Proposals for the reform of the Malaysian financial sector and financial markets

Abstract

As compared to the goods, the financial sector, (not unlike the services sector), has been subject to over-regulation and restriction on competition. This has As compared to the goods sector, the financial sector, (not unlike the services made the domestic banking sector inward-looking. It has also made the economy too reliant on the banking industry and not enough on the fund management industry to intermediate funds between savers and investors. As a result, the higher and of risk intermediaries, have penalised the goods sector which has been exposed cost of financial services and the under-development of risk management products always to keen world market competition. Unless this situation is rectified, the Malaysian economy which has been raised on the back of the goods sector. may remain in a state of imbalance and may not become a fully developed economy. The liberalisation and deregulation of the financial sector can, however, make the economy more vulnerable to internal and external shocks if the banking system is not sound and if the macroeconomic policies pursued are inconsistent. And as banks are the conduit for payments, there is also the fear that any banking crisis can expose the economy to systemic risk. In fact, as a result of the fear of such risk, Governments in many countries have not been prepared to let their banks, especially their big banks, to go bankrupt. This in turn has increased the problem of moral hazard, namely of bankers having an incentive to engage in more risky lending. This incentive will be greater the lower the capitalisation of a bank.' A case is made in the paper for the deregulation of the financial sector in Malaysia in two critical areas, firstly, with respect to the country's exchange control regime and secondly, with respect to the banking system's reserve and liquidity requirements. With respect to the exchange control regime, I am not calling for its dismantling. I am only making a case for freer investing and borrowing and for investors and borrowers to be given the right to hedge their foreign exchange exposures. Presently only exporters and importers enjoy this right. With respect to the system of reserve and liquidity requirements, I am making a case for a substantial reduction in these requirements (if necessary on a phased basis). Given the current problems of the Malaysian economy, the timing may not be considered right for the deregulation of the financial sector in these two critical areas. But this is a debatable point in respect of the exchange control regime. As the value of the ringgit appears to be entirely market-determined now and as volatility is therefore higher, (especially given the uncertainties engendered by the current regional financial market crisis), a strong case can be made for the central bank to approve hedging requirements on a freer basis. In what follows, there is a discussion in Section II of the soundness of the Malaysian banking system and macroeconomic policies as well as of the vulnerability of the country's banks and economy to internal and external shocks. Thereafter, there is an overview of the financial revolution in Section III that has been sweeping the developed world from the 70s. As Malaysia and much of Asia has been cut-off from this revolution, this Section examines how this has disadvantaged us. In Sections IV and V, there is a review of the rationale for the A bank's low capitalisation can be due to its under-capitalisation or because its capital has been impaired by actual or potential loan losses.