Liberalization of Malaysia's financial markets, tackled in earnest in the early 1980s, has been gradual and cautious. It has been a process of structural deregulation and prudential reregulation, with the authorities willing to change course when borrower net worth (and the banks) have come under pressure. The result appears to be a financial system that is more stable and competitive, with a wider public choice of financial instruments, as well as institutions, and more effective conduct of monetary policy by the Central Bank.
Malaysia began the reform process with a relatively deep financial sector, compared with the simple structure of the mid-1950s. It also had a relatively open economy, with little financial repression and negative real interest rates only at the time of the first oil shock in 1973. Yet there were many structural weaknesses in the economy and the financial system, which came to the fore only during the recession of the early 1980s. Malaysia's experience suggests that in financially repressed countries contemplating liberalization, governments should first administratively raise interest rates, sort out the health of banks, and at the same time build a strong central bank on both the regulatory and monetary side.
Malaysia's Central Bank was a key player in its financial reform. By keeping inflation down, the Bank helped the spread of long-term financial markets and facilitated the growth of money markets. The introduction of repos and swaps has broadened the range of monetary instruments, while the reforms in government securities' markets have made it easier for the Central Bank to conduct open-market operations, although these are still small.