Institutional Investor, June 2009

Earlier this year Institutional Investor was invited to Kuala Lumpur to meet with Dr Zeti Akhtar Aziz, governor of Bank Negara Malaysia, on the 50th anniversary of the institution’s foundation.

Aside from her standing in Malaysia, she is also one of the world’s most important figures in Islamic finance, and one of the most senior women in the Islamic world.

Institutional Investor: How do you balance deregulation with keeping sufficient control of the financial system?
Zeti: The supervisory and regulatory framework has been strengthened, our communication has intensified and surveillance has become more significant. The information we obtain is very forward-looking. We do not just look at the financial position of financial institutions: we stress test them, and look, for example, if commodity or property prices dropped, how would they fare under those more extreme circumstances?

We have consolidated from a fragmented banking system to having larger players, and even though we do still have medium-sized financial institutions that focus on specialised areas, they are not similar to what we had before the [Asian financial] crisis where there were very small institutions who were vulnerable, who couldn’t take advantage of economies of scale, or do the massive investment needed in new technology. Additionally, we have instituted best practices in risk management and corporate governance, and this is key. And there are a few incentives that we give: if they are better managed in terms of their risk management, they are given greater flexibility in their product development, and so on.

II: Will you impose restrictions on the sorts of assets banks can hold?
No, because we have moved away from that, but we do strengthen the regulations on the role of the board. The board and their risk management committee have to sign off that they are aware of the risks associated with any products they enter in to, so there is accountability.

II: You have presided over the removal of a number of capital controls. Is Malaysia better served in a global financial crisis by these removals – particularly those around the currency?
We have removed all the controls except one, which is the non-internationalisation of the currency. I think, at this point particularly, it is quite important that we keep that in place: it reduces the vulnerability of our currency being attacked by speculative activity financed from offshore sources. It is fine to have flows of funds that have come into the country, and those can flow in and out freely. But to give speculators access to ringgit financing, to sell the currency down, which is what was happening during the crisis, that renders us vulnerable.

We see an important precondition of removing that particular control is to develop our own domestic foreign exchange market. Once we have a vibrant market, with all the hedging instruments and so on that will develop, and the talent in our own financial system, we would see the potential to remove that restriction.

II: Do you need other tools to intervene, and in what circumstances would you use them?
Right now we have moved to a flexible exchange rate regime. We were on a fixed rate for about seven years: during that time we built the preconditions to move to a flexible regime, such as participating in the open market with market based instruments, strengthening the banking sector, and developing the bond market into one of the largest in southeast Asia, where the private debt securities market is now larger than the government securities market. When we were ready to move it was a successful transition, and very orderly. We do not stand in the way of an appreciation in the currency. We have a very good understanding for the potential for reversals, and we highlight this to the market so there won’t be any overreaction if the reversals take place, but so far it’s been well within our expectations.

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