Business

Saturday August 8, 2009

Future of banking


Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz has a penchant for mind mapping, a way pioneered by Tony Buzan for all manner of thinking and planning by putting things down in words and pictures on a sheet of paper and linking them.

Excerpts from the interview.

StarBizWeek (SBW): Going forward, what are some of the key things for the banking sector as well as those pertaining to banking regulations?

Zeti: The recent crisis has demonstrated several issues, one of which relates to the regulatory structure.

The central bank has the mandate for financial stability, regulatory and supervisory authority. The current crisis shows that there is a fragmented regulatory structure and institutional arrangements have been less effective.

The central bank can leverage on its other functions which include macroeconomic management, reserve management and the oversight on the payment systems as well as money and foreign exchange markets.

These are important elements that provide information in terms of our surveillance, liquidity and other forward-looking indicators that will have influence on the financial system. These relate to the regulatory function.

In terms of surveillance, it has to go beyond the banking sector to monitor developments outside the regulatory reach.

Regulation and supervision has to be, therefore, strengthened in accordance with the developments taking place.

What is your take on how far central banks are actually taking steps to control future crises?

A central bank cannot micro-manage. It has to ensure that the system has the governance and risk management structures and practices in place.

There should also be no gaps in the financial system where you have highly regulated and non-regulated institutions, for instance, in the US.

In our case, our investment banks are jointly regulated by Bank Negara and the Securities Commission. So it has to do with the regulatory coverage and scope of the regulation.

It is during good times that one needs to build the buffers, and this is what we also did. Our banks are very well-capitalised and not over-leveraged as we have a huge deposit base to begin with.

What do you think are the main banking and regulatory challenges in the coming years?

First, the banking sector has to have the expertise if it wants to advance forward in innovation or to participate in markets. It must have a great awareness of how to manage what it views as new areas of growth.

Second, it has to be in a position to be accountable to the board as the banking sector is very different from the corporate sector as it handles the monies of the public at large and has to be accountable for it.

As a central bank, we will monitor this and our surveillance has been intensified. It is highly vigorous and very forward looking through the stress tests which we have been conducting for more than 10 years. It is now much more sophisticated.

We have the ability to detect and evaluate problems well before they have deteriorated.

What are the key guiding principles that you operate by and do you see them changing in the near future?

The surveillance function will become even more important to detect problems early. The regulatory outreach has to cover both parts of the financial system and may not necessarily be 100% perfect and there may be parts which are less regulated.

What usually happens is that funds migrate to the less regulated parts and this is where the risks emerge.

The regulations have to be reviewed. For example, issues of leverage, compensation and incentive structure are being reviewed by the international community.

Going back into history, during Tun Ismail Ali’s tenure as governor, there was almost always an underlying belief that banks would need to be properly regulated to meet national interest aspirations. What is the difference now?

The kind of regulation then involved mostly portfolio restrictions such as liquidity requirements, ceilings on lending to particular sectors and so on.

As we move into an environment that is more deregulated and liberalised, the approach has changed from a rule-based to a more risk-based approach.

There has to be a balance. You don’t abandon the rules but, at the same time, you must provide the flexibility to the system to adjust to changing conditions due to the complexity of the system.

The nature of finance and the range of products and services then and now are significantly different to meet the changing demands of consumers and businesses.

Which are the areas in which you foresee greater liberalisation of the banking sector?

There are two aspects.

One is deregulation which involves the move towards greater market orientation. We now have interest rates that are determined by the market. Before that, they were determined by a rigid formula.

A few years ago, we moved towards allowing banks to set rates while Bank Negara set the overnight policy rate and allowed the market to determine the other rates in the financial system.

That was a big shift and with that, a higher level of transparency was required. We published, for example, comparative rates so that consumers and businesses can make comparisons.

Banks have the potential to offer different financial products that charge different rates with different features.

Deregulation is, therefore, a major change.

Liberalisation means opening up the system to foreign participation. This has been done at a sequential pace.

We have been more aggressive recently.

We have always believed that it is important for liberalisation to produce win-win results that must benefit the country as much as the foreign investor.

Liberalisation will bring in, first, expertise and transfer of technology from advanced financial systems and, second, it enhances our economic and financial linkages.

It can also facilitate trade and investments across borders and portfolio investment in our financial markets.

Besides the benefits, the risk to us is that we will be vulnerable to external developments. They will demand our talent.

These are the two areas that we have put in place as pre-conditions so that we will not be vulnerable to external developments.

And indeed, we have achieved that. Given the crisis and our open economy, our financial system has remained solid. It is able to absorb the increased volatility that we have seen.

In talent, we have invested massive amounts in education for the financial services sector.

For example, the training centre called the Asian Institute of Finance consolidates all the training arms pertaining to the financial sector.

We have allocated a RM500mil endowment fund for The International Centre for Leadership in Finance (ICLIF) and another RM500mil for The International Centre for Education in Islamic Finance (INCEIF) to support its operating expenditure.

Do you foresee that non-bank financial services providers will play a more important role in serving the financial needs of customers?

There are non-bank financial institutions such as capital market intermediaries and non-financial entities such as stores, telcos, supermarkets using card payments and mobile banking.

These are new developments that are likely to become more significant and highlight the importance of consumer protection which will be intensified.

What are the challenges faced in the migration to e-payments?

That is an important agenda. When we saw that the progress towards e-payments was so slow, we approached the Government to channel their transactions via electronic means. They have given their support and, currently, most of the Government transactions are conducted via the electronic channel.

We should increase the usage of electronic payments which can contribute 1% to growth. This efficiency also translates to lowering of costs.

Some countries went through a second stage of major investments in infrastructure. We want to avoid that and make the quantum leap.

We also want to make it more secure to gain further confidence and be more linked to other financial systems.

SBW: Malaysia’s financial liberalisation is taking place at a time when the “reverse” is seen happening in the developed world because of the financial crisis. What are the implications of such a trend for our financial services sector?

Zeti: Malaysia’s approach to liberalisation has been to sequence the liberalisation according to the pace that can be absorbed by the financial system.

Now that the development of our financial system has made significant progress and with our domestic financial institutions now well-capitalised and more resilient, the pre-conditions are, therefore, in place for further liberalisation.

Liberalisation must result in win-win outcomes. Malaysia has now reached the stage where we will benefit from liberalisation. The current crisis has, therefore, not discouraged us to proceed with our liberalisation plans. The significant interest that has been received also indicates that foreign interest in participating in our financial system has not been discouraged by this international financial crisis.

Malaysia has recently announced financial sector liberalisation measures to further strengthen the role of the financial sector as a key enabler of economic growth. What is the purpose of these measures and the challenges faced in implementing them?

The reform and modernisation of our financial system has now brought it to a stage where we are able to benefit from liberalisation.

Liberalisation not only brings with it the transfer of expertise and technology, more diverse financial products and services and more cost-effective pricing but also facilitates greater trade and investment across borders.

Liberalisation will also enhance the role of the financial sector of the economy, generating income and employment.

The more aggressive liberalisation in Islamic finance is to contribute to the development of our Islamic financial system and to enhance our linkages with financial systems in other parts of the world.

The challenge comes in two forms. The first is the increased exposure to external developments. This can be managed by enhancing our resilience. The second is the increased demand for good talent. This has been the reason for the massive investment in education for the financial services sector so as to create the supply of the required talent.

What is the level of interest shown in the potential take-up of world-class banking licences?

We have had a lot of enquiries from foreign players both to participate as niche players as well as (to apply for) other licences that we shall be issuing in Islamic finance and conventional banking in 2012.

The date for submission is Oct 30. It is a long process of submission to prepare business plans and their value propositions and contribution to our economy as well the financial system.

They have engaged us in discussions. Some have indicated directly that they would make a submission while some have sent letters indicating interest.

Is this the best time as a lot of banks are looking inwards at this point in time?

Those that are doing well or have survived better have come forward to express their interest, and these are the ones that have been waiting for this moment.

They have talked to us and we have said we want to see certain milestones in place. They have been waiting patiently and are now very excited at the prospect of being considered.

So your sense of timing, once again, is shown here?

This crisis has not set back our plans for liberalisation. We have the pre-conditions in place and will press ahead.

Our financial system and economy will stand to benefit. Our Islamic financial system will also benefit as it will reinforce its position as an international Islamic financial centre.

Renewed focus On risk management

In the developed countries, it was the introduction of certain kinds of investment products which was the underlying reason for the financial crisis. Are you going to keep a close watch on these types of products?

We are going to keep a close watch on governance and risk management practices, and that the boards are fully aware of the risks associated with these products and are able to manage them.

We look at their risk management and activities and see if they commensurate with the kind of developments that have taken place in their systems.

The global financial crisis has pointed to the age-old truth that size does not count. In the end, it is good financial accounting, corporate governance and risk management that matter.

Do you think this development will change the parameters set for Malaysian banks to be managed and regulated?

Our regulatory and supervisory framework has always placed emphasis on strong governance, effective risk management and having adequate capital buffers rather than on placing restrictions on size.

The supervisory expectation with respect to governance and risk management structures and practices will, however, be strengthened over time to stay ahead of developments in the financial system.

For institutions that have become exceptionally large, more rigorous surveillance will, however, be imposed and the expectations will be higher. There will essentially be tougher supervisory oversight on such systemically important institutions. This will allow for early intervention and thus prevent widespread disruptions to the overall financial system as well as high resolution costs.

While there is no restriction on how large an institution may become, a minimum size is important. After the Asian financial crisis, the minimum capital requirement was raised. This not only allowed for greater economies of scale and the ability to invest in the required technology and talent, but also strengthened the level of resilience to external developments.

How are banks preparing for the advanced implementation of Basel II? Will this significantly change the landscape of banking with risk-based pricing?

The standardised approach took place in 2008 but the more advanced approach is in 2010. Our banks are well-positioned for this.

There are some issues that are still being revisited by the Basel committee at the Bank for International Settlements.

I think this will be ongoing and a number of flexibilities that will require significantly better risk management in the system in the pricing of risks. This is the problem with risk under-estimated which generated a lot of the problems we saw recently.

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