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Malaysian Central Bank governor on global financial crises

Malaysian Central Bank governor on global financial crises Anthony Harrington

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On 29 June, Zeti Akhtar Aziz, the governor of the Central Bank of Malaysia, and one of the central figures in managing the Asian crisis of the late 1990s, gave the annual Per Jacobsson Foundation Lecture at the Bank for International Settlements (BIS) in Basel. Her theme was "Managing Financial Crisis in an Interconnected World: Anticipating the Mega Tidal Waves".

She pointed out to her audience that, since the 2008 global financial crisis, there has been a veritable flood of academic studies on the theme of interconnected systemic risk and how a build up of such risks can be identified ahead of the game:

"These channels (for the spread of systemic risk) include the linkages that exist between financial institutions, the interactions between the financial intermediaries and financial markets, and the linkages between the financial sector and the real economy. Further channels exist through the market infrastructures and the two-way interaction between the financial sector and the Government."

Aziz adds that the increased international integration of financial systems and the scope for cross border contagion means that there are new regional and international dimensions that need to be managed in the run up to and during a crisis. Her starting point is to concede that all this management will not prevent financial crises. She expects them to keep reoccurring. But the thrust of her argument is that it is possible to get better at managing them.

We now have global supply chains and global financial flows, further tightening the economic integration between countries. At present there might be an argument that emerging markets are decoupling from advanced markets, but as their financial systems become more developed, the channels for contagion develop ever more strongly, she warns.

Part of the task for regulators is to square up to the challenge of mapping financial interconnections on a regional and international scale. In doing this, regulators will need to bear in mind that financial networks are highly dynamic, changing rapidly over relatively short time frames. Plus regulators will have to take into account "secondary effects" such as the fact that market participants will themselves be making assumptions about how contagion might be spreading.

Inevitably this will tend to show up as an increasing liquidity crunch as suspicions spread about the creditworthiness of potential counterparties.

Aziz is clear that regulators now have better tools for identifying and measuring interconnectedness, but there is still much work to be done in this area, she points out. Focusing on the interplay between corporate finance and the banking sector and between consumer credit and the banking sector are key areas in the assessment of how risks can be transmitted between sectors. Also important is the relationship between the shadow banking system and the banking system.

What regulars need is better data on financial networks to help them understand what Aziz calls "the major nodes in the networks where risk propagation is likely to be the strongest, both in terms of magnitude and speed".

Her speech, in short, gives a very accurate account of where regulation is going and how it needs to focus its energies in order to become more sensitive to the build up of risks and how things potentially need to be unwound or addressed when a bubble bursts. What Aziz can't do, other than by calling for increased international co-operation, is to predict the obstacles to co-operation that might flow from the way different countries evaluate their own self interests through the boom time preceding any crash.

Once exuberance takes hold, politicians, bankers and corporate management all tend to succumb to the belief that "this time, it's different", and the regulators find their power and influence waning. Right now there is a global willingness to extend the reach of regulation. That itself could be merely a consequence of the hangover that follows a major bust. The real test will come when we see how much power regulators are allowed to retain when the boom times roll.

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Tags: BIS , Malaysia , Malaysian Central Bank , Per Jacobsson Memorial Lecture , regulation , Zeti Akhtar Aziz
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