While the 1988 Accord was a milestone achievement, its simple risk-weighting scheme has had difficulty incorporating innovations in the way banks today manage and mitigate credit risks. More fundamentally, the 1988 Accord does not adequately differentiate among degrees of credit risk. As a result, banks have had incentives to take on higher risk exposures within each of the Accord’s broad risk categories. Banks have also tended to engage in transactions that lower capital requirements without reducing economic risk. The effect of these developments has been to erode the significance of the Basel ratios as an indicator of a financial institution’s capital adequacy, particularly for the large, internationally active institutions which were the original targets of the Accord. To address these shortcomings in the 1988 Accord, the Basel Committee proposes two primary approaches: (1) a standardized approach that ties risk weightings to external credit assessments such as credit ratings, and (2) an internal ratings-based approach that would begin by mapping internal risk ratings into standardized risk weightings but might eventually evolve into something closer to the full use of credit risk models. Each approach treats the trade-off between simplicity versus accuracy somewhat differently and thus one or the other is likely to be relevant to banks with different levels of sophistication. Importantly, both proposed approaches attempt to introduce greater risk sensitivity into the minimum capital standards.

Let me now touch on several important aspects of the Malaysian Islamic financial markets that are important to issuers and investors. These relate to the freedom to move capital into and out of Malaysia, the availability of credible and timely market information and the capacity of the Malaysian Islamic financial market to allow for greater product diversification and risk management. On capital mobility, Malaysia maintains a highly liberal foreign exchange administration regime. The primary focus of foreign exchange administration is to support the monitoring of flows of funds to promote financial and economic stability. As part of the continuous effort to enhance efficiency and reduce the cost of doing business, the foreign exchange administration rules have been progressively liberalised and simplified. There is free mobility of inward and outward movement of funds relating to both foreign direct investment and portfolio capital investments. Foreigners investing in Malaysia are also free to hedge with onshore banks their committed flow of funds such as the repatriation of investment proceeds, dividend and profits from Malaysia as well as the purchase of ringgit assets in Malaysia. In addition, investors are freely able to obtain ringgit and foreign currency to fund their investments in Malaysia. Strategic measures have also been taken to allow non-residents, in particular, Multinational corporations and Multilateral agencies to issue ringgit denominated bonds in Malaysia. The ringgit funds raised may be used either in Malaysia or outside Malaysia. Both the foreign issuers and investors are free to hedge their foreign exchange exposure from the issuance and interest respectively.