In the wake of the sub-prime mortgage crisis in the United States, several aspects of Basel II have attracted attention. Among them has been the use of ratings in the regulatory framework and whether this has unintentionally discouraged investors from performing their own due diligence. The underestimation of risk for structured credit securitisations has now come under greater scrutiny. There has also been increased debate over the cyclicality impact of Basel II. The effectiveness of the supervisory review process in ensuring that additional capital buffers are provided by banks for risks not fully captured under Pillar 1 of the framework has also been the subject of this review by authorities. The relative importance of these issues will be different for different countries, depending on the stage of development of the financial markets and the banking system, as well as the supervisory structure that is in place. Among Asia Pacific countries, experiences with the implementation of Basel II have been varied. For emerging economies, Basel II has arguably a more far reaching impact. This is on account of several factors. Firstly, many emerging economies continue to depend heavily on the banking system to finance economic activity. With a few exceptions, commercial banks are the main providers of credit in most emerging economies, accounting for an average of 90% of total credit. This produces a higher correlation to the economic sectors where the implications on the banking system could result in significant disruptions to credit supply which could in turn affect economic activity.

The highly fragmented banking system and relatively weak risk management systems within the domestic financial institutions which prevailed in Malaysia prior to the financial restructuring and reforms that were undertaken from 2001 would have rendered the implementation of Basel II extremely difficult, if not impossible to achieve without risking disruptions to the intermediation process. The financial reforms that were undertaken to strengthen the underpinnings of our banking system are therefore instrumental in facilitating the smooth transition to the adoption of Basel II in Malaysia without adverse market outcomes. In the more recent period, the Asian region as a whole has made significant strides towards strengthening market structures and institutional arrangements for financial stability. Two developments deserve mention, in view of their important contributions towards mitigating some of the concerns surrounding Basel II for emerging economies. First, in the decade following the Asian crisis, the emerging economies in Asia have extensively developed their bond and equity markets. Measured in terms of market capitalisation, East Asia's equity markets have more than trebled since 1997. The bond markets in the East Asian region have also seen significant growth during this period with significantly improved liquidity conditions in these markets. There is therefore now a more diversified structure in the financial system. Second, within Asia, the regional cooperative framework has been substantially strengthened to support financial sector development, surveillance, crisis management and capacity building.