Introduction

The focus of this chapter is on financial reforms in Malaysia after the 1997 East Asian Financial Crisis when the economy suffered its worst recession since independence in 1957. The 1997 currency crisis has been seen as a consequence of the fragility of the banking system by those who diagnosed the crisis as being due to short term overborrowing by the banking system (Radelet and Sachs 1998, p. 9) resulting in the twin problems of currency and maturity mismatches (Corsetti 1998, p. 24). However, those who saw it as a consequence of the decline in exports diagnosed the problem as being due to the inability of the countries to finance their external debt because of the widening current account deficit (Corsetti 1998, p. 24; Radelet and Sachs 1998, pp. 19–26).

The tapering of the growth rate of exports as a result of the cyclical downturn in the world electronics industry in 1996 led to the withdrawal of loans by Japanese and European banks, who had provided short term financing to the Malaysian banks. The Malaysian banks were caught because they had used the short term loans to finance long term infrastructure and property development and other lumpy investments.

Foreign Portfolio Investments (FPI), which had peaked in the Kuala Lumpur Stock Exchange (KLSE) in 1993–94, took flight as a result of the banking panic and the subsequent devaluation of the ringgit (Radelet and Sachs 1998, pp. 9–11). This led to the further depreciation of the ringgit, which had an adverse effect on the balance sheet of the corporations (Krugman 1998) and the capital adequacy of the banks.

The Malaysian government however viewed the crisis as being a conspiracy of western hedge funds, western governments and the IMF to impoverish East Asia by creating the conditions for the crisis (Athukorola 2001, pp. 63–66; Mahathir 1998). The Malaysian government view received some academic credibility from the writings of Stiglitz (1998), Bhagwati (1998) and Wade and Veneroso (1998) who elaborated the Treasury-Wall Street Complex theory, whereby the Federal Reserve Bank collaborated with Wall Street by making cheap credit available for hedge funds to invest in East Asia to create a bubble which they could profiteer from being the first one to be out or “sell and run”.