to banking services to fulfil their wider range of requirements. Comprehensive changes to the
organisational structure of the development financial institutions have also been undertaken to provide
a clearer scope and focus to service the needs of targeted sectors. At the same time, measures were
also instituted to expand the role of the credit guarantee agency to further facilitate the development of
the small and medium enterprises, a critical component of the nation's economy.
On the regulatory front, a series of enhancements to the risk management regulatory framework has
been introduced with the aim of promoting a more robust and comprehensive risk management
practices within banking institutions. In addition, significant effort has also been put in place to prepare
the industry towards the implementation of Basel II, which is targeted for January 2008 for the
standardised approach and January 2010 for the IRB approach. The industry has responded well -
with various improvement measures that have been instituted, and investments made to enhance their
systems and approaches to elevate their capability to manage risk exposures. This will contribute
towards enhancing further overall financial stability, and towards the development of new products
with better pricing of the financial services.
takaful
The Islamic banking and industries have been among the most dynamic in the sector. In terms
of assets, the annual growth rate of Islamic banking and takaful averaged 19 percent and 25 percent
respectively. In 2005, profitability of Islamic banking surpassed the RM1 billion mark for the first time,
while its assets breached the RM100 billion threshold. As of end-March, the Islamic banking assets
takaful
accounted for almost 12% of the total assets of the entire banking system. The industry's
assets stood at about 6% of the industry total.
The Islamic banking industry has begun to maximise the competitive advantages of the Islamic
banking concept of profit and risk sharing. We are seeing this concept more keenly being exploited in
profit and risk sharing ventures, and Islamic fund and wealth management which are emerging as
rewarding banking activities. Developing a pool of the required skills and talent, and putting in place of
proper risk management systems and good corporate governance practices becomes vital to sustain
the growth momentum of the industry.
As we move towards the final phase of the Master Plan and into a more competitive landscape, we
require robust financial institutions that are resilient, effective, efficient and well placed to serve the
nation, and thus support sustainable economic growth and transformation. In the area of Islamic
banking and finance, our aim is to be a leading international Islamic financial centre. To achieve this,
we have to strengthen our position and focus our resources on achieving two broad aims. The first is
to become an international leader in the origination, issuance as well as trading of Islamic capital
market and treasury instruments, fund and wealth management services, offshore Islamic financial
services, and takaful and re takaful . As a services sector, the robustness of the industry is a direct
function of the calibre of the workforce in the industry. As such, our second goal is to position Malaysia
as a centre of excellence for Islamic banking and finance education, training, consultancy and
research. Not only will this provide a deep pool of highly trained and capable employees, it will also
further promote the innovation of Islamic financial products and services.
In a dual financial environment, neutrality in treatment between Islamic and conventional financial
products is important in order to create a level playing field. It also sets the stage for greater innovation
to take place to support the development of the Islamic financial services industry going forward. With
the strengthened and robust Islamic financial infrastructure firmly achieved in the first two phases of
the FSMP, the Islamic financial services industry is poised to tap new growth opportunities and grow to
its full potential. This will inevitably increase the breadth and depth of the Islamic financial market and,
more importantly, strengthen Malaysia 's position as an attractive and dynamic international Islamic
financial centre.
In preparing for the pressures of liberalisation and increased competition, continuous review of the
regulatory framework and their implications on the efficiency and an environment conducive for
innovation is taken into consideration. The cost and benefits of regulations are carefully weighed to
ensure a well-balanced regulatory framework that meets prudential objectives yet remaining relevant
and adaptable to the changing environment. Premised on this, the prudential framework is evolving
towards a predominantly principle-based regulatory approach.
The underlying flexibility inherent in the principle-based approach would involve a regulatory
framework that relies more on market discipline, where the market will be entrusted to allocate
resources and risks, with greater reward for prudent practices. The emphasis is on self-regulation,
where stronger corporate governance, integrity and transparency are critical for banking institutions to
achieve investor confidence and public trust. Moving forward, as market discipline improves and both
banking institutions and insurance companies are better positioned to undergo self-regulation, further
deregulation can be expected. A differentiated regulatory approach will increasingly be adopted,
where banking institutions and insurance companies that exhibit strong corporate governance and risk
management practices will be given greater regulatory flexibility.
Whilst it is recognised that the regulatory framework should foster efficiency and competition, this has
to be balanced with the objective of attaining soundness and preserving the stability of the financial
system through the promotion of sound risk management practices. Commensurate with the diversity
and complexity of products and services, the financial landscape of the future will require the
continuous upgrade of the risk management practices with improvements in the governance standards
and enhancing of information management systems. The rationalisation exercises aimed at
maximising cost efficiency and reaping benefits of group synergies has led to the emergence of more
complex group structures of more diversified financial conglomerates. In relation to this, a holistic and
integrated regulatory approach is being adopted to ensure that the activities of these financial
conglomerates do not introduce excessive risks to the financial system. Risk management standards
are applied across the group and safeguards have been introduced to ensure risks are efficiently
managed with necessary infrastructure for an overall view of the risk exposures within the group.
Fostering a customer-centric culture encompasses fair and equitable dealings with customers to
engender greater trust and loyalty among customers and serving customers in good faith by extending
products and services that are appropriate to their financial requirements and circumstances. Greater
innovation must therefore be complemented by higher levels of service quality. Greater attention on
excellence in customer service requires continuous investment in staff development, which will be a
vital part of the process. Harnessing the technology to deliver distinctive customer experience that
combines the right mix of convenience and value is also an essential part of the process. In addition,
adequate emphasis and resources need to be accorded to protecting customers' privacy and
safeguarding their interests.
In order to make a quantum leap forward, it is vital to continuously invest in human intellectual capital
so as to create a pool of talent, skill and expertise that will drive the performance of the financial
system. Skilled individuals are needed to be able to deliver high value-added products and services,
adopt advanced business practices and have the necessary competence to build confidence in the
financial market and trust of the consumer. Initiatives have been taken for putting in place specialised
training organisations as part of the infrastructure for the development of highly skilled workforce for
the financial sector. The International Centre for Leadership in Finance is now in its 3 rd year of
operations and more recently the International Centre for Education in Islamic Finance was
established to meet the increased demands of Islamic finance professionals, both in the domestic and
international markets. The programmes carried out by the Institut Bank-bank Malaysia and Malaysian
Insurance Institute has also been reviewed to meet the demands of the financial sector.
Ladies and Gentlemen,
While Malaysia has approached liberalisation in a gradual manner, our track record has shown that
the process is accelerated when it brings benefits to the country. Financial liberalisation has on several
occasions been brought forward. In particular, liberalisation has been focused on the new areas of
growth that is, in the insurance sector, in Islamic finance and in investment banking. New licences in
Islamic banking to foreign financial institutions and larger foreign equity participation in both Islamic
takaful
banking subsidiaries and operators, and in investment banking of up to 49% is aimed at
achieving a more internationally integrated financial system. While liberalisation in the traditional
sector will continue, its already highly liberalised status and its higher level of capacity relative to the
economy does not introduce urgency to the liberalisation compared to the new growth areas. These
traditional sectors may lead to overcrowding. The focus of a more rapid liberalisation is where
significant market development are likely to take place. Emphasis would be towards attracting foreign
players who are recognised as specialist in a specific segment. This would also include new growth
areas such as micro-financing or agricultural lending. The aim is to produce niche players delivering
specialized value added products and services that will be able to cater towards specific segments of
the market and over time, and thus develop a more comprehensive financial system that would
contribute towards the development of a more diversified economy.
Given the background of emerging economies, the transition to a more liberalised environment would
indeed demand appropriate sequencing of measures and careful management of the liberalisation
process that are guided by broad principles that would ensure that there are benefits and opportunities
brought about by the liberalisation process. The financial sector is an important and strategic sector
that has a significant role in supporting the economic growth and transformation. Liberalisation needs
to commensurate with the pace of economic development and strength of the regulatory structure to
avoid destabilising effects on the stability of the financial sector and the overall economy.
Key considerations for the strategic opening up of the financial sector would be to steer the financial
sector towards increased competition whilst ensuring domestic financial institutions are not
marginalised by the liberalisation process. Liberalisation should instead serve as a catalyst for
domestic banks to further improve their performance and enhance efficiency and capabilities in order
to sharpen their competitive edge and elevate themselves to a level that is at par with the international
players. Benefits of foreign direct investment are manifold ranging from efficiency gains brought about
by new technologies to the introduction of innovative products and management techniques. Further,
more advanced research and development facilities and adoption of best practices from more matured
financial markets will contribute to the transfer of skills and knowledge, adoption of sound risk
management culture, technology and ideas in the domestic financial system.
Another consideration in the liberalisation process is that of promoting financial inclusion, where all
segments of society will have access to adequate financial services. The wide branch network of
domestic banking institutions has ensured that non-urban areas have access to banking services,
thereby eliminating the use of informal financial services. Domestic banking institutions with large
presence in the non-urban areas, some as high as 20% of total branches, have succeeded in
achieving sustainable performance while meeting this objective. Locally incorporated foreign banks
are however located mainly in major cities and serve only certain segments of the banking public. A
wider dispersion of branches of locally-incorporated foreign banks across the country would contribute
towards achieving greater financial inclusion. For further expansion outside major cities to be a
commercially viable proposition, it is recognised that the attainment of critical mass is essential. In this
regard, in addition to the flexibility accorded to establish up to four new branches, consideration will be
given to allow for greater presence in the non-urban areas and to serve the segments of the economy
which are currently underserved.
The banking sector is now in a prime position for the next step in evolution. The foundation for the
development of a more efficient, effective and stable financial system has been laid. The task is now
for the industry to move forward and undertake the necessary actions towards realising goals as
envisaged in the FSMP. Nevertheless, this journey does not end in 2010. We should also look forward
towards what lies beyond 2010. As an open economy, we should also be cognisant with the
developments that take place around us. I believe that the Malaysian financial services industry is
ready to take on this challenge to elevate the performance and standards of the sector. With this, I
wish you a productive summit.