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1.

1 Bank Negara Malaysia


Background

1954, government appointed G.M. Watson of Bank of England & Sir Sydney Caine, Vice
Chancellor of University Malaya to advise on the model of central banking.

1959, Bank Negara Tanah Melayu was up and running

Since 1959, BNM has been helmed by 7 governors:


(a) Tan Sri W H Wilcok (Jan 1959 July 1962
(b) Tun Ismail Bin Mohd Ali (July 1962-July 1980)
(c) Tan Sri Abdul Aziz Bin Taha (July 1980 Jun 1985)
(d) TanSri Dato Jaffar Bin Hussein (Jun 1985 May 1994)
(e) Tan Sri Dato' Ahmad Bin Mohd Don (May 1994 Aug 1998)
(f) Tan Sri Dato Seri Abdul Hassan Bin Sulaiman (Sept 1998 April 2000)
(g) Tan Sri Dato Sri Dr Zeti Akhtar Aziz (May 2000 - Current)

The law requires the annual account to be audited by Auditor General of Malaysia. A report to be
published yearly before end of March

Central Bank of Malaysia Act 2009

The Central Bank of Malaysia Act 2009 (The Act) came into force towards
the end of 2009. With this, the Central Bank of Malaysia Act 1958 is
repealed and thus, ceases to apply.

The Act will enable Bank Negara Malaysia to more effectively manage
emerging risks and challenges in performing its role and responsibilities
as the nation's central bank.

Primary Functions of BNM

To formula and conduct monetary policy in Malaysia

To issue currency in Malaysia

To regulate and supervise financial institutions which are subject to the


laws enforced by the Bank

To provide oversight over money and foreign exchange markets

To exercise oversight over payment systems

To promote a sound, progressive and inclusive financial system

To hold and manage the foreign reserves of Malaysia

To promote an exchange rate regime consistent with the fundamental of


the economy

To act as financial adviser, banker and financial agent of the Government

1.2 Banking Structure

Malaysian financial system is structured into two major categories:


(i) Financial Institution and
(ii) Financial Market

Financial institutions comprise Banking System and Non Bank Financial


Intermediaries

Financial Market comprises four major markets:- Money & foreign Exchange Market
- Capital Market
- Derivatives Market &
- Offshore market

(Refer to unit 1 page 17- The financial system structure in


Malaysia)

The Financial System Structure in Malaysia

Primary Functions of Bank Negara Malaysia (unit 1, pg 7)


1. To formulate and conduct monetary policy in Malaysia.
2. To issue currency in Malaysia.
3. To regulate and supervise financial institutions which are subject to the laws
Bank.

enforced by the

4. To provide oversight over money and foreign exchange markets.


5. To exercise oversight over payment systems.
6. To promote a sound, progressive and inclusive financial system.
7. To hold and manage the foreign reserves of Malaysia.
8. To promote an exchange rate regime consistent with the fundamentals of the economy.
9. To act as financial adviser, banker and financial agent of the Government.

Functions of Bank Negara Malaysia

Issue currency and keep enough international reserves to


maintain the value.

Banker and financial advisor to Government.

Promote monetary stability and financial stability.

Influence the credit situation: Monetary policy instruments.

Act as lender of last resort: Provide emergency funding like


through the discount window to insolvent banks.

Lesson 3

Tan Kock Lim

Issue currency and keep enough


international reserves to maintain the value.
A specific function of BNM is to be the sole issued of currency in
the country, is has exclusive authorisation to issue all legal tender
currency for use in the country
It also plays an important role in maintaining a sufficient amount of
currency reserve in order to ensure stabilise for the Malaysian
Ringgit
BNM maintain gold & foreign reserves to "backup" the value of
currency.
BNM holds the nation's international reserve in the form gold,
foreign reserve, reserve positioned with IMF and holding of SDR

Banker and financial advisor to


Government.
To advise government on financial related matters
It also advises the government on its loan
programme as well as raising loans for
government and managing goverment public debt
Twice a year, governor of BNM will outline the
performance and challenges of the economy to
the Finance Ministry as well as make
recommendation for action

Promote monetary stability and financial


stability....con't
As the country's monetary authority, BNM is responsible
for maintainence of monetary stability and a sound
financial structure
This means making approaches changes in monetary
policy to ensure that inflation is kept low and the
purchasing power of RM is not diminished.
An important policy consideration is also to ensure
financial stability including stability in the domestic
money and foreign exchange market

Promote monetary stability and financial stability.


Central bank has the ability to control the size of its balance sheet. In other words,
it has the ability to control the size of the assets as well as liabilities that exist in its
balance sheet.
1. Open

market operation

It is the process of buying and selling of government securities by the central bank in order
to influence the money supply. The buying and selling activities of government securities will
increase or decrease the assets of the central bank.
2. Foreign exchange intervention
It is the transaction of buying and selling of foreign currency reserves by the central bank.
3. Discount loan
Discount loan is the loan provided by the central bank to commercial banks.
4. Withdrawal of deposits by depositors
It is the decision made by depositors to withdraw their money from the banks and this will
affect the excess reserves of the commercial banks.

Influence the credit situation: Monetary


policy instruments.
BNM must ensure that general money supply
and credit volume are sufficient to meet the
demand in the domestic economy without
creating under pressure on measures in the
economy
BNM regulate the volume of money and the
generation of credit by the commercial banks
through wide range of monetary policy
instruments (SRR, OMO, Discount loan......)

Act as lender of last resort


BNM acts as last source of funds for CB & other
banking institutions where they encounter
shortage of funds.
BNM extend its financial assistance in varous
forms:
Discount of bills such as T/B, government
securities
Direct loan

Commercial Banks
Mobilizing surplus funds in the economy.
Offering transaction accounts like savings account, current
account and fixed deposit.
Offering payment system: Local and overseas e.g ATM and TT.
Offering loans and financing for economic growth.
Miscellaneous financial services: Credit card, insurance and
mutual funds.
Lesson 3

Tan Kock Lim

Investment Banks

Underwriting: Initial Public Offering [IPO].


Advisory: Merger & acquisition.
Fund management.
Financial innovation: Offering structured products
and call warrants.
Fund raising.
Securities trading.
Wealth management/ Private Banking.
Deposits: Whole sale business.

Lesson 3

Tan Kock Lim

Islamic Banking
Same as conventional commercial and investment
banking except based on Syariah principles of mutual
risk and profit sharing between parties, the assurance
of fairness for all parties involved and transactions
dedicated to assets or underlying business activities.
Activities such as gambling (masir), speculation
(gharar) and those that involve interest (riba) are not
allowed.

Lesson 3

Tan Kock Lim

Non Bank Financial Intermediaries


1. Provident and pension funds
The main aim of provident or pension fund is to provide benefits to its
members when they retire from their existing employment.
Similar to other financial institutions, provident and pension funds also
have their own sources and uses of funds.
However, since they do not accept deposits and give out loans, they
are not categorised as banking financial institutions.

Lesson 3

Tan Kock Lim

Non Bank Financial Intermediaries


2.Insurance companies
Insurance companies are also nonbank financial institutions.
Nevertheless, they do play a significant role in the Malaysian
financial system.
They perform the role of intermediaries that link the deficit units with
the surplus units through their investment activities.
Their main sources of funds include premiums paid by
policyholders.
These premiums are then used for the purpose of investment in
selected instruments in order to generate income.
Lesson 3

Tan Kock Lim

Non Bank Financial Intermediaries


3. Development Financial Institutions (DFIs)
Malaysian Development Financial Institutions (DFIs) are specialised
financial institutions established by the Government with the specific
mandate to develop and promote key sectors that are considered strategic
to the overall socio-economic development objectives of Malaysia.
The focused sectors include agriculture, small and medium enterprises
(SMEs), infrastructure, maritime, export-oriented sector and also
capitalintensive and high-technology industries.
DFIs provide a range of specialised financial products and services
together with consultation and advisory services to suit the specific needs
of the targeted sectors for the purpose of long term economic development.

Lesson 3

Tan Kock Lim

Feature of Banking Assets And Liabilities


Lists of main criterion banks will be emphasizing before
granting long term loan to their clients:

Capital adequacy and the role of capital (RWCR = Capital/Total risk


weighted assets x 100%)

Assets and liability management How much to lend to make


a profit?

Interest rate risk indicate how changes in interest rates


affect profitability

Liquidity - proportion of outstanding loans to total assets


(if > 60-70% of total assets are loaned out, the bank
is considered to be highly illiquid

Asset quality What is the default risk of the loan book?

Profitability earnings and revenue growth.

(Refer to unit 1, page 17 Feature of banking assets and liabilities)

1.3 The Regulatory Framework of the Malaysian


Banking Industry
Regulatory Bodies in Malaysian's Banking Industry

Central Bank of Malaysia Act 2009

Financial Service Act 2013

Islamic Financial Services Act 2013

Development Financial Institutions Act 2002

Anti Money Laundering & Anti Terrorism Financing Act 2001

Money Changing Act 1998

(Refer to unit 1, page 36-38 pieces of legislation to regulate and


supervise the financial system)

Financial Service Act 2013

The Financial Services Act 2012 ("FSA") came into operation on


30 June 2013.

The FSA, which has the aim of promoting financial stability, is an


extensive legislation which consolidates the various legislations
pertaining to banking, investment banking, insurance and
payment systems businesses and the oversight of the money
market and foreign exchange administration in Malaysia.

Thus, the Banking and Financial Institutions Act 1989, the


Insurance Act 1996, the Exchange Control Act 1953 and the
Payment Systems Act 2003 are all repealed by the FSA although
licences which were issued and approvals which were granted
under the repealed legislations are deemed to have been issued
under the FSA and continue to apply.

1.3 Regulatory Framework of the Malaysian


Banking Industry
Justification for regulating the financial system:- To ensure financial stability and maintain market participants'
confidence in the financial market
- To ensure that banks, investment firms and insurance companies
comply with applicable rules and maintain adequate control of their
business and risk.
- To protect consumer & other users in financial service such as
bank depositors, insurance policy holders, investors on securities
market.
- To protect banking confidentiality
- To avoid misuse of banks being used for criminal purpose eg.
laundering the proceeds of crime

Instruments & Requirements of Bank Regulation

Capital requirement (min requirement of 8%risk capital weighted ratio)

Reserve requirement (Liquidity reserve ratio)

Corporate governance (a set of process, policies, law affecting the way a


corporation is administered/directed/controlled stakeholders)

Financial reporting and disclosure requirements

Credit rating requirement (Credit rating agency - RAM, MARC) to disclose to


investors / prospective investors)

Large exposures restrictions (single customer limit not more than 5% of bank's
total capital

Regulatory Body of Securities Industry


The securities industry in Malaysia is governed by:
1. Securities Industry Act 1983.
2. Securities Industry (Central Depository) Act 1991.
3. Securities Commission Act 1993.
4. Companies Act 1965.
5. Securities Industry (Central Depositories) (Foreign Ownership) Regulations
1996.
6. Securities Industry (Reporting of Substantial Shareholding) Regulations
1998.

Clarification of Some Basic Terms- Basel I & II


Pillar 1: The rules that define the minimum ratio of capital to risk weighted assets.
Pillar 2: The supervisory review pillar, which requires supervisors to undertake a qualitative
review of their banks capital allocation techniques and compliance with relevant standards.
Pillar 3: The disclosure requirements, which facilitate market discipline.
Internal Ratings: The result of a banks own measure of risk in its credit portfolio.
External Credit assessments: Ratings issued by private or public sector agencies.
Consolidation: The measurement of a banks risk on a groupwide basis.
Operational Risk: The risk of direct or indirect loss resulting from inadequate or failed
internal processes, people and systems, or from external events.
Credit Risk: The risk of loss arising from default by a creditor or counterparty.
Market Risk: The risk of losses in trading positions when prices move adversely.
Credit Risk Mitigation: A range of techniques whereby a bank can partially protect itself
against counterparty default (for e
Asset Securitisation: The packaging of assets or obligations into securities for sale to third
parties.

DEFINITION of '1988 Basel Accord'


A set of agreements set by the Basel Committee on Bank
Supervision (BCBS), which provides recommendations on
banking regulations in regards to capital risk, market risk
and operational risk.
The purpose of the accords is to ensure that financial
institutions have enough capital on account to meet
obligations and absorb unexpected losses.

Basel 1
Basel I, that is, the 1988 Basel Accord, is primarily focused on credit risk and appropriate riskweighting of assets. Assets of banks were classified and grouped in five categories according to
credit risk, carrying risk weights of :

0% (for example cash, bullion, home country debt like Treasuries),

20% (securitisations such as mortgage-backed securities (MBS) with the highest AAA rating),

50% (municipal revenue bonds, residential mortgages),

100% (for example, most corporate debt), and some assets given No rating.

Banks with an international presence are required to hold capital equal to 8% of their

risk- weighted assets (RWA).


The tier 1 capital ratio = tier 1 capital / all RWA
The total capital ratio = (tier 1 + tier 2 + tier 3 capital) / all RWA
Leverage ratio = total capital/average total assets
Banks are also required to report off-balance-sheet items such as letters of credit, unused
commitments, and derivatives. These all factor into the risk weighted assets.

Tier 1 Capital vs Tier Capital


Tier 1 Capital
Tier 1 capital consists of shareholders' equity and retained earnings. Tier 1
capital is intended to measure a bank's financial health and is used when a
bank must absorb losses without ceasing business operations. Under Basel
III, the minimum tier 1 capital ratio is 6%, which is calculated by dividing the
bank's tier 1 capital by its total risk-based assets.
Tier 2 Capital
Tier 2 capital includes revaluation reserves, hybrid capital instruments and
subordinated term debt, general loan-loss reserves, and undisclosed
reserves. Tier 2 capital is supplementary capital because it is less reliable
than tier 1 capital. In 2015, under Basel III, the minimum total capital ratio is
8%, which indicates the minimum tier 2 capital ratio is 2%, as opposed to
6% for the tier 1 capital ratio.

Basel I & II
The first Basel Accord, known as Basel I, was issued in 1988 and focuses
on the capital adequacy of financial institutions. The capital adequacy risk, (the
risk that a financial institution will be hurt by an unexpected loss), categorizes
the assets of financial institution into five risk categories (0%, 10%, 20%, 50%,
100%). Banks that operate internationally are required to have a risk weight of
8% or less.
The second Basel Accord, known as Basel II, is to be fully implemented by
2015. It focuses on three main areas, including minimum capital requirements,
supervisory review and market discipline, which are known as the three pillars.
The focus of this accord is to strengthen international banking requirements as
well as to supervise and enforce these requirements.

Difference between Basel 1 & II


The main difference is that the Basel I accord
mainly focused on capital requirements for banks.
The Basel II adds supervision and market
discipline to these capital requirement through
the "Three Pillar" concept.

The first pillar is about capital requirement.


The second pillar is about regulation and
supervision.
The third pillar describes market discipline.

Basel II (Unit 2, page 28=30)....con't


Basel II go beyond Basel I minimum capital requirements, allowing leaders to use internal
models to ascertain regulatory capital, while seeking to ensure that banks amend and improve
risk management culture from the bottom up.
A strong risk management culture goes hand in hand with aligning banks capital requirements
with prevailing modern risk management practices and with ensuring that the focus on risk is
elevated to supervisory levels and market discipline through enhanced risk- and capitalrelated disclosures.
In June 2004, the Bank for International Settlements (BIS) finalised the Basel II Capital Accord
(Basel II) following more than five years of industry and regulatory consultation.
A key objective of Basel II is to revise the rules of the 1988 Basel Capital Accord in such a way
as to align banks regulatory capital more closely with risks.
Basel II is to better align regulatory capital measures with the inherent risk profile of a bank
considering credit, market, operational and other risks.

Basel II (Unit 2, page 28=30)


The Basel II framework consists of three pillars,
i.e.,
Pillar I: minimum capital requirements,
Pillar II: supervisory review and
Pillar III: market discipline

The Basel II Framework


The key differences etween the 1988 capital Accord and
Basel II are summarised

The Basel II Framework

First Pillar
The first pillar deals with maintenance of
regulatory capital calculated for three major
components of risk that a bank faces:
credit risk,
operational risk and

market risk.
Other risks are not considered fully quantifiable at
this stage.

Second Pillar
The second pillar deals with the regulatory response to
the first pillar, giving regulators much improved tools
over those available to them under Basel I.
It also provides a framework for dealing with all the other
risks a bank may face, such as systemic risk, pension
risk, concentration risk, strategic risk, reputation risk,
liquidity risk and legal risk, which the accord combines
under the title of residual risk.
It gives banks a power to review their risk management
system.

Third Pillar
The third pillar deals with transparency and
the obligation of banks to disclose
meaningful information to all stakeholders.
Clients and shareholders should have a
sufficient understanding of the activities of
banks, and the way they manage their risks.

Basel II (Unit 2, page 28=30)....con't


Malaysian banks will need be compliant with the highest
level of Basel II banking risk management to keep up with
global developments because Basel II is an upgrade
of the previous global banking risk management accord
Basel I that focused on credit risk and subsequently
market risk.
Under Basel II, the risk capital charge has been extended
to cover all risks including operational risk thus, making it
sort of a necessity to be within the global playground
arena.

Basel II (Unit 2, page 28=30)....con't


The benefits of Basel II cannot be achieved with just a strict regulatory
compliance approach.
While Basel II serves as a powerful catalyst to reposition the role of, and
the attention to risk management in banking institutions, significant efforts
need to be directed at strengthening the financial structure, corporate
governance, risk management and data capabilities within the banking
institutions.
The approach adopted by Bank Negara Malaysia has been for these efforts
to complement and reinforce the positive outcomes of Basel II.
These are important preconditions for, and not automatic outcomes from the
adoption of Basel II.

Basel II (Unit 2, page 28=30)....con't


One of the most important consequences of Basel
II lies in the effect that it will have in sharpening
the focus on corporate governance in banking
institutions.
While there has been considerable attention focused on
the quantitative implications and operational aspects of
the Basel II framework, there has been less attention
given to the corporate governance dimensions
associated with its implementation.

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