Zeti Akhtar Aziz: Key issues confronting the financial sector in Malaysia
Keynote address by Mrs Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the
Financial Industry Conference 2009, Kuala Lumpur, 17 November 2009.
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It is my great pleasure to welcome you to our financial industry conference for this year. This
conference takes place at a time when the global financial landscape is experiencing
fundamental change. Even as we meet, events continue to unfold in directions that are likely
to fundamentally alter the way in which financial institutions conduct their business. Reforms
to strengthen the foundations of financial stability are wide-ranging to improve the
supervision and regulation of financial institutions, and the institutional arrangements for
coordination and cooperation in the area of surveillance and crisis management within and
across jurisdictions. This Conference is organised by Bank Negara Malaysia to engage in
constructive dialogue with the industry on developments affecting the international and
domestic financial industry, focusing in particular on implications for financial institutions in
Malaysia.
Economic developments and outlook
After a challenging beginning to this year, Malaysia is now gradually moving on a path of
recovery supported by strong macroeconomic fundamentals and a sound financial sector.
Economic activity has continued to show a marked improvement in the third quarter, with
positive growth expected in the fourth quarter. This improvement has been underpinned by a
recovery in domestic demand, particularly in consumption, supported by better employment
conditions, the accelerated implementation of fiscal measures, the accommodative monetary
environment and the continued access to financing. In 2010, the Malaysian economy is
expected to sustain the growth momentum, driven by domestic economic activity and
reinforced by improvements of growth of our major trading partners.
The role of the domestic sector in driving growth is not new. Domestic demand has in fact
been the main source of growth for the overall economy since 2003, complementing our
large external sector. This trend highlights the fact that our economy is evolving towards a
balanced growth model, deriving advantages from our economic linkages with the global
economy while at the same time strengthening the domestic sources of growth.
While growth in domestic consumption has been encouraging, the next step towards further
rebalancing the sources of growth will be to increase the contribution from investment. A
higher level of private investment would further improve our productive capacity and increase
the potential for higher growth. In this, many new areas of growth would benefit from higher
investment, including in the services sector, as well as in the development of enabling
infrastructure for modern economies such as in broadband and green technology.
Rising above the economic challenges
While economic prospects have improved, the road to economic recovery will not be without
challenges. Firstly, the better economic prospects for recovery in Asia, and the expectations
that Asia will lead in the emergence from the global recession could draw large capital
inflows into the region. Such flows would not only lead to more volatile exchange rates, but
also to increases in asset prices. Increases in commodity prices could also potentially feed
into inflation and affect the economic recovery process. Most economies in Asia, including
the policy makers, the financial industry and the private sector, have however, the capacity to
manage these challenges. Stronger financial positions, low levels of leverage and buffers
built during the good times have rendered the potential to manage the more challenging
environment. The role of the financial sector is particularly important in ensuring the flow of
financing to productive economic activity is not disrupted, while exercising prudential restraint
in an environment of excess liquidity.
Towards the medium term, significant uncertainties remain for the outlook of the global
economy. Overall global growth is expected to remain weak over the medium term with
structural weaknesses in the advanced economies weighing down the overall economic
growth in these economies. Being highly integrated with the global economy, the continued
weakness of the advanced economies could present a challenge for overall economic growth
for most emerging economies in the medium term. Therefore, it is crucial for the external
sector of Malaysia to evolve into a more diversified structure to increase resilience and rely
less on the traditional markets for growth. It is encouraging to note that this is already
happening. Since 2000, our share of exports to emerging economies has increased from
53% to 66% in 2008. This represents an important trend towards a more broad-based
economic integration with the global economy, through increased trade and investment.
Going forward in 2010, to enhance the growth prospects in this more challenging
environment is through increasing productivity whereby the same levels of investment
generates higher output. Focus also needs to be on high impact investments that will have a
higher multiplier impact on the economy. Attracting foreign direct investments through
liberalisation and strategic alliances would also contribute to this process. To raise the level
of economic performance, it is not only important to invest right, but equally important is to
have the enabling environment to maximise the return on investment. The efficiency of
financial intermediation is a vital part to the success of this strategy.
International regulatory reforms
Let me now turn to the international regulatory reforms. This global financial crisis has
resulted in the world experiencing the worst recession in modern history. This has prompted
the world to come together with wide ranging proposals to strengthen the foundations for
financial stability and to address weaknesses in the international financial system. A
fundamental issue being deliberated is the determination of the balance between private
decision-making, the market system and Government intervention. While at one end of the
spectrum, the case is being made that there is no other alternative to the market to generate
an efficient functioning financial system, at the other end of the spectrum the call is for a
more interventionist regime. The solution lies in a balance between these, and the avoidance
of an over reaction in addressing weaknesses and excesses that have been built over an
extended period of time.
Equally important is to recognise that for markets to function efficiently, institutional and
market infrastructure need to be well developed. The incentive structure, the rules of the
game, the transparency and the levels of financial literacy also needs to be in place. When
these elements are still yet to be developed, as in many emerging economies, it increases
the risk to financial stability. For advanced financial systems, however, when the institutional
structures and rules became deficient and less relevant, it is necessary for them to be
changed. In essence, the environment has become highly dynamic requiring regular
regulatory reinvention.
Let me turn to the approach adopted by Bank Negara Malaysia. The recent global
developments will not fundamentally alter the main tenets of our approach to the regulation
and supervision of financial institutions in Malaysia. It will continue to be a balance between
rules-based and principles-based regulation. The principles-based approach is more likely to
produce more efficient market outcomes, better risk-alignment and socially responsible
behaviour. The approach will also continue to be risk-based, in which the expectations in
governance and risk management are higher for the larger and more complex financial
institutions, and when these expectations are not met, the Bank will respond with supervisory
actions. The Bank will continue to act pre-emptively to deal with the risks, at the institutional
and system levels. Judgements will be applied based on a broad range of information
available on the potential build-up of risks.
The regulatory framework adopted will continue to be consistent and aligned to international
standards to safeguard the stability of the financial system. In this regard, Bank Negara
Malaysia will implement the changes by the Basel Committee to improve the risk capture of
Basel II for trading book, securitisation and counterparty credit risk exposures. We will also
positively consider developments by the International Association of Insurance Supervisors
to achieve internationally consistent capital standards for insurance companies. We will be
introducing changes to improve the liquidity framework and strengthen the quality of capital,
focusing in particular on equity as the predominant form of capital. We also support the
global initiatives that are aimed at reducing the complexity of products, strengthening
transparency and improving incentive structures.
An area of current international deliberation which will have a significant implication on the
domestic regulatory and supervisory environment is the increased emphasis on the
macroprudential dimension of regulation and supervision. A key lesson drawn from the crisis has
been the inadequacy of supervision that was primarily focused on individual institutions.
Even before the build-up of financial imbalances, the underpricing of risk and increased
leverage in the financial system had been identified as sources of potential instability well
before the eruption of the crisis. The warnings that were issued by central banks and
international institutions were largely ignored and failed to result in appropriate responses
either by market participants or by the authorities responsible for the oversight of individual
financial institutions or the specific market segments.
This has led to calls to regulate such market excesses through counter-cyclical or
macroprudential measures such as increasing capital buffers in good times which could be drawn
upon under stress conditions, the implementation of a leverage ratio to supplement
riskbased capital requirements and through-the-cycle provisioning standards. There is also a call
for systemically important institutions to be required to meet higher regulatory standards that
are reflective of the risks that they pose to the system, rather than a consideration only of
their institutional risk profile. The international reactions to these measures have been mixed,
mainly because they are extremely difficult to calibrate in a way that will not unduly constrain
output potential in good times, while avoiding significant demands for more capital and a
confidence crisis during bad times. The Bank will carefully assess the details of these
measures as they are released, and we will do so taking into account the regulatory and
supervisory regime in Malaysia.
Bank Negara Malaysia has already for some time now, put in place a framework in which the
supervision of individual institutions is complemented with macro-prudential assessments.
Risks identified at the macro-level provide important inputs to supervisory assessments of
individual institutions, while the collective behaviours of individual institutions provide
information on the build up of risks in the system. Financial institutions would already be
familiar with this through the Financial Stability Report of the Bank and with the stress testing
parameters.
The ability of the Bank to undertake surveillance and act pre-emptively to avert risks to
financial stability will also be further enhanced when the new Central Bank of Malaysia Act
2009 comes into force on 25 November 2009. This includes the expanded powers for the
Bank to undertake surveillance and prompt resolution on financial institutions including on
non-regulated institutions that are systemically important. As we continue to refine our
approaches, and develop a better understanding of market behaviours, financial institutions
will also need to better integrate institutional risk assessments with macro-economic
developments.
International reforms have also focused on delivering fair outcomes for consumers. In
relation to this, the Bank will continue to ensure that financial innovations are developed to
meet the real needs of consumers and businesses, and do not expose the system to
excessive risks. Ongoing efforts to strengthen avenues for consumer redress will continue
through the establishment of a financial ombudsman and improved product transparency,
particularly in the area of pricing, commissions, fees and charges so as to support more
informed consumer decisions. Timelines for some of these measures have already been
announced. These reforms will be reinforced by strengthening further the current consumer
protection framework to address mis-selling practices and facilitating a more effective
enforcement of business conduct regulations.
Strengthening the domestic infrastructure for financial stability
An important part of the efforts to strengthen the domestic infrastructure for financial stability
is legislative reform. The Bank is in the process of drafting a new legislation that will
amalgamate existing legislations governing financial institutions and intermediaries in
Malaysia that are administered by the Central Bank. Provisions in the current banking,
insurance and takaful laws will be updated to support a more differentiated regulation and
supervision according to risk. It will also reinforce the emphasis placed on effective board
oversight and enable pre-emptive supervisory and enforcement actions by the Bank. This will
include the introduction of a broader and more flexible enforcement framework, with
consideration to civil and administrative penalties to deal with different types of offences.
Proposed legislative changes also include the introduction of a more comprehensive
insurance compensation system for the protection of policyholders. The draft legislation is
expected to be completed in 2010.
Progressive liberalisation of the financial sector
This year marks the ninth year into the implementation of the Financial Sector Masterplan.
Following the release of the Plan in 2001, more than 90% of the recommendations in the
Plan have been implemented. Collectively, these measures have contributed towards
achieving a more efficient, effective, stable and resilient financial sector as was envisioned in
the Masterplan. This is evidenced by the significant transformation of the financial system
that is now more diversified with well developed financial markets and broadened product
offerings, that is more competitive with home-grown regional players, that is more inclusive
with higher levels of banking and insurance penetration, and with improved financial strength
indicators as financial institutions are better supported by strengthened governance and risk
management standards and practices.
The development of Islamic finance has also made significant strides both in the domestic
and international front as Malaysia evolves as an international Islamic financial hub.
Enhancements to the payment infrastructure have also supported the increased use of
epayment channels. With these building blocks in place, the financial system has also been
progressively deregulated and liberalised. The more recent liberalisation to allow for greater
foreign participation in the domestic financial markets and increased foreign presence will
enhance further our financial and economic international linkages.
As we move into the final phase of the Masterplan, we are confident of the strength and
resilience of the domestic financial sector to face greater competition and benefit from the
liberalisation measures recently announced. We have received strong interest in the new
licences from Asia, the Middle East, Europe and the United Kingdom that bring with them
strong value propositions that will add significantly to the depth and breadth of the financial
sector in Malaysia.
In the insurance sector, greater competition will emerge from the progressive deregulation of
product rates. The current reforms in the motor insurance sector will introduce far-reaching
changes in a key segment of the industry, with significant implications for the business
strategies of insurers and their approaches to risk management. With the introduction of a
new scheme for basic motor insurance cover, pricing for non-statutory motor insurance will
be gradually liberalised, thus removing price distortions. This will allow rates to adjust to
underlying risk factors. This will also be accompanied by a holistic review of motor insurance
practices and the supporting infrastructure to enable more scientific underwriting and
improve claims management. Industry groups have been formed to study these issues and
make recommendations for the smooth transition to this new and more competitive
environment, while at the same time improving practices across the entire value chain of the
motor insurance sector. The groups have made good progress and the recommendations
are expected to be finalised for implementation in the second half of 2010.
A new blueprint for the financial sector
Beyond this international financial crisis and economic recovery, a global shift is taking place
that is resulting in an increasingly multi-polar world. In this new phase of globalisation, the
concentration of economic power in the global economy will become more dispersed. Asia
will be very much part of this new future that is emerging. As Asia's importance as a growth
centre in the world economy increases, three major trends can be expected to intensify going
forward. First, domestic demand, supported by the large and fast-growing middle income and
young population in the region, will increasingly have a greater role in driving economic
growth in Asia. This would contribute towards a greater balance between domestic and
external sources of growth. Second, the diversification of external markets will accelerate,
towards greater economic inter-linkages with emerging economies in other parts of the world.
Part of this trend includes the creation of the ASEAN Economic Community by 2015 in which
ASEAN will transform into a single market with free movement of goods and services. This
will include the lifting of restrictions to the flow of capital in the region. And third, is the greater
financial integration within Asia that will result in an increased part of the savings in Asia
being reinvested in Asia.
The new spending patterns as incomes rise in the region will drive the modernisation of the
retail sector across the region. Financial services to the household sector will become
increasingly important in this new environment. Reforms to pensions and retirement benefit
systems will be key to providing a more comprehensive social safety net, thus reducing the
need for high precautionary savings and encouraging consumption. In addition, the large
trade sector in Asia and large capital investments required to move towards higher
valueadded activity will also provide an expanding market for financial services. The more
regionally integrated financial system will allow firms and investors increased options in the
regional financial markets for financing and investment. These trends are being further
supported by enhanced linkages in the payment systems to facilitate the intermediation of
funds in the region.
The economic transformation of Malaysia will move us to the next level of development.
Malaysia has been a middle income country for almost three decades, having benefited
considerably from rapid industrialisation and integration with the global economy. Moving into
the next stage of economic development, the domestic economy will change to a productive
structure that is more innovation-driven and knowledge-intensive, with the services sector
assuming an increasingly dominant role in the economy. In this next decade, the services
sector is expected to account for about two thirds of the economy, with growth focused on
higher value added activities.
To support and drive this transformation, a new blueprint for the financial services sector is
being developed by Bank Negara Malaysia. The blueprint will chart the next phase of the
evolution of the financial sector, with the aim of positioning the financial sector, including
Islamic finance, not only to become a catalyst to the transformation process, but also having
the flexibility to respond to the key trends that are emerging. In essence, we need to evolve a
financial system that best serves Malaysians in this new environment.
As the global financial services industry going forward strives to regain thrust and
confidence, the starting point in Asia is to build on the solid foundations put in place during
the decade following the Asian financial crisis. Asia is seeing the payoffs from the financial
reforms, institutional development and the strengthening of the financial infrastructure. While
financial markets have become more volatile, financial intermediation has not been
interrupted.
While our starting point is from a position of strength, we must nevertheless draw upon the
lessons from the current crisis. The lessons from the crisis must not be lost. This crisis offers
Malaysia and other emerging markets an opportunity to steer the future path of development
of the financial sector to a stronger and more sustainable path one which avoids the
trappings of greed and reckless behaviour that have significantly set back the financial sector
in many advanced economies. It would be foolish of us not to take heed of these lessons and
leverage on the opportunity to leap forward on a more solid foundation.
Despite these developments, going forward, the trend for liberalization will continue as
financial integration in the region will intensify. This will mean greater foreign participation in
terms of new institutional presence, strategic alliances and greater participation in our
financial markets. Efforts to develop further our foreign exchange market will be intensified.
Our financial links will also need to extend beyond the region to facilitate economic links with
other emerging economies.
On the domestic front, financial services to SMEs need to evolve from transactional and
lending-based business to a full-service, relationship-based business. The household sector,
already an important segment being served by the industry, will see further transformation
with the continuing evolution of multi-channel distributions with online channels becoming
more popular and increased customer demands for product transparency and overall service
levels. We expect to see a re-orientation of processes and incentives towards value over
volume, further differentiation in the management of customer-relationships and an
increasing focus on technology-driven transformations that are more aligned with business
strategies. The outgrowth of these strategies will include an accelerated shift in product
offerings towards more comprehensive end-to-end financial solutions and further changes in
the traditional roles of physical branches and intermediaries, with greater use of more
efficient direct channels and strategic alliances to widen the outreach of financial products
and services. In the area of e-payments, the creation of a mobile ecosystem is envisaged, to
provide an open and inter-operable platform for all financial institutions, mobile network
operators and services providers to offer highly automated and cost-effective mobile
payment services.
Going forward in this new financial system, the role of boards of financial institutions in
determining the risk appetite of their institution, in ensuring that strategies are consistent with
that appetite and in overseeing risk management systems will become increasingly critical.
Shortcomings in how boards discharged their roles in a number of major international
financial institutions were a material contributor to the global financial crisis. Boards must be
relentless in pursuing the effective governance of risk, continuously develop their capacity to
do so, and insist on strengthening processes, systems and structures as appropriate to
effectively monitor and control risk.
Conclusion
Let me conclude my remarks. We need to prepare ourselves for a future in which we can
prosper. We have every potential to do so. The authorities have great determination to
provide the enabling environment for this to happen. Financial institutions need to decide on
their own strategy and the business model to not only perform but also survive in this more
challenging environment. The demands are for world class service and real value added to
the economy. For the Central Bank, as the supervisory authority, our role will be to push the
frontier of the financial infrastructure with its international inter-linkages, while not losing sight
of ensuring overall financial stability.
On that note, I look forward to productive discussions during these next two days on the key
issues confronting the financial sector.