The Malaysian Financial System PDF

T O (N SE FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO ) CHAPTER 1 THE MALAYSIAN FINANCIAL SYSTEM THE MALAYSIAN FINANCIAL SYSTEM Learning Outcome At the end of the chapter, you will be able to: SE ) Explain the components of the Malaysian financial system and their respective roles. FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO Key Topics In this chapter, you will be able to read about: Introduction Roles of the Financial System The Banking System Financial Institutions and Non-Bank Financial Intermediaries Non-Bank Lending Organisations The Insurance Industry The Capital Market System Capital Market Institutions and their Roles Summary Assessment Criteria During the exam, you will be expected to: T Discuss the Malaysian financial system and its roles. Outline the characteristics of the key participants operating in the Malaysian O 1. THE MALAYSIAN FINANCIAL SYSTEM financial system. (N 1-1 1.1 INTRODUCTION At its most basic level, the term “financial institutions” refers to institutions such as commercial banks, which mobilise funds from depositors, investors and savers to lend to borrowers from both the private and public sectors. The banking system in Malaysia is a well-established industry, formally set up with the arrival of the Chartered Mercantile Bank of India, London and China in Penang in 1859. Bank Negara Malaysia (BNM), the Central Bank and the chief financial regulator in the country, was established a century later to ensure the orderly development of the industry. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-2 The increased awareness of linkages and inter-relationships between these two elements have expanded the scope of the term “financial institutions” to include capital markets and other related elements. The term “financial system”, according to Section 2 of the Central Bank of Malaysia Act of 2009, “refers collectively to financial institutions, capital market intermediaries ) or participants, financial markets and payment systems in Malaysia.” SE While BNM functions as the chief regulator of the financial sector in Malaysia, the system has incorporated external frameworks to reinforce and supplement formal FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO regulation. The external frameworks governed by other agencies include: the Malaysian Deposit Insurance Corporation (PIDM), which administers the statutory deposit insurance apparatus in the banking system to protect depositors; the Malaysian Accounting Standards Board (MASB), which is responsible for promulgating financial accounting and reporting standards and promotes convergence with international accounting and financial reporting standards (IFRS); industry associations, which establish industry best practice and codes of conduct for market intermediaries, such as the Association of Banks in Malaysia; and professional bodies such as the Bar Council and the Malaysian Institute of Accountants, which establish codes of conduct and best practice and guide members on their roles and responsibilities. The broader definition of “financial institutions” reflects Malaysia’s move away from a financial system that was traditionally reliant on banks as the largest source of funding to an increasingly market-based financial system. In a bank-based financial system, financial markets are typically less developed T and offer a narrower range of options than market-based financial system such as O those in the UK and USA. Financial markets in the latter tend to be highly developed, (N offering a range of different products for different types of participants. These markets are generally more active than bank-based financial systems and thus possess greater liquidity. Financial institutions play a vital role in the real economy by providing funds that enable companies to operate efficiently and competitively and grow their operations. To this end, the financial institutions operating within an economy must be able to provide products that meet the present and future needs of the players involved, i.e., the needs of businesses and individuals. Moreover, financial institutions play the crucial role of facilitating payment transfers and maintaining financial stability within the economy by supplying funds when required. In summary, the financial system in Malaysia comprises two major components: the banking system and capital markets. As the financial system is mainly made up of the Banking and Capital Market Systems, the key outputs of the financial system is reflected in the roles of both these systems. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1.2 ROLES OF THE FINANCIAL SYSTEM 1.2.1 The Role of the Banking System The financial system, comprising financial markets and their intermediaries such as banks and non-banks, plays the main role of reallocating funds from savers and depositors to borrowers. These savers and users are made up of SE ) private sector companies and individuals, as well as government agencies or public sector organisations. The system also operates as a payment FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO mechanism, facilitating money transfers from one party to another. A well-run, flexible and competitive banking system contributes to the growth of the economy. It provides the means through which the central bank can exercise monetary policy intended to manage growth and influence the inflation rate. Conversely, a weak banking system that is unstable and/or uncompetitive can limit growth and undermine the economy and confidence of investors. Depending on its quality, the supervision of the banking system can either contribute to or limit the system’s effectiveness within the broader financial system and the economy. a. The Banking System as a Financial Intermediary The primary role of the banking system is to provide a mechanism for individuals and entities to save surplus funds for future events, such as retirement, education, medical treatment or investment in housing. These funds represent the primary source of borrowing for businesses and individuals to participate in economic activities. Banks facilitate this savings–investment process by providing the appropriate infrastructure and mechanism to support the transactions. In a fully developed and T interlinked system, the savers and borrowers may be either domestic or O foreign parties. (N 1-3 Banks gather deposits and disburse loans through products that meet specific depositor and borrower needs. Banks generally mobilise deposits as short-term funds into short-term funding for borrowers, while longerterm funding needs are usually facilitated within the capital markets. The process of mobilising funds from savers and depositors and allocating them to users or borrowers is known as financial intermediation (see Figure 1.1). Proper and efficient allocation of funds and the secure transfer of money are two components of economic stability and growth. For this reason, public and investor confidence in the financial market system is an important component of vibrant economic growth. The efficient allocation of funds for this purpose requires a high level of skill, a strong regulatory framework and efficient linkages between various components of the financial market. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-4 The heart of the banking system is the money market, comprising the domestic money market and foreign exchange market. The money market is a network of financial intermediaries dealing in local currency deposits between depositors and users of such funds. SE ) Depositors place funds with banks for security and interest income FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO FINANCIAL INTERMEDIATION Banks lend depositor funds to borrowers in return for interest income Borrowers use the money for economic activities to generate revenue Banks are financial intermediaries facilitating the flow of funds from depositors to borrowers. They secure funds from the depositors whilst returning an interest income to them. These funds are then lent to borrowers who use them for economic activities. Borrowers are expected to repay the loan plus interest at a specified time Figure 1.1: The process of financial intermediation This is a market for short-term money, pending long-term investment T opportunities in the capital market. As such, funds deposited in the (N O money market are available to borrowers for short duration, typically from overnight to 90 days. Funds meant for longer loan tenure, i.e., 12 months or more, are less common in the money market environment. Dealings in foreign currency are linked to domestic currency transactions in support of international purchases and sales, as well as investment fund flows conducted by local businesses and investors. These dealings are short-term in nature and involve alternative currencies. This results in the creation of a separate foreign exchange trading system within the money market. b. The Banking System as a Facilitator of Payments Another important role of the banking system is to facilitate the settlement of payment obligations and the transfer of funds between various parties within the financial system (see Figure 1.2). This is the “back-office” or “engine room” of the financial sector and is critical for the uninterrupted operation of the financial system as a whole. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM Banks generally provide the infrastructure and means required to facilitate such transfers. Some of the bank services provided here include payment settlement and clearing systems for securities, cheques, funds, derivatives and electronic funds transfer. The banking system plays a critical role as a facilitator of payments. The failure of a financial institution to settle its obligations in a timely manner ) could have a significant impact on the financial system as a whole. The SE failure to remit payments in time could result in the failure of counterparties, FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO usually other institutions, to settle their own obligations, resulting in a domino effect. Importer who needs to forward payments to his foreign supplier O T Cheque clearance for local businesses (N 1-5 Bank as a facilitator of payments Backed payment services for online merchants Transfer of funds from one bank to another Figure 1.2: Examples of a bank’s payment facilities The Asian Financial Crisis of 1997 (AFC) and Global Financial Crisis of 2008 (GFC) highlighted the danger of counterparty risk to the overall financial system, especially the links between payment settlement, credit and liquidity risks, and transparency. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-6 c. The Importance of Banking Regulation The two most recent financial crises emphasised the need for an effective regulatory framework and greater prudence within the national financial system. These are the major concerns and policy objectives of BNM. The fallout from the AFC led to the introduction of the new Malaysian Deposit Insurance Corporation (PIDM) Act in 2005, administered by ) Perbadanan Insurans Deposit Malaysia, and the Takaful Insurance Benefits SE System (TIPS). These pieces of legislation provide additional safety nets to FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO depositors and the insurance and takaful sectors through the provision of insurance on deposits with institutions covered by the legislation. The activities of financial intermediaries must be closely regulated to safeguard the interests of all stakeholders, especially the depositors and borrowers. Various laws have been enacted in the country to protect these interests, including: i. the Financial Services Act 2013 (FSA 2013), which replaced the Banking and Financial Institutions Act 1989 effective 30 June 2013, for the banking sector; and ii. the Capital Markets and Services Act 2007, as amended by the Capital Markets and Services (Amendment) Acts 2010, 2011, 2012 and 2015, for the capital markets. The presence of a strong regulatory framework and efficient linkages require stringent oversight, which is conducted chiefly by BNM. 1.2.2 The Role of the Capital Market System T The capital market system operates in parallel to the banking system. Its O primary role is to facilitate the pooling of long-term funds for larger and (N longer-term financing needs of the economy that the banking system cannot provide. The capital market plays two important functions in the financial market system: While the banking system mobilises short-term funds, the capital market system enables the mobilisation of long-term investment funds for permanent capital needs. Businesses that require long-term financing can raise equity funding by way of initial public offering (IPO), rights issue and securities placement. The capital market provides liquidity through its secondary market activities by enabling investors with funds to buy or sell their securities. Liquidity is crucial to attract long-term funding in an economy. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM The capital market system consists of three interlinked markets namely the equity, debt securities and derivatives. MALAYSIA’S CAPITAL MARKETS SYSTEM subsequently traded in a secondary market. ) raised from public investors, and company shares are FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO Market The equity market is where companies’ share capital is SE Equity The debt securities market differs markedly from the equity Debt Securities Market market as the type of securities issued and traded are vastly different. Securities issued in the debt market are known as debt securities, and come in the form of bonds, loan stocks and convertible debt instruments, which generally have a specific maturity date for repayment and usually carry a pre-determined coupon interest rate. The third component within the capital market system is the derivatives market, which trades derivative instruments Derivatives Market used by investors to hedge their financial risks. A derivative is a financial instrument that derives its value from an underlying asset. In other words, the value of a derivative is dependent on the value of an asset that it covers. Examples of derivatives include common palm oil futures and interest T rate futures, as well as share warrants and options. O Equities and debt securities differ significantly in their risks and rewards, and the separate markets catering to each, provide a more organised structure (N 1-7 for fund-raising and trading purposes. At the heart of the capital market system is the Securities Exchange, i.e., Bursa Malaysia, which is the trading hub for capital market institutions and other market participants. Capital market institutions include investment banks, stockbroking houses and fund managers. The regulatory agency that supervises the capital market system is the Securities Commission acting under the provisions of the Capital Markets and Services Act 2007, as amended by the Capital Markets and Services (Amendment) Acts 2010, 2011, 2012 and 2015. Currently, all trading of equity shares, bonds and debt securities, and selected derivatives are conducted through Bursa Malaysia by capital market services license holders such as equity dealers and futures brokers. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-8 1.3 THE BANKING SYSTEM The banking system is made up of banking intermediaries and non-bank financial intermediaries. These institutions collectively provide the mechanism for the mobilisation of savings and investments as well as the payment system for the Malaysian economy. BNM is the regulatory agency for the banking system. ) Aside from BNM, the Central Bank, the banking system in Malaysia comprises SE commercial banks, both domestic and foreign controlled. Other financial institutions operating within the banking system include Islamic banks, discount houses, FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO representative offices of foreign banks and offshore banks in the International Offshore Financial Centre of Labuan. BACKGROUND: Regulators of the Malaysian Banking System BNM stands at the head of the monetary and banking system in Malaysia. With the exception of offshore banks, BNM has been entrusted to regulate and supervise Malaysia’s banking system to ensure a sound and strong financial system, which is essential for Malaysia’s steady and balanced economic and social development. BNM’s role is presently stipulated under the Financial Services Act 2013, and previously under the now-repealed BAFIA. The Labuan Financial Service Authority (LFSA) was set up on 15 February 1996 as a single regulatory body to spearhead and coordinate efforts to promote and develop Labuan as an International Business & Financial Centre (IBFC). The establishment of the LFSA is part of the government’s commitment to turn Labuan into a premier IBFC of high repute. The Authority’s chief responsibility is to regulate all offshore institutions located in Labuan. While Bank Negara T Malaysia does not directly supervise these offshore institutions, the Governor of (N O BNM sits as Chairman of the Authority. At the heart of Malaysia’s banking system is the electronic money market i.e. the Kuala Lumpur Interbank Market, which mobilises funds from bank and non-bank institutions, channelling them to borrowing entities. Parallel to this role, the banking system facilitates the efficient transfer of funds within the domestic financial system, as well as outside Malaysia on behalf of various intermediaries. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1.4 FINANCIAL INSTITUTIONS AND NON-BANK FINANCIAL INTERMEDIARIES 1.4.1 Financial Institutions FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO SE ) a. Commercial Banks Commercial banks are the largest and most substantial providers of funds in the Malaysian banking system. Under the licensing terms recommended by Bank Negara Malaysia and granted by the Minister of Finance, commercial banks undertake a wide range of banking activities and business. Commercial banks now provide financial services such as leasing and hirepurchase following the merger of finance companies and banks in the late 1990s and early 2000s. Some of the key banking services provided by commercial banks in Malaysia include: ▶ deposit facilities for the saving of funds through current, savings and fixed/time deposit accounts and other financial instruments; ▶ funds transfer facilities to make payments on behalf of customers; ▶ loans and credit facilities (including hire-purchase and leasing) for both individual borrowers and corporations; ▶ financing for the government through the purchase of government securities and treasury bills; and ▶ other banking services such as fund remittances, foreign exchange transactions and the financing of both domestic and international trade. O T Under Section 10 of FSA 2013, commercial banks and investment banks are licensed to undertake “banking business” and “investment banking business” respectively. In the first case, “banking business” is defined by FSA 2013 as the business of: (N 1-9 ▶ accepting deposits on current accounts, deposit accounts, savings accounts or other similar accounts; ▶ paying or collecting cheques drawn by or paid by customers; ▶ providing finance; and ▶ such other business as prescribed under Section 3, FSA 2013. Meanwhile, “investment banking business” is defined by the Act as the business of: ▶ accepting deposits on deposit accounts; ▶ providing finance; ▶ any regulated activity carried out in pursuant to a Capital Markets Services License under the Capital Markets and Services (Amendment) Act 2015; and ▶ such other business as prescribed under Section 3 of the FSA 2013. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-10 b. Islamic Banks Islamic banking was introduced in Malaysia in 1983. The Islamic Banking Act 1983, passed to regulate Islamic banking, came into effect on April 7, 1983. The Islamic Financial Services Act 2013 (IFSA) replaced the Islamic Banking Act 1983 in June 2013. The provisions of the IFSA 2013 regulate and supervise Islamic financial ) institutions, payment systems and other relevant entities. The IFSA provides SE oversight of the Islamic money market and the Islamic foreign exchange FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO market to promote financial stability and compliance with Shariah tenets for all related matters. Meanwhile, the Government Investment Act 1983 (amended in 1990 and 2005, and now known as the Government Funding Act 1983) was enacted to empower the Government to issue Government Investment Certificates, i.e., Government bonds that are compliant with Islamic Shariah principles. See Figure 1.3 for the differences between conventional banks and Islamic banks. The Islamic banking system is available to both Muslims and nonMuslims alike. The underlying philosophy of Islamic banking is to remove uncertainties from financial transactions. Profit sharing is in the form of dividends rather than interest. Dividends are considered discretionary payment as the dividend is declared when profit is made. Furthermore, in Islamic banking, profit sharing rates are fixed at the beginning of the financing agreement and not subject to fluctuations or variations. This removes uncertainties and enables cashflow planning to be undertaken with more predictability. Meanwhile, losses are shared (N O T according to pre-determined ratios. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM Interest is haram, i.e. illegal in Islamic Finance FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO SE Interest income is a key ISLAMIC BANKS ) CONVENTIONAL BANKS Can invest in any asset class except in those that are deemed illegal by law Can only invest in asset classes that are acceptable by Shariah law Can accept any amount of risk to maximise profibility Can only accept risk to maximise profitability in accordance with Shariah law Figure 1.3: Some key differences between conventional and Islamic banking In contrast, interest payments in conventional banking are compulsory. Interest payments must be made regardless of whether profits are earned. There are presently 16 established Islamic banks in Malaysia, with six of them owned by foreign institutions. Bank Islam and Bank Muamalat are the two earliest Islamic banks in Malaysia. They were subsequently followed T by banks with Islamic banking windows, which were later converted into O licensed Islamic banking subsidiaries of their respective banking groups. (N 1-11 Islamic banks are required to adhere to the same regulatory rules as conventional banks This includes maintaining a minimum risk weighted capital adequacy ratio and minimum capital for operational and market risks in line with the Basel framework and maintaining a statutory reserve account with BNM. In addition, they have to observe liquidity and leverage ratios requirements in accordance with the Basel framework. The long-term objective of BNM is to create an Islamic banking system that operates in parallel to the conventional system. To achieve this status, the Islamic banking system has to meet three targets: i. The creation of a large variety of Islamic financial instruments; ii. The establishment of a significant number of Islamic banking players; and iii. The establishment of an Islamic inter-bank market. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-12 As at the end of 2019, Malaysia’s Islamic banking assets were worth USD 254 billion representing 38.0% of the total banking sector deposits1 BACKGROUND: Development of the Malaysian Islamic Banking System ) To enhance the Islamic banking sector, the government established the SE Malaysian Islamic Financial Centre (MIFC) in 2006 to play the role of an FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO international marketplace for Islamic funds and investments. The MIFC draws cooperation and support from BNM, the Securities Commission, various other government agencies and industry participants from the public and private sectors. The expanding Islamic finance sector requires professional Islamic banking expertise. The International Centre for Education in Islamic Finance (INCEIF) and the Islamic Banking and Finance Institute Malaysia (IBFIM) were set up to provide training and education to develop expertise and knowledge in Islamic financing. At the same time, the Islamic money market has developed into a sound secondary market having recorded achievements in the following areas: the issuance of Government bonds that are compliant with Islamic Shariah requirements; the establishment of an Islamic interbank money market; the creation of a full-fledged Islamic banking system with qualified participants; (N O T the creation of a dual banking system, i.e., an Islamic banking system operating in parallel with the conventional banking system. Malaysia’s Islamic finance continues to grow rapidly, supported by a conducive operating environment. Malaysia has also placed a strong emphasis on human capital development alongside the development of the Islamic financial industry to ensure the availability of Islamic finance talent. These initiatives have transformed Malaysia into one of the most developed Islamic banking markets in the world. 1 Source: Bank Negara Malaysia, Islamic Banking and Takaful Overview CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM c. Characteristics of Islamic Banking The principal regulatory objective of the IFSA 2013 is to promote financial stability and compliance with Shariah requirements amongst Islamic banks. BNM bears the responsibility of promoting the safety and soundness of Islamic financial institutions, including the Islamic money and foreign exchange markets and all related instruments. ) Additionally, BNM is responsible to ensure the professional conduct of FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO using Islamic financial products and services. SE Islamic banking players and protect the rights and interests of consumers At the same time, Islamic banks in Malaysia are required to do the following: i. Seek Advice from the Shariah Advisory Council An Islamic bank is obligated to seek the advice of the Shariah Advisory Council on Shariah matters related to its banking business. This is provided for under Section 51 of the Central Bank of Malaysia Act 2009. It is also obliged to comply with the advice of the Council. Section 29 of the IFSA 2013 empowers BNM to specify, in accordance with the advice of the Shariah Advisory Council, standards on Shariah matters in accordance with Islamic law. This provision empowers BNM to specify standards on Shariah governance. This includes the functions and duties of key functionaries, fit and proper requirements, disqualification of members of Shariah committees, and any other matters. It is for the purpose of compliance with Shariah principles by the Islamic bank. Islamic banks are required to ensure that their internal policies and procedures on Shariah governance are consistent with the standards specified by BNM. T O (N 1-13 ii. Establish a Shariah Committee Section 30 of the IFSA 2013 requires all Islamic banks to establish a Shariah committee to advise on its business, affairs and activities to ensure that their operations comply with Shariah requirements. A financial group may, with the approval of BNM, establish one Shariah committee to serve all Islamic financial institutions within the group. d. Development Financial Institutions (DFIs) Development Financial Institutions (DFIs) are specialised financial institutions established by the Government to promote investment and development in specific sectors such as agriculture, manufacturing and small and medium enterprises (SME). Their main purpose is to fill the gap in the supply of funding and financial services to these sectors, which are not usually covered by established financial institutions. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-14 The main objective of DFIs in Malaysia is to provide long-term funds tailored to the needs of borrowers in the targeted sectors. Both federal and state governments provide funding in the form of equity participation and low interest loans. The Development Financial Institutions Act 2002 (DFIA) was enacted and became effective on 15 February 2002. Its purpose was to provide a SE safe and sound financial management. ) comprehensive regulatory and supervisory framework to ensure the DFIs’ FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO There are currently six institutions prescribed under the DFIA, overseen by Bank Negara Malaysia. They are: ▪ Bank Pembangunan Malaysia Berhad; ▪ Small Medium Enterprise Development Bank Malaysia Berhad (SME Bank); ▪ Export-Import Bank of Malaysia Berhad; ▪ Bank Kerjasama Rakyat Malaysia Berhad; ▪ Bank Simpanan Nasional; ▪ Bank Pertanian Malaysia Berhad (Agrobank). One of the main goals of the DFIA 2002 is to ensure that the roles, objectives and activities are consistent with the government’s national objectives, and the mandated roles are effectively and efficiently implemented. The DFIA thus requires DFIs to submit their proposed business and development activities, and projected sources of funding to BNM on an annual basis. Furthermore, the DFIA 2002 provides a mechanism to monitor the management of government allocated funds to ensure the funds are utilised as specified. T Importantly, Section 125 of the DFIA 2002 stipulates that the provisions of (N O the DFIA shall prevail in the event of conflict or inconsistency between the provisions of DFIA 2002 and the potential applicability of other laws. The other laws that may introduce conflicts or inconsistencies include: ▪ The Financial Services Act 2013; ▪ The Bank Kerjasama Rakyat Malaysia Berhad (Special Provisions) Act 1978; ▪ The Companies Act 2016; and ▪ The Co-operative Societies Act 1993. i. Bank Pembangunan Malaysia Berhad (BPM) The Ministry of Finance Inc. and the Federal Lands Commissioner established BPM (previously known as Bank Pembangunan dan Infrastruktur Malaysia Berhad) in 1973 with the aim of increasing Bumiputera participation in business and industry. Today, BPM focuses on the development of four key sectors of the economy, in keeping with CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM the government’s policy: infrastructure development, maritime and shipping, oil and gas, and technology. In 1998, BPM was entrusted with the role of providing finance for infrastructure projects, particularly those belonging to the government. In 2002, the Bank received an “exempt dealer status” from the Ministry of Finance, allowing it to offer corporate advisory, financing and SE ) underwriting services to companies engaged in infrastructure projects. BPM operates under various subsidiaries and associates. Major FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO companies within the group include Global Maritime Ventures Bhd. (GMV) and Pembangunan Leasing Corporation Sdn. Bhd. Global Maritime Ventures Bhd (GMV), the flagship company of the BPM Group, was established to develop and promote the Malaysian shipping industry and reduce the country’s dependence on foreign vendors for freight services. It was mandated to manage a RM500 million government fund earmarked for the development of the Malaysian shipping industry. GMV is 90% owned by BPM. In November 2021, BPM completed the acquisition of Danajamin Nasional Berhad to become a wholly owned subsidiary. Danajamin is principally engaged in the business of providing financial guarantee insurance. ii. The Small Medium Enterprise Development Bank Malaysia Berhad (SME Bank) The SME Bank, previously known as Bank Industri dan Teknologi Malaysia Berhad, was established to provide financial support for SMEs to develop as an engine of growth in line with the national economic agenda. The principal role of the Bank is to provide Malaysian SMEs—defined within the SME classification guidelines of the National SME Development T O (N 1-15 Council—with financing support as well as financial and business advisory services. iii. The Export–Import Bank of Malaysia (EXIM Bank) EXIM Bank was incorporated on 29 August 1995 as a government-owned development financial institution. It is a wholly owned subsidiary of the Ministry of Finance Inc. The Bank was established to support reverse investments and the exports of strategic sectors. EXIM Bank also helps facilitate the entry of Malaysian companies into new, non-traditional markets. EXIM Bank provides financing for capital investment, as well as working capital and export credit assistance to companies selling their goods overseas. It also provides business information and services and helps promote ‘project exports’ such as the construction and engineering services of Malaysian contractors. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-16 In 1998, EXIM Bank was designated the manager of the Export Credit Refinancing (ECR) scheme formerly funded by the Government and Bank Negara Malaysia. The scheme’s primary objective is to encourage exports by structuring competitive lending rates for exporters with the support of commercial banks participating in the scheme. While the funding comes from EXIM Bank, the lending bank underwrites ) the credit risk. Facilities are extended in the form of pre-shipment and SE post-shipment financing to eligible exporters on an order-based or FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO a certificate of performance-based method. EXIM Bank also provides credit insurance and credit takaful to cover potential losses arising from international trade. EXIM Bank took on this role following its merger with Malaysia Export Credit Insurance Berhad (MECIB) on 30 December 2005. iv. Bank Kerjasama Rakyat Malaysia Berhad Bank Kerjasama Rakyat Malaysia Berhad was established in 1954, under the Co-operative Ordinance Act 1948. On 6 January 1973, its name was changed to Bank Kerjasama Rakyat Malaysia Berhad following the broadening of its scope of activity. Bank Kerjasama Rakyat was placed under the purview of BNM with the introduction of the DFIA 2002. As a co-operative, the main objective of Bank Kerjasama Rakyat Malaysia Berhad is to improve the standard of living of its stakeholders through the provision of financing facilities as well as financial and advisory services for the commercial, industrial, and agricultural sectors, and encourage savings among its members. The principal activities of Bank Kerjasama Rakyat Malaysia Berhad are providing financing for property, education, personal and other (N O T financing options, including Islamic pawn broking to members of the public and co-operatives. Since 1997, all banking facilities offered by Bank Kerjasama Rakyat Malaysia Berhad are based on Shariah principles. v. Bank Simpanan Nasional (BSN) The BSN principal activity is to play the role of a national savings bank, accepting deposits, and providing retail loans. The government guarantees all deposits received by BSN. BSN’s deposit funds are channelled to finance housing, personal credit cards, hire-purchase and corporate loans. BSN has subsidiaries and associates engaged in asset management, insurance and takaful services. BSN has almost 400 branches and banking agents nationwide particularly in rural areas and has over 7 million customers with saving deposits amounting to several billion Ringgit. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM vi. Bank Pertanian Malaysia Berhad (Agrobank) Bank Pertanian Malaysia Berhad (Agrobank), formerly known as the Agriculture Bank of Malaysia, was established in 1969 to promote sound agricultural development through the provision of loans and advances. The main functions of the bank are to co-ordinate and supervise the granting of credit facilities for agricultural purposes and ventures ) and mobilise savings, particularly from the agriculture sector and FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO now under the purview of Bank Negara Malaysia. SE community through a branch network similar to commercial banks. It is Apart from the above 6 prescribed institutions under the DFIA 2002, there are a number of non-prescribed development financial institutions in Malaysia (incorporated under legislation other than DFIA), as follows: i. Sabah Development Bank (SDB) The Sabah Development Bank (SDB) was established in 1977 by the Sabah State Government to finance development projects and act as the Sabah State Government’s financial intermediary. The primary role of Sabah Development Bank is to act as the mobiliser of financial resources in the state of Sabah and facilitate economic development and investment in the state. The bank also provides advisory services to the Sabah state government, raises funds for state government projects and manages the state’s surplus funds. ii. Sabah Credit Corporation (SCC) The Sabah Credit Corporation (SCC), a wholly owned entity of the Sabah State Government, was incorporated in 1955 as the North Borneo Credit Corporation. It was renamed Sabah Credit Corporation in 1972. The SCC’s main objective is to extend financing for investments in O T agriculture, industry, rural and urban housing, buildings and public (N 1-17 utilities, and amenities, with a view to promoting Sabah’s economic development. iii. Perbadanan Insurans Deposit Malaysia (PIDM) The Malaysian government established an independent statutory body called Perbadanan Insurans Deposit Malaysia (PIDM) to administer the deposit insurance system. PIDM was established on 15 August 2005 through the Malaysia Deposit Insurance Corporation Act 2005. PIDM’s chief mandate is to provide insurance against partial or full loss of deposits while providing incentives for sound risk management in the financial industry. PIDM is an important contributor to the overall stability of the Malaysian financial system. Under the deposit insurance system, eligible deposits are insured up to the prescribed limit of RM250, 000 per depositor, per member institution, including principal and interest. There is a separate CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-18 coverage of RM250,000 per depositor, per member institution for Islamic deposits, accounts held under joint ownership and trust accounts, sole proprietorships and partnerships. PIDM also undertakes the resolution of banking institutions in certain circumstances based on the assessment of BNM. The deposit insurance system is designed to strengthen financial ) institutions and provide incentives to adopt sound financial and SE business practices. PIDM is designed to enhance public confidence FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO in the financial system by providing explicit protection of deposits. To meet its objectives, PIDM is required to act in a manner that promotes stability in the financial system. iv. Malaysian Industrial Development Finance Berhad (MIDF) Malaysian Industrial Development Finance Berhad (MIDF) was incorporated on 30 March 1960 for the main purpose of ensuring access to financing for manufacturing-based SMEs as part of Malaysia’s policy to accelerate the development of the industrial sector. Following its merger with Amanah Capital Partners Berhad in 2003, its acquisition of Utama Merchant Bank Berhad (UMBB) in 2004, and the establishment of MIDF Amanah Investment Bank Berhad (MIDF Investment) in 2006, the MIDF Group became a comprehensive financial services provider in three core business areas: investment banking, development finance and asset management. MIDF Amanah Investment Bank Berhad (MIDF Investment) emerged following the amalgamation of four subsidiaries of the MIDF Group: ӽ Amanah Short Deposits Berhad; (N O T ӽ Malaysia Discounts Berhad; ӽ MIDF Sisma Securities Sdn. Bhd.; and ӽ UMBB. MIDF Investment offers a comprehensive range of investment bankingrelated services, including financial advisory, underwriting of equities and debt instruments, treasury activities and equity brokerage services. MIDF’s Development Finance Division promotes the development of the industrial sector in Malaysia through the provision of financing for manufacturing and services-based companies. The financing includes conventional and Shariah-compliant products for new projects in the manufacturing and services sectors. It also provides funding for other capital expenses including business expansion, modernisation and relocation programmes. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM The Division’s financing products, which are generally medium-to long-term in nature, include project, machinery, factory mortgage and working capital term loans, industrial hire-purchase and leasing facilities to finance the acquisition of machinery and equipment as well as revolving credit and factoring facilities for working capital. MIDF Amanah Asset Management Berhad (MIDF Amanah) provides ) fund management services to statutory bodies, private pension funds, SE insurance companies, state government-related funds, charities and FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO foundations, and corporations. MIDF Amanah is an asset management company, and its investment mandates include equity, fixed income, and balanced portfolios. MIDF Amanah also manages portfolios based on specific requirements. v. Development Bank of Sarawak Berhad (DBOS) DBOS was incorporated on 11th May 2017 as a public company limited by shares. It carries on business as a Development Financial Institution which includes lending activities. DBOS’s source of funding emanates from capital injections from DBOS’s holding company, deposits from the Sarawak State Government and deposits from the Sarawak State Government’s statutory bodies and Government linked companies. DBOS plays a pivotal role in providing financing of public infrastructure and strategic sectors of the state’s economy. The goal is to facilitate faster economic growth of Sarawak and transform the state’s nonrenewable resource-based economy. 1.4.2 Non-bank Financial Intermediaries T Non-bank financial intermediaries are organisations that have access to the O banking system and money market because of their pool of funds or the roles they play in certain segments of the economy. (N 1-19 a. Housing Credit Institutions Borneo Housing Mortgage Finance Berhad (BHMF) is a housing credit institution which together with commercial banks, supply housing credit to the private sector. MBSB (see below, item (b)) and BHMF are pioneer institutions established to provide housing loans. In addition, two state government enterprises in Sabah and Sarawak (see items (c) & (d) below) have been established for this purpose. MBSB’s function has since been assumed by MBSB Bank. BHMF’s operations are confined to Sabah and Sarawak. It is funded by loans from EPF, shareholders equity and deposits from the public including institutions. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-20 b. Malaysia Building Society Berhad Malaysia Building Society Berhad (MBSB) was defined as a Scheduled Institution under the repealed Banking and Financial Institutions Act 1989 (BAFIA). The status of an Exempt Finance Company was granted to MBSB in March 1972 by the Ministry of Finance and the status has remained since. The Employees Provident Fund (EPF) is currently the financial holding ) company of MBSB. SE Presently, MBSB is the intermediate financial holding company of MBSB FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO Bank Berhad, known formerly as Asian Finance Bank Berhad (AFB). The purchase of AFB was completed in early 2018. AFB became a wholly owned subsidiary of MBSB on 7th February 2018 when its name was changed to MBSB Bank. MBSB Bank is regulated and supervised by BNM under the Islamic Financial Services Act, 2013. c. Borneo Development Corporation (Sabah) Sdn. Bhd. The Borneo Development Corporation (Sabah) Sdn. Bhd. was established in 1992, as a state enterprise, wholly owned by the Sabah State Government. Its main objective is to enable home ownership by providing financial assistance to the general public in the form of mortgage loans. The principal activities of the company are property development and the provision of loans to buyers of properties developed by the corporation. A total of four subsidiary companies were actively involved in property development, construction, hotel management and educational training. The main source of funding for the Development Corporation is borrowings from financial institutions. It is also funded by shareholder funds, funds generated from the sale of housing loans to the National Mortgage Corporation of Malaysia (Cagamas) and borrowings from the state O T government. (N d. Borneo Development Corporation (Sarawak) Sdn. Bhd. The Borneo Development Corporation (Sarawak) Sdn. Bhd. was incorporated as a wholly owned business enterprise of the Sarawak State Government. Its main objective is to undertake property development and construction activities and provide financing facilities for home buyers in the state. Funding is sourced from shareholder funds and through borrowings from financial institutions. e. National Mortgage Corporation of Malaysia (Cagamas) The National Mortgage Corporation of Malaysia, (Cagamas), was established in December 1986 to ensure a steady flow of funds to the housing industry and develop a secondary mortgage market. Cagamas issues debt securities including notes and bonds to raise funds. Its note issuances are generally for the short-term, with maturity dates of less than a year. Its bonds are typically long-term, with maturity dates of more CERTIFICATE IN CREDIT 1-21 THE MALAYSIAN FINANCIAL SYSTEM than a year. Proceeds from its debt securities issuance are deployed in the following manner: i. Cagamas, together with other institutions, provide funding to the Housing Loans Division of the Treasury, which in turn provides housing loans to civil servants in the public sector. ii. Create a secondary mortgage market. Cagamas purchases housing SE ) loans from primary lenders of housing loans, thus acting as an intermediary for long-term investors. Since the inception of Cagamas, FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO financial institutions have been able to provide longer repayment tenures for housing loans. Prior to the establishment of Cagamas, housing loan tenors did not exceed ten years, but now they extend to 25 years and beyond. This has been due largely to Cagamas’ intermediation, as financial institutions can adjust their liquidity positions through the sale of their housing loans to Cagamas. It is important to note that the banks sell the housing loans, and not the houses, to Cagamas. The legal owners of the houses remain the chargors.2 The banks merely sell their interest in the property by way of a sub-charge. Cagamas has extended its operations to finance industrial property, hire-purchase and leasing debts, as well as credit card receivables by purchasing these debts from financial institutions. This also includes Islamic financing for homes and other forms of debt. f. Credit Guarantee Corporation The Credit Guarantee Corporation (CGC) was established in 1972 by Bank Negara Malaysia and the commercial banks to help SMEs gain access to credit facilities from financial institutions. Many SMEs have difficulties (N O T obtaining credit facilities due to a lack of security and credit support. CGC provides financial guarantees to lending institutions for loans granted to SMEs and acts as the administrator of special funds set up by the Government to assist SMEs. g. Provident Funds There are two main pension fund schemes set up by law for employers and employees: i. The Employees Provident Fund (EPF) or Kumpulan Wang Simpanan Pekerja (KWSP) is a compulsory fund that accepts contributions from both employers and employees on behalf of the employee until he or she reaches retirement age. The EPF Board manages and invests contributions in money markets and capital markets on behalf of the contributors. 2 A chargor is an individual or company who provides a charge over assets owned by the individual or company as security for the loan CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-22 ii. The Lembaga Tabung Angkatan Tentera (LTAT) or AFFB, is a special fund established for the personnel of the Malaysian Armed Forces. Contributions come from both military personnel and the Government. The funds can only be withdrawn upon the personnel’s discharge from active service. The LTAT Board manages these funds by investing them in the money market as loans and short-term securities, and in equity ) shares of public listed companies and private equity holdings. SE h. Pilgrims Fund FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO Tabung Haji was established to help Muslim pilgrims save and invest their funds in preparation for their Haj pilgrimage, which is required of all adherents of the Muslim faith. A board, Lembaga Tabung Haji, manages the funds and invests in a portfolio of Shariah compliant investments. The funds can be invested in the money market, or in listed and unlisted company equity by way of placements through Islamic banks. Tabung Haji is not an employee pension scheme. i. Co-operative Societies The co-operative movement was first introduced in the country in 1922. The Department of Co-operative Development was established the same year. Co-operatives are organised societies of consumers or producers who voluntarily pool their resources together to meet common objectives. The Co-operative Societies Act 1993 defines a co-operative society as a “society which has as its objective the promotion of the economic interest of its members in accordance with co-operative principles”. The aim of a co-operative is to provide opportunities for its members to save, invest and participate in economic interests, since members possess better bargaining power collectively than they would as individuals. Co- (N O T operatives can be classified as single purpose or multi-purpose. Comprehensive guidelines under the National Co-operative Policy formed a framework and guide to eradicate poverty, create jobs and businesses and improve quality of life. To date, there are 4,330 co-operatives with five million members. 1.5 NON-BANK LENDING ORGANISATIONS Not all lending companies are banks. Some companies and organisations that provide lending and credit services to consumers are not registered as licensed financial institutions. These organisations are typically regulated by either BNM or by another set of regulations. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1.5.1 Leasing Companies Leasing companies constitute a relatively small but growing sub-sector of the Malaysian financial sector. Under Section 3, FSA 2013, leasing is a prescribed business in which BNM has the power to regulate and supervise. The Section defines a leasing business as: ) “the business of letting or sub-letting movable property on hire for the purpose SE of the use of such property by the hirer or any other person in any business, trade, profession or occupation or in any commercial, industrial, agricultural FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO or other economic enterprise whatsoever. This includes transactions where the lessor is the owner of the property, regardless of whether the letting is with or without an option to purchase the property, but excludes the business of hire-purchase which is subject to the Hire-Purchase Act 1967 as at 30 July 2012. Such other business as prescribed under Section 3, FSA 2013. Section 211 of the FSA 2013 further states that the leasing business is a financial inter-mediation activity, and Section 212 provides that the Finance Minister may prescribe any person not under the supervision or oversight of BNM and engaging in financial intermediation activities as a prescribed financial institution. Leasing companies’ funds are made up of shareholder funds, borrowings from financial institutions and inter-company borrowings. 1.5.2 Factoring Companies Factoring companies are specialised lenders providing financing for sales invoices, particularly to small and medium-sized businesses facing difficulties in accessing normal bank financing. Factoring lines are pre-agreed between T the borrower and the factoring company and selected sales invoices are O accepted. These invoices are then purchased by the factoring company at a margin of between 70% and 90% of the amount depending on the factoring (N 1-23 agreement. The financing amount is repaid when the sales invoices are due and collected from invoiced customers. Factoring companies may also extend their services to include managing the collections of invoices. Factoring houses can be subsidiaries of banks or be independently owned. Under Section 3 of the FSA 2013, a factoring business is a prescribed business which BNM has the power to regulate and supervise. The Section defines “factoring business” as: the business of acquiring debts due to any person; and such other business as prescribed under Section 3, FSA 2013. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-24 Section 211, FSA 2013 states that the factoring business is a financial intermediation activity, and Section 212 provides that the Finance Minister may prescribe any person not under the supervision or oversight of BNM and engaging in financial intermediation activities as a prescribed financial SE 1.5.3 Venture Capital Companies ) institution. A venture capital company is an investor in a new project or business that FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO takes on full business risk. Venture capital companies typically help fund new companies that might have difficulty securing funding from banking sources due to unproven business models or new technology. The venture capitalist is prepared to undertake this new venture risk in return for a share of prospective profits and will provide funds for a new start-up or for the expansion of the business. The terms of the loan typically involve a stake in the company’s equity and profits. The agreement can be negotiated to include an eventual buyout of the venture capitalist by the original promoter, or by market investors through a stock market public offering. 1.5.4 Credit Token Companies The credit token business refers to businesses where a token, such as a card, voucher, stamp, etc, is given to a customer by an issuer who undertakes to supply cash, goods or services on credit upon the production of the token. The issuer can also undertake to pay a third party on behalf of the customer T upon the production of the token. Examples of credit token businesses include (N O credit card and charge card companies. The credit token business is now regulated under the FSA 2013, which replaces the Payment Systems Act 2003. Section 278, FSA 2013 states that the terms and conditions made under the repealed Payment Systems Act 2003 remain applicable. 1.6 THE INSURANCE INDUSTRY The insurance industry complements the banking system by underwriting the risks of business entities and individuals to minimise the potential for economic loss. Insurance companies in Malaysia, including their Islamic equivalents, Takaful operators, are regulated by BNM under the FSA 2013, which replaced the Insurance Act 1996 and the Takaful Act 1984. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM Insurance companies operate as commercial entities and are driven by the profit motive as with other commercial enterprises. There are two broad categories of insurance companies in Malaysia: life insurance and general insurance. Islamic insurance operators, or Takaful operators, are similarly divided into Family Takaful and General Takaful businesses. Under Section 16(1) of the FSA 2013, a licensed insurer cannot undertake both life ) insurance and general insurance business unless it is a licensed professional SE reinsurer. Section 16(3) states that any licensed insurer who contravenes Section FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO 16(1) commits an offence that is punishable by prison time not exceeding eight years, a fine not exceeding twenty-five million Ringgit, or both. However, Section 276 of the FSA 2013 grants a special dispensation to insurers who were, under the former Insurance Act 1996, licensed to lawfully undertake both life and general insurance businesses. These companies are given a period of five years to comply with Section 16(1) of the FSA 2013, or a longer period as specified by the Minister of Finance on the recommendation of BNM. BACKGROUND: The General Workings of Insurance Companies Insurance companies can afford to assume the risk of insured persons because they have a large pool of clients with differing risk profiles. The larger the pool of clients typically equates to a lesser risk. For example, if an insurance company covered the risk of only one client and the client has a 50% chance of triggering the risk event, then the insurance company now has the same 50% chance of suffering from the same risk event. If the insurance company covered two clients, one with a 50% chance of triggering T the risk event and the other only a 20% chance of covering the risk event, then O the average probability of the insurance company suffering from a risk event is given by: (N 1-25 (20% + 50%) / 2 = 35% At the same time, the insurance company has minimised the risk of triggering both risk events as the chances of that happening is given by: 20% × 50% = 10% This is a simple illustration of the basic functioning of insurance and insurance companies. In the real world, such companies deal with tens of thousands of policies and require complex mathematical models to calculate risks and premiums. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-26 1.6.1 Life Insurance Companies Life insurance companies offer protection, or coverage, against premature death or disability often resulting in the loss of personal income. Their products are typically known as policies. Life insurance companies provide three types of basic policies, namely: ) a. Whole life policies SE These policies provide coverage throughout the entire life of the insured party, with a sum guaranteed to be payable upon death or permanent FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO disability of the insured, i.e., when the policy is “surrendered” back to the company. b. Endowment policies These policies contain an investment element while providing coverage to the insured. Endowment policies thus provide a mix of protection and savings for the policy holder. c. Term assurance policies These are basic policies providing coverage for a specified period of time but have no surrender value unlike the other two types of policies. Insured persons have to make regular payments towards the policy, i.e., pay premiums, for these policies to remain in effect. Premiums are computed based on the individual’s health, age, the total sum assured and the selected benefits on maturity, death or permanent disability. 1.6.2 General Insurance Companies General insurance provides coverage against all risks except risk to life. T General insurance provides coverage by pooling together the risks of a O sufficiently large number of people seeking protection from loss, such as loss (N of property or income resulting from accidents, burglaries, fires or unexpected events. In the event of such a loss, the insured is entitled to claim compensation. The main economic function of general insurance is to mitigate the risks borne by an entrepreneur, by converting part of his risks into a contractual cost or premium which forms part of the pooled risks. The premiums on general insurance business depend on the statistical probability of the occurrence of loss causing events together with the type of risk and the value of the insured property. The general revenue of these general insurance companies emanates mainly from annual policy premiums and net investment income, while their major expenditure comprises claims on policies, agents’ commissions and management expenses. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1.6.3 Reinsurance Companies Reinsurance companies are insurance companies that assume some of the risks of ordinary insurance companies by purchasing policies from them. Insurance companies reinsure some of their risks to ensure that overall risks are within prudential limits and increase their capability of absorbing losses. ) Reinsurance thus provides insurance companies with the opportunity to SE share risk and premium income with reinsurers. The Malaysian National Reinsurance Bhd. was formed in 1973 to spearhead the development of the FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO Malaysian reinsurance industry. 1.6.4 Takaful Operators Takaful Operators provide insurance coverage in compliance with Islamic principles. Accordingly, they share the same limitations of Islamic banks in that premium funds can only be placed in halal investments and their investments cannot yield interest returns. Takaful operations, like their conventional counterpart, are divided into the Family Takaful (Life Insurance) and General Takaful businesses. Under the Family Takaful business, the company offers Takaful plans, which provide investment returns to participants as well as cover or protection in the form of mutual financial assistance in the case of untimely death. The General Takaful business operates in line with the co-operative principles of shared responsibility and mutual help. The participants agree at the outset that the company shall pay compensation or indemnify to fellow participants T who have suffered a defined loss from the general Takaful fund. O Any surplus (profit) arrived at after deducting compensation or indemnity to fellow participants and paying other operational costs, is shared between the (N 1-27 participants and the company, provided the participants have not incurred any claims and no Takaful benefits have been paid to them. 1.7 THE CAPITAL MARKET SYSTEM The capital market system comprises various capital market institutions (CMI) and is aimed at mobilising long-term funds and investments for companies and other organisations. The capital market system is centred on the securities exchange i.e., Bursa Malaysia or Malaysian Securities Exchange, and its administration falls under the purview of the Securities Commission. The capital market system plays three main roles: CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-28 SE ) a. As the primary market for raising long-term finance, which commercial banks often avoid in the banking system. Typically, a company in need of funds will obtain a loan directly from the bank, fulfilling its role as a financial intermediary. The bank accepts the credit risk and earns a spread (i.e., the difference between lending rate and cost of funds). In the capital market system, the company needing funds goes directly to the investors with the assistance of investment banks and advisors. There is no credit risk but there is investment risk, which is to be undertaken directly by the investors. The investment banks provide advice and professional support to facilitate the transaction. FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO b. As the secondary market for investors to dispose or acquire investment securities. This is important as long-term investors need a platform to trade their investments. Without the secondary market, the investment is illiquid, which is a disincentive to invest. c. As the market for the trading of derivatives providing participants with a risk management mechanism through the provision of derivative instruments such as futures, options and warrants. Selected futures and warrants are traded as Bursa Malaysia Derivatives on the securities exchange. The Securities Commission (SC) regulates the issuance and trading of capital market products and all capital market activities. The Securities Commission was set up on 1 March 1993, following the promulgation of the Securities Commission Act 1993. It is regarded as the “market watch dog” overseeing the capital market’s growth in complexity and sophistication. The SC is also responsible for monitoring and supervising new financial instruments to protect stakeholder interests. (N O T The SC is responsible for the regulation and development of the securities industry, financial futures and option markets, unit trust and property trust schemes, and company takeovers and mergers. The function of the SC, in relation to futures contracts under the Securities Commission Act 1993 does not cover commodity futures contracts, which remain under the purview of the Ministry of Primary Industries and governed under the Commodities Trading Act 1985. The SC has powers to administer the following legislations: Securities Industry (Central Depositories) Act 1991; Securities Commission Act 1993; and Capital Markets and Services (Amendment) Act 2015. 1.7.1 Equity Market The equity market is an organised market for the issuance and trading of shares in companies listed on the Bursa Malaysia securities exchange. Companies raise equity funds through initial public offerings (IPOs) and the subsequent rights issue and private placement of shares through the equity market. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM The equity market is further made up of the Bursa Malaysia Main Market and the ACE Market. The main market comprises the list of established companies with larger turnover and profits. The profit requirement is at least RM6 million after tax for the year and an aggregate of at least RM20 million in the 5 years before listing. FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO SE It is intended to encourage new ventures and innovative ideas. ) The ACE Market is intended for smaller companies with little or no profit record. 1.7.2 Debt Securities Market The debt securities market is referred to as the Private Debt Securities (PDS) or the Bond Market. The PDS market in Malaysia primarily trades through the Bursa Malaysia securities exchange as private debt securities in the form of corporate bonds. Companies typically prefer to issue debt securities rather than equity to raise financing for most of their operational expenses. Unlike equities, debt securities have a finite maturity date and may include an option to convert into equity. Government bonds or securities are traded through Bank Negara, and major participants are commercial banks, Islamic and investment banks. Government securities are also available to local and foreign retail investors through the Asian Bond Malaysia Fund (ABF Malaysia Bond Index Fund), which is currently listed as an exchange-traded fund on Bursa Malaysia. Islamic private debt securities (known as Sukuk) have now become a cornerstone of the local debt market. These are securities issued in accordance with Shariah principles and subject to the guidelines of the O T Securities Commission before their issuance to investors. (N 1-29 1.7.3 Derivatives Market Derivatives are instruments that derive their value from underlying products or securities and used to hedge risks associated with the underlying assets. Some typical derivatives include futures and options. Some investors treat derivatives as investment assets although they are typically more volatile, and hence riskier, than their conventional counterparts. Bursa Malaysia Derivatives (BMD), as part of Bursa Malaysia securities exchange, currently offers trades in three categories namely, Commodity Derivatives, Equity Derivatives and Financial Derivatives. Commodity Derivatives main product is the Crude Palm Oil Futures contract (FCPO), which functions as the global price benchmark for the price of crude palm oil. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-30 Equity derivative products are priced based on the underlying Bursa Malaysia equity market. The equity derivatives presently available on Bursa Malaysia Derivatives are index futures contracts, which are based on the FTSE Bursa Malaysia Kuala Lumpur Composite Index (FBM KLCI), and the Single Stock Futures contracts based on selected stocks. FTSE Bursa Malaysia KLCI options (OKLI) contracts are also available. ) Bursa Malaysia Derivatives offers derivative products derived from Malaysian SE short-term interest rates. The interest rate and bond futures products FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO mainly refer to the underlying 3-month KL Interbank Offered Rate (KLIBOR) that is traded in the KL interbank money market. The interest rate derivative products currently offered are the 3-month KLIBOR futures, 3-year Malaysian Government securities futures and the 5-year Malaysian government securities futures. 1.8 CAPITAL MARKET INSTITUTIONS AND THEIR ROLES Capital market institutions refer to all participants in the capital market system. They include: The Securities Commission as the supervising agency The Securities Exchange as the regulated marketplace Bursa Malaysia Bhd. as the operator of the Securities Exchange Investment banks as participating organisations in the Securities Exchange Universal brokers and broking firms Issuing houses Fund management companies (as institutional investors) O T Other institutional and retail investors (N The focal point of a capital market system is the securities exchange, which operates as a marketplace serving companies and investors. As a marketplace, the exchange provides a platform where market participants can find the appropriate investments fitting their funding profile. 1.8.1 The Securities Exchange in Malaysia The Securities Exchange is the marketplace for raising long-term capital funds and a platform for investors to trade their shares or equity investments. As the exchange has other investment instruments traded such as bonds and loan stocks, it becomes more appropriate to term it a securities exchange rather than a stock exchange. Bursa Malaysia’s securities exchange is divided into two markets: the Main Market and the ACE market. Companies are grouped into each CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM respective category based on a number of considerations including market capitalisation and the track record of the company. In addition, there are selected derivatives traded on the Bursa Malaysia securities exchange. The main market of Bursa Malaysia comprises established companies with good profit track records, large shareholding bases and high paid-up capital. SE aggregate of at least RM20 million in the 5 years before listing. ) The profit requirement is at least RM6 million after tax for the year and an The ACE market is designed for new companies and for those that have yet to FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO reach maturity as main market companies. The listing requirements are more liberal and relaxed, but they are associated with higher risks for investors compared to more established main market companies. Many of ACE market companies have new concepts, ideas and unproven technologies and need capital funding to develop. There are no minimum requirements for capital and profit track record. 1.8.2 Bursa Malaysia Berhad Bursa Malaysia Bhd. is a company registered with a paid-up to RM250 million. The Capital Market Development Fund, Ministry of Finance Inc., and licensed stockbroking companies initially subscribed a 30% stake or 150 million shares each. The remaining 10% or 50 million shares were held by eligible remisiers. Some of these shareholdings have since been traded in the market. The business of securities trading is carried out at the Securities Exchange operating under Bursa Malaysia Bhd.’s subsidiary, namely Bursa Malaysia Securities Bhd. (BMSB). The major subsidiaries of the Bursa Malaysia Bhd T Group are listed below, followed by a short description of the key companies: O ▶ Bursa Malaysia Securities Bhd. ▶ Bursa Malaysia Securities Clearing Sdn. Bhd. (BMSC) (N 1-31 ▶ Bursa Malaysia Depository Sdn. Bhd. (BMD) ▶ Bursa Malaysia Derivatives Berhad. ▶ Bursa Malaysia Derivatives Clearing Bhd. ▶ Bursa Malaysia Information Services Sdn. Bhd. ▶ Bursa Malaysia Bonds Sdn. Bhd. ▶ Labuan International Financial Exchange Inc. ▶ Bursa Malaysia Depository Nominees Sdn. Bhd. ▶ Bursa Malaysia Islamic Services Sdn. Bhd. CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-32 The major subsidiaries are described below. a. Bursa Malaysia Securities Bhd. (BMSB) BMSB is the operator of the securities exchange and provides the facilities for investors to transact utilising its communication networks and price quotation system. It is the main subsidiary of Bursa Malaysia Bhd. ) b. Bursa Malaysia Securities Clearing Sdn. Bhd. (BMSC) SE BMSC is a subsidiary of the Bursa Malaysia Bhd. Its role is to provide clearing and settlement facilities for the buying and selling of Bursa securities. FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO This ensures all trades carried out through the Securities Exchange are delivered and completed in an orderly manner. c. Central Depositories System (CDS and MCD) The CDS or Central Depositories System operates in Malaysia as a custodian of all securities traded in the Malaysian securities exchange for and on behalf of all investors. Bursa Malaysia Bhd. operates a wholly owned subsidiary, Bursa Malaysia Depository Sdn. Bhd. (MCD), under the CDS. In practice, it appoints stockbroking houses and investment banks as its Authorised Depository Agents (ADA). The establishment of the CDS eliminates the need for investors to hold physical securities and underlines the ‘script-less trading’ concept. This reduces the incidence of fraudulent or false securities certificates and the fraudulent transfer of such securities. 1.8.3 Investment Banks Investment banks are capital market institutions, and their key role is to T facilitate the raising of long-term finance such as equity, bonds and loan O stocks. They are permitted to mobilise deposits of RM500,000 and above and (N conduct lending activities incidental to their investment activities. An investment bank is a licensed business under the FSA 2013. An investment bank is required to hold two licences, namely, an investment banking license from Bank Negara Malaysia under Section 10 of the FSA 2013, and a dealer’s licence under Section 12 of the Securities Industry Act 1983 (now provided for under the Capital Markets and Services (Amendment Act 2015) from the Securities Commission. If an investment bank trades in futures, it has to hold a licence under the Futures Industry Act 1993 (now provided for under the Capital Markets and Services (Amendment) Act 2015). Consequently, both Bank Negara Malaysia and the Securities Commission regulate investment banks. Investment banks can provide corporate finance advice on fund raising, takeovers, mergers and acquisitions, IPO and other fund-raising exercises. In CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM addition, they can undertake asset and investment management activities and financial risk management strategies. An investment bank must have a minimum paid-up capital of RM500 million or RM2 billion if it is part of a banking group. SE ) 1.8.4 Stockbroking Firms and Universal Brokers Stockbroking firms are licensed capital market institutions with restricted FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO activities. A stockbroking firm is licensed as either a ‘Universal Broker’ or a ‘Stockbroking Company’. Each broking firm is permitted to have licensed dealers and representatives to market and serve investors in all trading activities. A Universal Broker is an entity made up of at least three merged stockbroking companies. It has a paid-up capital of at least RM100 million and complies with other requirements of the Securities Commission. A Universal Broker is allowed to offer a wider range of capital market services including corporate finance activities, trading in derivatives, debt securities and fund management. They are allowed to have branches and electronic access facilities. Ordinary stockbroking companies are restricted to ordinary securities trading and hold a dealer’s license. Each stockbroking company must have a paidup capital of RM20 million and maintain minimum shareholders’ funds at that level at all times. The permitted activities and privileges for universal brokers are not extended to ordinary stockbroking companies. 1.8.5 Issuing Houses T The issuing house is another capital market institution. Its role is to find and O organise securities, including the required logistics such as balloting and allocation, and issuing script-less certificates to successful applicants in the (N 1-33 new issue. There are two issuing houses in Malaysia. MIDF Consultancy and Corporate Services Sdn. Bhd. (MIDFCCS), a subsidiary of MIDF described earlier, was the first to be incorporated. Malaysian Issuing House Sdn. Bhd. (MIH), incorporated in 1993, was the second. Both issuing houses undertake and provide share issuance facilities for Initial Public Offerings (IPOs) and consultancy services. They play the role of organising the public issue of shares and the related logistics. 1.8.6 Fund Management Companies Fund management companies are licensed under the Capital Markets and Services (Amendment) Act 2015 (CMSA) and regulated by the Securities CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM 1-34 Commission. A fund management company is permitted to raise funds and conduct collective investment. A fund management company is an institutional investor, as opposed to retail investors who are individuals buying and selling their investments at the securities exchange. The collective investment schemes are popularly known as a unit trust, where retail investors purchase ‘units’ issued by a unit trust scheme. The appointed ) fund manager of a unit trust scheme collects these funds and places them SE in the money market for short-term investments or invests in the securities FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO market according to conditions announced in the unit trust prospectus. All returns from such investments belong to the unit trust investors and the distribution of income is made according to stipulated conditions. Investors wishing to withdraw from such a scheme can either sell their units back to the fund manager, who will arrange for new investors to buy them, or, if the unit trust scheme is listed on a securities exchange, investors can sell them in the securities exchange. Such listed unit trust schemes are known as Exchange-Traded Funds or ETFs. SUMMARY It is evident from the foregoing discussion that Malaysia possesses a broad and deep financial system. The various institutions, bank and non-bank, play specific roles in intermediating funds, as well as facilitating other financial activities for both consumers and businesses. Credit officers need to be aware of the different sources of funding. Institutions specialising T in a particular type of credit, e.g. housing loan institutions and leasing companies, often O have deeper and more thorough knowledge of their specialised activity compared to (N banks, which are general lenders. As such, specialised non-bank institutions may be a more suitable avenue for a borrower with specialised needs. Students should be aware of the key differences of the various systems and institutions in Malaysia, e.g. The difference between the banking system and capital markets system The difference between conventional banking and Islamic banking The difference between the equity, debt and derivatives markets The difference between bank and non-bank lenders The list above is not exhaustive, but simply covers some of the key players in Malaysia’s financial system. CERTIFICATE IN CREDIT 1-35 THE MALAYSIAN FINANCIAL SYSTEM PRACTICE QUESTIONS (INDICATIVE ANSWERS CAN BE FOUND IN THE TOPICS LISTED FOR THE RESPECTIVE QUESTIONS) 1. What is the Malaysian financial system made up of? Explain the roles of an efficient banking system. (1.2 to 1.8) 2. Why do you think a financial system is important for a country’s economic development? (1.2) ) 3. How important is it for the country to develop a capital market system in addition to its SE banking system? (1.2.2) FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO 4. There are a number of other laws regulating the financial system in addition to the Central Bank Act 2009 and the Financial Services Act 2013. Name three and explain their purpose. (1.4 to 1.7) 5. Islamic banking and financial services for both consumers and businesses are present everywhere in Malaysia. What are some of the considerations that you might make as a consumer or a business in deciding whether to choose conventional or Islamic banking? (1.4.1 (a), (b) & (c)) 6. What are some of the main differences between commercial banks, investment banks and DFIs? (1.4.1 (a) (d) & 1.8.3) 7. Describe the Malaysian Deposit Insurance scheme and its features. The main role of the deposit insurance scheme is to strengthen the financial system. Explain how this can help. (1.4.1 (d), (vi), (iii)) 8. Think about some of the considerations that you would make if you were (i) borrowing for your own personal use and (ii) borrowing to start a business. Where would you go to seek a loan and why? (1.4.1) 9. A start-up business owner comes to your bank, for a loan to help supplement funds he is getting from a venture capitalist. What are some of the key considerations that should immediately come to mind? (1.5.3) T 10. Describe the following elements of the Malaysian financial system: O a. The capital market system and its participants. (1.7) (N b. The roles of the securities exchange in the economy. (1.8.1) c. The money market and its operations. (1.2.1 (a) 11. As we saw above, there is a wide range of lending institutions in Malaysia. You should be able to tell from their descriptions whether a lending institution is tailored more towards consumer borrowers or business borrowers. For practice, identify two institutions that you think cater more towards consumer borrowers and another two institutions that cater to business purposes. (1.4.1) 12. A manufacturer needs to borrow funds to purchase inventory. He believes that he can repay the loan in six months’ time from the revenue he earns through sales. Should he borrow from a bank or try to raise money from the capital market? (1.4.1 & 1.7) 13. The same manufacturer decides to expand his operations by building a new warehouse and opening more outlets. He needs to borrow a substantial sum that he won’t be able to repay anytime soon. What should he do? (1.7) CERTIFICATE IN CREDIT THE MALAYSIAN FINANCIAL SYSTEM KEY TERMS Financial institutions Banking business Financial system Banking system Fund management companies Bond market Investment banking FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO SE ) Bank Negara Malaysia Islamic banking Commercial banks Issuing house Credit token business Leasing business Debt market Market system Derivative Non-bank financial intermediaries Derivatives market Private debt securities Development financial institutions Securities commission Equity market Shariah advisory council Factoring companies Stockbroking firms Financial intermediation Venture capital company (N O T Capital market system CERTIFICATE IN CREDIT 1-36 T O (N SE FO P R RIN C T O A M B M LE ER C CO IA P L Y PU R PO )

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