muhammad bin ibrahim : recent developments and emerging trends in asia keynote address by mr muhammad bin ibrahim, deputy governor of the central bank of malaysia, at the second annual south east asian institutional investment summit – “ recent developments and emerging trends in asia ”, kuala lumpur, 2 december 2010. * * * let me first thank asian investor for the invitation to speak at this institutional investment forum. i am honoured to be given the opportunity to speak before such a distinguished group of investors, fund managers and government officials at this important gathering. my remarks will consist of three parts – the first part, on the current trend of rising capital inflows to asia and its implications, secondly on regional market developments and lastly, i will make some observations on the region ’ s institutional and central bank investing space. asia as the investment destination and its implications it has been three years since the financial crisis first erupted. emerging market economies have demonstrated resilience, showing a steady growth path to recovery, well ahead of major developed countries which face challenges of low growth, high unemployment and mounting fiscal burdens. such large disparities in the growth rates and economic environment have inevitably led to divergence in monetary and fiscal policies. where developed countries had maintained low interest rates, expanded quantitative easing policies and implemented stimulus programmes to revive their economies, emerging markets had started normalising their interest rate policies. the recent financial crisis differed from the 1997 – 98 crisis in many aspects. emerging market countries have a much stronger fundamentals, better growth prospect and higher interest rates. these differences in fundamentals have attracted growing and significant capital flows to these parts of the world. net private capital flows into emerging markets was projected by the institute of international finance to rise to usd825 billion by the end of 2010, representing a 42 % increase from last year. many analysts expect the recent federal reserve ’ s policy decision to purchase another usd600 billion of us treasury bonds under “ qe2 ” will intensify further flows to the region. economists estimated that between a quarter to half of the qe2 liquidity will flood into emerging markets. the inflows if not managed properly will pose difficulties to asian and emerging markets. policymakers would face several predicaments from policy perspectives. the influx of capital inflows, have led to a rapid expansion of liquidity translating into rising prices, leading to concerns on asset bubbles and the possibility of overheating the economy. however, the impact on each economy will differ depending on the

rating agencies in flagging the risks built up in banks and sovereigns, ahead of the crisis. most credit rating agencies also tend to apply ordinal ranking of credit, rather than specific risk metrics that can be mapped to default probabilities or expected losses. in my view, one of the major weaknesses of credit rating agencies is their objective to establish rating stability by applying smoothing methodology that can potentially delay minor downgrades, but trigger cliff - like and abrupt downgrades in the event of sharp credit deterioration. the abrupt regrading of credits tend to spook markets and is certainly not good for investors with a heart condition. regional central banks and major institutional investors are aware of such limitations ; hence the best way forward is to complement rating - embedded investment guidelines with a more robust and rigorous internal credit risk evaluation framework. in tandem with diversification into alternative asset classes, there is a growing emphasis to improve the sophistication of risk modelling, taking into account how risk can be initially understated when herding behaviour dominates, but rears its ugly head during reversals. iv ) the growing importance of islamic finance as events unfolded in the midst of the financial crisis, the sustained expansion of global growth and development in islamic finance has emerged as one of the most prominent trends in global financial landscape. the industry continues to draw significant interests from all corners of the world. the global financial crisis underscores the potential role and relevance of islamic finance as a viable approach in investing. due to the shariah prohibition of excessive leverage and unproductive cash hoarding, shariah - compliant funds have outperformed their conventional peers since the onset of the crisis. as a result, there has been greater appreciation of the principles of islamic finance, as evidenced by the expansion of interest and demand for islamic financial products on a global scale. in line with the rapid growth of islamic finance, emphasis has been placed on the development of the international financial infrastructure such as setting prudential standards and international best practices, a role spearheaded by the islamic financial services board. the most recent significant development was the establishment of international islamic liquidity management corporation in kuala lumpur. this corporation will act as a conduit to issue highly rated short - term islamic instruments to enhance cross - border liquidity management and provide islamic financial institutions with an additional avenue to manage their short - term liquidity. complemented by other initiatives under the “ malaysian as an islamic financial centre ”, i am quite confident that