Zeti Akhtar Aziz: Enhancing the soundness of the banking sector The New Capital Accord Keynote address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the Risk Management Seminar on the New Capital Accord (Basel II), Kuala Lumpur, 15 April 2004. *  *  *  Distinguished guests, Ladies and Gentlemen, It is my pleasure to welcome you to the Risk Management seminar on Basel II organized for the directors and senior management of banking institutions. The objective of this seminar is to promote greater understanding of the impending changes to the international capital adequacy regulation. Given the importance of the subject and its implications on the banking industry, it is important for the industry to understand the intentions and the challenges arising from these changes so that the necessary action may be taken in a manner in which the benefits to be derived from it can be maximised. While there has been global acceptance of the broad principles of the new accord, differing implementation approaches are being adopted by different countries. I will take the opportunity to discuss the new Accord from our perspective and the approach that will be adopted for Malaysia. This seminar will provide you with the opportunity to engage in discussions on the issues concerning the new Accord. Philosophy and objective of capital regulation A well functioning and efficient banking sector is vital to the economic growth process. The banking institutions perform the important intermediation function of mobilizing funds to finance productive activities.

This intermediation process needs to be performed in an environment of financial stability. Therein lies the importance of confidence and soundness of the financial system. Banking business inherently involves risks and these risks need to be rigorously managed. In an environment of heightened uncertainty and increased volatility, this needs to be reinforced with the development of a more robust and resilient banking system. Hence the importance of prudential regulations to ensure the soundness and stability of the financial system. An important component of prudential regulation is having a sound capital framework that measures risks accurately and allocates adequate capital to the risks. The current capital accord issued in 1988 has served as the international benchmark for capital adequacy assessment for banking institutions. While it has achieved the desired results in terms of developing more well-capitalized banking institutions globally, the rapid developments in the financial markets over the years, including the growth of off-balance sheet financing such as asset securitisation have rendered the broad-brush measurement of the existing accord to be less effective. Risk and risk management - the need for new accord New institutional structures and evolving market practices have reduced the effectiveness of the existing accord. While the basic categorization of risks have not changed significantly, the ways in which risks present themselves have changed quite substantially. With the introduction of new products and more complex financial transactions enabled by technological innovations, risks can be disaggregated and rebundled in new ways.