Since the start of the crisis in 2008, Malaysia has experienced three episodes of large foreign capital outflows. Thankfully, our policy framework, a healthy level of foreign exchange reserves, and the robustness of our financial system, have enabled us to withstand such flows without significant disruption of domestic economic and financial activity. The third form of risk is through interest differentials. Very low interest rate in the AEs do not just attract yield-searching foreign funds to the higher yields in the emerging markets (EMs), they also create a very strong temptation for residents in EMs to borrow from abroad. We saw this type of vulnerability in this region in the period before the Asian financial crisis and more recently, in the Eastern European economies. The build-up of unhedged foreign currency debt by residents can be a significant source of vulnerability during times of economic and financial upheaval. Then there are global liquidity spillovers into domestic liquidity that put downward pressure on domestic interest rates. We see this most evidently with the negative interest rates of the ECB, which has resulted in capital flows to the neighbouring countries and pressure on their exchange rates. As a consequence, interest rates in neighbouring Denmark, Sweden and Switzerland have all also become negative. Such contagious fall in interest rates can lead to excessive borrowing, a decline in savings, increases in asset prices, and increases in leverage, which in turn increase the risks of financial imbalances developing and undermining financial stability.

Financial liberalisation and advancements in information and communications technologies have connected the different national financial systems to create a global financial network through which financial resources flow around the world. In such a system, when there are disturbances in the small financial systems, it would merely be a ripple in the global financial system. But, if something happens in a large financial system, its impact would send shockwaves across the entire network. If policymakers, especially in the large economies, do not understand this, or underestimate its implications, it could lead to an overestimation of the effectiveness of national macroeconomic policies and underestimation of the global impact of those policies. The global financial system is in a state of constant evolution with key impetus coming from technological advancements, financial innovation, regulatory changes, financial incentives and regulatory arbitrage. The globalised financial system and what it means to be a part of it So, let me first turn to the implications for Malaysia of being a part of the globalised financial system for there is no doubt that Malaysia has become more financially integrated globally. Malaysia’s financial integration with the world Based on data on Malaysia’s International Investment Position, which is compiled by Malaysia’s Department of Statistics, outstanding non-resident investments in Malaysia increased by almost 4½ times between 2001 and 2014 to reach $ billion. That is the amount that non-residents have invested in Malaysia as of 2014 in the form of FDI, portfolio investments and other investments such as deposits, loans and trade credits by banks and corporates.