BBEM1103 Topic 8

Topic X The Financial
8 Sector
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Describe the evolution of the financial sector;
2. Identify the role of the Securities Commission (SC);
3. Explain BAFIA 1989;
4. Discuss the restructuring process of the banking sector in the 1990s;
5. Describe the impact of financial liberalisation on the banking sector;
6. Identify four key principles for BASEL II; and
7. Disucss Islamic finance disclosure and transparency.
X INTRODUCTION
Before the crisis, more than three decades ago, Malaysia was characterised by
stable economic growth with relative price stability. This follows its profound
structural changes, evolving from a primary commodity producer into an
increasingly broad-based economy with an expanding industrial base. However,
the Asian financial crisis worsened in 1997 to 1998 and spilled over into the
Malaysian financial system amid the external environmentÊs volatility. A
comprehensive restructuring plan was implemented during the second half of
1998. One of the policies pursued by the government to promote economic
recovery was the major consolidation of the banking system to resolve weaker
banking institutions. The Government acts as a regulator that would include
making and revising banking laws and regulations as well as monitoring,
educating, mediating and arbitrating in case of disputes.
Copyright © Open University Malaysia (OUM)

106 X TOPIC 8 THE FINANCIAL SECTOR
LetÊs start this topic by looking at an overview of the financial sector and the
development of Malaysian banking institutions in past decades. We will learn the
role of the Securities Commission (SC) and discuss the role of the International
Offshore Financial Centre (IOFC) and the performance of Malaysian banking
institutions.
8.1 THE EVOLUTION

In the 1970s, the financial sector emphasised on instilling integrity and
professionalism in bank management. The number of banks was restricted and
the capital structure and branch network of the existing domestic banks was
gradually strengthened. The Credit Guarantee Corporation (CGC) was set up to
help finance SMEs to ensure credit accessibility of small borrowers to bank credit
at a reasonable cost, including the reform of the system of Post Office Savings
Banks into a National Savings Bank (Bank Simpanan Nasional) to mobilise small
savings. At the same time, the Kuala Lumpur Commodity Exchange (KLCE),
merchant banks and development banks were established. By the end of the
1970s, Malaysia had a well-diversified financial system expanding from the
foreign exchange market to commodity exchange.
The 1980s period posed great challenges in the financial system due to the
contractionary impact on domestic liquidity from the external sector. An
expansionary monetary policy was pursued to encourage private productive
capacity to counter the dampening effects of severe global recession of 1985 and
1986. The financial authorities adopted a stance of fostering greater financial
discipline among financial institutions, manipulate savings interest rates to
stimulate domestic savings, attract capital inflows and stimulate private
investments. This was done while ensuring adequate bank credit was made
available to private investors at a reasonable cost. Bank Negara Malaysia (BNM)
managed the domestic currency to reduce a large deficit of the balance of
payments and avoid speculation against the ringgit. As for the spirit of
developing Islamic finance, the first Islamic banking system in Malaysia was set
up in 1983 under Bank Islam Malaysia Berhad.
In the 1990s, there was a deregulation of the interest rate. Until 1978, Malaysia
had adopted a flexible interest rate regime, under which the BNM determined
the minimum lending rate and put a ceiling on deposits rates. In 1978, banks
were permitted to determine their own interest rates on deposits and the
minimum lending rate charged to their customers, which resulted in
asymmetrical interest rates for borrowers. Therefore, BNM introduced the base-
lending rate (BLR) in November 1983 that required banks to peg their lending
rates to the BLR. However, since 1 February 1991, the framework of BLR started

TOPIC 8 THE FINANCIAL SECTOR W 107
to become free from the administrative control of BNM. In other words, the
banking institutions were free to quote their own BLR at any level based on their
cost of fund, subject to the maximum spread of four per cent between the actual
lending rate and BLR. Subsequently, the framework of BLR was further
liberalised on 1 November 1995, whereby the maximum BLR was fixed based on
the three months interbank rate and administrative margins were capped at 2.5
per cent. Effective from 1 September 1998 the computation of BLR was further
revised and based on the three months BNM intervention rate and the
administrative margin was cut by 25 points from the previous 2.5 per cent to 2.25
per cent. With this, it permitted greater flexibility for banking institutions to
respond rapidly to changes in market liquidity situations and encourage greater
efficiency.
Have you heard of Securities Commission (SC)? It was established to

complement BNM on 1 March 1993 and is responsible for the regulation and
development of the banking and money market. Meanwhile, the Government
continued to broaden the framework of the financial system. For instance,
Labuan was established as an International Offshore Financial Centre (IOFC) in
October 1990 to enhance broader contributions of the financial sector to economic
growth. The Labuan Offshore Financial Services Authority was exempted from
BNM as the regulatory body. On the other hand, the Islamic interbank money
market was introduced on 3 January 1994, making Malaysia the first country
with a full-fledged Islamic banking system that functions on a parallel basis with
the conventional system.
Did you know that the Malaysian financial system can be structured into two
broad groups? They are the banking system and non-banking financial
intermediaries
(a) The baanking system is the largest financial institution. The banking system
attributed 70 per cent and 68 per cent of the total assets in 1990 and 2000
respectively compared to 30 per cent and 32 per cent from non-bank
financial intermediaries. Anyway, proliferation of non-bank financial
intermediaries should be promoted to better cater to the needs of the
economy with respect to venture capital and financing other types of
lending companies. Commercial banks are the largest banking system in
terms of total assets, total loans and total pre-tax profits. The marginal
increase of non-bank financial intermediaries implies the growing
importance of the funds as a financial intermediary in the economy. The
downturn in 1998 adversely affected the performance of the Malaysian
banking system. The banking system recorded a pre-tax loss of RM2.3
billion in 1998 compared to a pre-tax profit of RM7.7 billion in 1997. Loan
loss provisions, which rose from RM6 billion in 1997 to RM19 billion in

1998, were the main contributory factor for the poor performance in 1998.
At the end of 2002, there were one Central Bank, 26 commercial banks, 11
finance companies, 10 merchant banks, seven discount houses and 50
offshore banks operating in Labuan (Bank Negara Malaysia, 2002; and
Labuan Offshore Financial Services Authority, 2002).
(b) The non-bank financial intermediaries consist of provident and pension

funds, insurance companies, finance institutions and savings institutions.
Other non-bank financial intermediaries are unit trust companies, Pilgrims
Fund Board, housing credit institutions, Cagamas Berhad, Credit Guarantee
Corporation (CGC), leasing and factoring companies, and venture capital
companies. Among those, the provident, pension and insurance funds are
the main contributors to the total assets of the non-bank financial
intermediaries.
The banking system remained healthy with improvements in asset quality. Look
at financing form bank loans from 1990 to 1995. Here, bank lending grew more
than double. However, the growth rate slowed from 2000 to 2005, especially for
financial companies and merchant banks. The asset quality of the banking system
improved further, following the reclassification of some non-performing loans
(NPLs) to performing loans, write-offs and lower incidence of new NPLs. The net
NPLs ratio based on three months declined 16.6 per cent from RM64.2 billion to
RM53.5 billion from 2000 to 2005. Financing small and medium scale enterprises
is prone to problems, especially in repayments. SME financing is largely based on
loans where control and monitoring are minimal. In 2004, SME non-performing
loans (NPL) accounted for 30.6 per cent of the total NPLs for the business sector.
The Malaysian Banking Law (BAFIA, 1989), to some extent, serves to protect
depositors. To prevent bank failure, it does not allow commercial banks to use
deposits to buy real assets and stocks for profit. BAFIA allows commercial banks
to own shares arising from debt restructuring activities. Moreover, loan
approvals for financing businesses show a rising trend.
SELF-CHECK 8.1
1. Describe the evolution of the financial sector.
2. What is the role of the Securities Commission?
3. What is the role of the International Offshore Financial Centre

(IOFC)?

8.2 BARRIERS
The Malaysian government limits foreign participation in financial services to
encourage the development of domestic financial services providers. The
government policies are guided by the Banking and Financial Institutions Act of
1989 (BAFIA) and the 10-year Financial Sector Masterplan unveiled in 2001. The
plan focuses on building competitive domestic banks through banking
consolidation and defers the introduction of new foreign competition until after
2007. No new licences are being granted to either local or foreign banks; foreign
banks must operate as locally controlled subsidiaries, except for Islamic banking
licences to foreign banks. On 1 April 2003, the government removed the
restriction that foreign-controlled companies were required to obtain 50 per cent
of their local credit from Malaysian banks. The Federal Territory of Labuan was
established as an International Offshore Financial Centre in October 1990.
Foreign investors receive preferential tax treatment for offshore banking
activities, trust and fund management, offshore insurance and offshore
insurance-related businesses, and offshore investment holding business (USTR,
2005).
8.3 RESTRUCTURING OF BANKING SECTOR

(1990s)
Do you know that Malaysia underwent a change in the late 1990s? In 1997, the
number of financial institutions in Malaysia was 58, which comprised 21
domestic commercial banks, 25 finance companies and 12 merchant banks. At
that point in time, Malaysia was over-banked, leading to inefficient use of
resources and duplication of resources and infrastructure of branches in the same
locality. In addition, Malaysia was affected by the currency crisis and financial
crisis which involved attacks by currency speculators, starting with the descent
of the Thai Baht in July 1997, making a deep impact of recession in Malaysia. The
impact of the financial crisis in 1997 spilled over into the Malaysian financial
system amidst a volatile external environment. Against this backdrop, a
comprehensive restructuring plan was implemented during the second half of
1998. One of the policies pursued by the government to promote economic
recovery was the consolidation of banking system to resolve weaker bank
institutions following the financial crisis. Over the past decade, the banking
industry has experienced an unprecedented level of consolidation. To a large
extent, on a belief that gains can accrue expense reduction, increase market
power, reduce volatility, and increase the scale and scope of economies.

BNM announced the specific proposal for the bank merger programme for the
domestic banking sector on 29 July 1999. At the time, the country had 55 banking
institutions, which were made up of 20 commercial banks, 23 finance companies
and 12 merchant banks. An MOU was signed among the six anchor banks and
their related groups by the stipulated deadline of 30 September 1999.
Nevertheless, there have been some objections especially pertaining to the
number and composition of the banking groups and the time frame. However,
due to certain problems, the government responded by letting the banks decide
on organising them into 10 big banking groups. Flexibility was given to the
banking institutions to form their own merger groups. A total of 10 banks
submitted the proposal for reviewing to BNM. Finally, all 10 were accepted as
anchor banks by BNM in February 2000. Next, the banks have to complete the
due diligence process by 15 November and sign the sales and purchase
agreements by the end of 1999. Early April 2000, all the anchor banks started
their operation as new merged entities.
BNM announced on 14 February 2000 that the consolidation programme of the

previously 58 financial institutions were merged into 10 anchors banking groups,
comprising at least a commercial bank, a finance company and a merchant bank
for each anchor bank group. In fact, capitalised banking institutions were poised
to compete in a more liberal financial market environment, hence boosting
capital base and increasing efficiency. Table 8.1 provides a summary of the bank
merger programme.
Table 8.1: Summary of the Bank Merger Programme
Time Description
1990 Initial merger occurred with the takeover of the United Asian Bank
by the Bank of Commerce.
October 1st, 1999 Subsequently, Bank of Commerce was merged with Bank
Bumiputra to form Bank Bumiputra Commerce.
The Bumiputra-Commerce Bank led the establishment of the

Bumiputra-Commerce Finance Berhad Group and the Commerce
International Merchant Bankers Berhad Group.
Late 1996 Next merger was the takeover of Kwong Yik Bank by the Rashid
Hussain Group to form RHB Bank.
RHB Bank was the anchor bank for RHB Sakura Merchant Bankers
Berhad, Delta Finance Berhad, and Interfinance Berhad.
1998 Sime Bank was taken over by the RHB Group.

See Poon (2008) for other merging activities. The new phase of banking
consolidation would be market driven and operating in a more competitive
environment in both financial and non-financial institutions.
ACTIVITY 8.1
Discuss to what extent the restructuring of the banking sector helps

expense reduction, increase market power, reduce volatility and increase
the scale and scope of economies.
SELF-CHECK 8.2
Describe the restructuring process of the banking sector.
8.4 MERGING
The deteriorating economic conditions seriously affected the asset portfolio of
banking institutions. The financial crisis in mid-1997 led to insolvency and
liquidity problems in the aftermath of excessive lending, insufficient collateral to
the property sector and reckless exposure to share-based lending during the
boom, leaving them saddled with bad debts with a growing level of NPLs. The
NPLs were absorbed by Danaharta to maintain the integrity of public savings
and to sustain the stability of financial system functions more efficiently. The IMF
prescription of closing down problematic banks was not supported by the
government as the social cost involved in terms of dislocation of resources was
high. In conjunction with the crisis, BNM implemented a rescue scheme by
acquiring shares in some of the ailing commercial banks and absorbing assets
and liabilities of the insolvent finance companies by stronger finance companies
with the purpose of restoring stability, capital and expertise and strengthening
the efficiency of finance institutions.
By merging, sellers can reduce informational problems by standardising product

offerings, prices and quality for consumers. Homogeneity across products or
retail units reduces customers' search costs via branding. As such, it enhances
economies of promotion, another significant source of scale and scope economies.
The economies of scale and scope can be realised by spreading the fixed costs
across greater volume of output (Dranove and Shanley, 1995). Invest the
resources to build sufficient capacity to achieve economies of scope by

concentrating on productive assets. Another source of scale and scope economies

was the spreading of fixed costs associated with administration over more units
of production. With bigger scale and access to a greater volume of customer base,
it will bring about cost efficiency.
Ten banking institutions have been receiving the injection of RM6.2 billion from
Danaharta as at the end of June 1999. This brought around an improvement of
the average risk-weighted capital ratio (RWCR) from 9.8 per cent at the end of
August 1998 to 13.9 per cent at the end of May 1999. This provided a stronger
ground for banking institutions to support the recovery of the Malaysian
economy. However, the sale of NPLs to Danaharta resulted in banking
institutions incurring losses as Danaharta purchased NPLs at fair market value.
In recognition of this, Danamodal was established to address capital erosion and
recapitalise weak banking institutions to promote systemic stability. The total
amount of capital injected by Danamodal Nasional Bhd into the banks during the
economic crisis dropped to RM4.6bil on 7 October 1999 from the original RM6.4
billion after some banks repaid their loans (The Star, October 23, 1999). On the
other hand, the Corporate Debt Restructuring Committee (CDRC) served as a
platform for voluntary debt restructuring.
Other factors which contributed to a merger were to create additional value to

the company and to ensure minimal disruption in the provision of banking
services. The underlying principle behind the merger exercise was to create
shareholder value by improving efficiency and profitability of the proposed
banking group vis-à-vis minimising post-integration costs that may affect the
merged entity. In sum, the objective of the merger programme was to create
strong domestic banking groups since the financial industry was open to foreign
competition. The need to merge was even more imperative in the face of
increasing pressure under the WTO to open up and provide no-barrier entry for
foreign banks. By becoming stronger through merger, the banking institutions
will be able to withstand pressure arising from increasing competition from
global players.
BNM had several requirements, such as that each merged banking group should
have an asset base of at least RM25 billion and minimum shareholdersÊ funds of
RM2 billion. BNM also intensified supervision of banking institutions through
on-site examinations conducted on a consolidated basis at least once a year with
the examination. This approach would detect potential areas of vulnerabilities
and therefore facilitate the implementation of corrective actions. Other
requirements are as shown below:

(a) Protection of the Public

It is believed that the investing public is likely to be affected by the
decision-maker on the merger activities. The directors of the company
possess the power to influence the shareholders of the company to accept
or reject a takeover offer. The regulators are therefore ensuring that the
interest of shareholders is protected and that the directors act in the best
interests of the company. Specific disclosure requirements are constructed
to ensure timely and adequate information disclosure.
(b) Licensing Requirement

The financial services sector is one of the industries which are regulated by
way of stringent entry requirements and laws to ensure integrity. In
Malaysia, the regulations that are imposed on merger activities are mainly
from the Securities Commission Act 1993 and Companies Act 1965. The
sections involved in regulating mergers and acquisitions activities are
Section 33 and 34 of Securities Act1993 and Section 180 of Companies Act
1965. The regulatorsÊ concern is of ensuring relevant technical skills and
know-how to manage the financial services sectors. Generally, this is to
safeguard the viability of the financial sector. It is also aimed at maintaning
public confidence.
(c) Prevention of Monopoly and Anti-Trust Practices

This has an important bearing on the integrity and soundness of the
financial system and public confidence. Mergers have secured a large
market and enhanced competitiveness through economies of scale. This
may result in a monopolistic market, which then enables a company to
charge higher prices for its services and carry out unfair practices. Hence,
the government put in place the relevant regulatory and institutional
framework to avoid such monopoly and anti-trust practices.
(d) Ensuring Equality of Treatment of Shareholders

The Malaysian Code on Takeovers and Mergers 1998 was designed to
ensure equal treatment of shareholders and adequacy and timeliness of
information to prevent manipulation of market prices and volatility.
ACTIVITY 8.2
Form a small group. Analyse the benefits of merging programmes and

how domestic banks are able to compete with the rest of the world in
terms of efficiency.

There are a few issues which have arisen due to the merging process. Initially, a
bank or finance institution faced difficulty in finding an appropriate partner for a
bank consolidation programme. The merger partners should understand their
position and be clear about with whom to merge to produce an optimum level of
management restructuring. There might be internal conflicts among the members
of the merged companies in determining the domain name for the newly
developed banking system. In addition, there is difficulty for the management of
the new company to integrate the culture of employees of both companies.
Apart from that, strategy integration of IT systems and streamlining of operating

processes make up another key area that will contribute to delivery efficiency.
Different banks may use a different information technology system platform.
Systems consolidation issues such as hardware, software, branch networks and
ATM machine are needed to be taken into account. In order to integrate the
system, high costs might be incurred. They have the right to decide which IT
system they need to use.
Next, we discuss the issue of unemployment. According to the BNM Annual

Report (2001), the first round of consolidation exercises saw 4,240 workers laid
off and 187 bank branches closed in 2000. It is possible that the workers opted for
a voluntary separation scheme (VSS). During the implementation of the merger,
the banks were integrated into 10 anchor banks. Therefore, retrenchment was an
inevitable effect. As inefficiency would arise from the overlapping of job
structures and in terms of cost inefficiency, the anchor banks had to reduce
human resource through retrenchment in line with staff cost reduction. BNM
directed all parties in the imminent mergers not to retrench employees for two
years after the exercise was completed.
ACTIVITY 8.3
With your group members, get some banking data for the past 10 years
and describe the pre-merger and post-merger situations.

8.5 LIBERALISATION AND FINANCIAL

FRAGILITY
Generally, liberalisation of financial system refers to the trend of reducing direct
government intervention in the economy. Financial liberalisation involves:
x Removal of banksÊ interest rate ceilings;
x Reduction of reserve requirements and entry barrier;
x Reduction of government interference in credit allocation; and
x Development of the local stock market.
However, financial liberalisation was accompanied by the reduction of controls

on capital movements. This process opened the way for the newly liberalised
financial intermediaries to take on another type of foreign exchange risk. This is a
source of increase in financial fragility. Thus, the positive view of financial
liberalisation was somewhat dismal by the remarkable increase of financial
fragility, particularly in the banking sector. This suggests that the benefits of
financial liberalisation have to be weighed carefully against the cost of increasing
financial fragility.
The 2007 budget demonstrates the GovernmentÊs pro-business stance. The

reduction of tax rates on REITs to 15 per cent for local individual investors and 20
per cent for foreign individual investors will certainly provide the impetus for
diversification of capital market activity in the country. The tax deductions for
establishing Islamic stock broking houses and income tax exemptions for Islamic
fund managers will open up the market on various fronts. It encourages the
growth of Islamic stock-broking facilities in Malaysia which attract local and
foreign investors, and subsequently boost trading of Syariah-compliant counters
and attract more Islamic funds into our market. The exemptions and tax
adjustments in both the Islamic banking and takaful business in foreign
currencies will add depth and breadth to the speedily growing Islamic finance
industry.
ACTIVITY 8.4
Explain how financial liberalisation impacts the banking sector in Malaysia.

Search for working papers and journal articles may help you in preparing
the answer.

8.6 FOUR KEY PRINCIPLES FOR BASEL II

According to Dr Zeti, who asserted in her keynote address at the Risk
management Seminar on the New Capital Accord in 2004, BNM will adopt four
key principles in the implementation of BASEL II in Malaysia. These principles
can be seen as below:
(a) Accommodate capacity-building efforts with strong emphasis on enhancement

risk management framework for all banking institutions;
(b) Allow a flexible timeframe for capacity-building measures to be implemented;
(c) Emphasis on strong business justification instead of the regulatory mandate

for the adoption of internal rating based (IRB) approaches; and
(d) Enhance supervisory methodology to assess internal models and advanced

risk management systems (BNM, 2004).
According to Dr Zeti, Malaysia adopted these four principles in a two-phase

approach for Basel II:
(a) The first phase began in January 2008 whereby all banks adopted the
standardised approach for credit risks and basic indicator approach for
operational risks. In phase one, BNM might allow banking institutions to
maintain their current accord if they adopted the Foundation Internal
Rating Based (FIRB) approach instead of the standardised approach.
However, banking institutions would require submission of business case
justification and a blueprint for implementation that has been approved by
the board of directors of the banking institutions concerned.
(b) The second phase of implementation commenced in January 2010, whereby

banking institutions adopted the FIRB approach. Banking institutions were
required to submit to BNM parallel calculation of capital adequacy on a
monthly basis for one year prior to implementation (see Zeti, 2004).
8.7 ISLAMIC FINANCE

Islamic finance is based on Islamic Jurisprudence as prescribed by the Shariah. It
has witnessed significant growth and development in the past decade. The
Shariah principles are based on fairness and equity. Islamic finance is based on
risk and profit sharing, and not on interest (riba). The most widely used principle

in Islamic finance is Mudarabah. Under Mudarabah, there is a need for

disclosure of information to investors and stakeholders to ensure that underlying
business operations, risk profile and risk control mechanisms are working in
proper order. If the information is to serve public interest, the people (ummah in
Islamic context) has the right to know the effects of the organisationÊs operations
on well-being. The reason behind the need to have better financial disclosure is
that disclosure leads to greater transparency and better supervision and
regulation of the stability of the banking sector (Alam and Shanmugam, 2008).
This is especially for large-scale international operations that provide many other
dynamic services aside from traditional banking activities such as securities and
insurance businesses. We need information to evaluate the Islamic bankÊs
financial performance, risk profile, risk management practices and process,
internal controls on credit rating and credit exposure matters, current loan and
non-performing loans information, investment portfolio and future investment
earnings, etc.
Credit risk is the most serious risk faced by financial institutions. It could emerge
from the inability of a debtor to settle debts on time that may cause liquidity
crisis and affect the quality of the bankÊs asset. Liquidity risk arises when there is
a sharp decline in the bankÊs net cash flow and the bank is unable to raise
resources at a reasonable cost in a ShariÊah compatible manner (Alam and
Shanmugam, 2008). This makes it difficult for banks to fund new profitable
businesses. There are two common conditions that may lead to liquidity risks or
a liquidity crunch for the banks:
(a) If banks are unable to sell the debts due to a fiqh restriction on the sale of
debts; and
(b) When there is slow development of Islamic financial instruments that delay
the fund-raising procedure.
With regard to the disclosure of investment risks, according to Chapra and

Ahmed (2002), though Islamic banks do not deal with interest, they are still
exposed to interest rate risk because they operate in a financial environment
dominated by conventional financial institutions. All the sales-based modes such
as murabahah, ijarah, salam and istisna involve a mark-up or a pre-determined
rate of return and a predominant part of their financing at present consists of
these modes.

SELF-CHECK 8.4
Under Islamic banking and financing, why is it important to enhance

bank disclosure and transparency? What are the possible risks involved
if there is inadequate disclosure or transprency?
x The Security Commission was established to complement BNM and be

responsible for regulating and developing the banking and money market.
x Government policies are guided by the Banking and Financial Institutions

Act of 1989 (BAFIA) and the 10-year Financial Sector Masterplan unveiled in
2001.
x Malaysia was affected by the currency crisis and financial crisis which
involved attacks by currency speculators, starting with the descent of the
Thai Baht in July 1997, making a deep impact of recession in Malaysia.
x The banking industry experienced an unprecedented level of consolidation.

1999 was a year of recovery. Mergers led to value gains and increased
shareholder profit gains. Nevertheless, it depended on how effective were the
mergers, how the groups evolved into globally competitive banks, and how
integrated was the cross-selling of products among commercial banks,
finance companies and merchant banks.
x Issues in the merging process included bank or finance institutions facing

difficulty in finding an appropriate partner for bank consolidation
programmes.
x There might have been internal conflicts among the members of the merged
companies in determining the domain name for the newly developed
banking system. There was difficulty for the management of the new
company to integrate the culture of employees of both companies. Strategy
integration of IT systems and streamlining of operating processes made up
another key area that determined efficiency.
x Unemployment was an inevitable effect of retrenchment.

x The sale of non-performing loans (NPL) to Danaharta resulted in banking

institutions incurring losses as Danaharta purchased NPLs at fair market
value.
x Danamodal was established to address capital erosion and recapitalise weak

banking institutions to promote systemic stability.
x Financial liberalisation involves the removal of banksÊ interest rate ceilings,

reducing reserve requirements and entry barrier, reducing government
interference in credit allocation and development of the local stock market.
x Regulatory and supervisory reforms have to be enforced to further enhance

resilience and ensure sound competitiveness of the domestic groups.
Bank Negara Malaysia (BNM) Financial fragility

Credit Guarantee Cooporation (CGC) Financial liberalisation
Danaharta Merging
Danamodal Security Commission (SC)
Bank Negara Malaysia. (2001). Bank Negara Malaysia annual report, Kuala
Lumpur: Bank Negara Malaysia.
Bank Negara Malaysia. (2002). Economic and financial data for Malaysia, June 16,
[Online] available: http://www.bnm.gov.my.
Bank Negara Malaysia. (2004). GovernorÊs keynote address at the risk

management seminar on the new capital accord (Basel II) on 15 April.
Retrieved March 14, 2007 from http://www.bnm.gov.my.
Chapra, M. U. & Ahmed, H. (2002). Corporate governance in Islamic financial

institutions. Occasional Paper, No.3. Jeddah: IRTI/IDB.

Dranove, D. & Shanley, M. (1995). Cost reduction or reputation enhancement as

motives for mergers: The logic of multihospital systems. Strategic
management journal, 16, 55-75.
Frohlich, C. & Kavan, C. B. (1998). An examination of bank merger activity: A

strategic framework content analysis. Working paper. University of North
Florida.
Labuan Offshore Financial Services Authority. (2002). Annual report 2002.

Labuan: Labuan Offshore Financial Services Authority.
Alam, N. & Shanmugam, B. (2008). Financial transparency of selected Islamic

banks: applying bank disclosure index. Review of Islamic Economics, 12(1),
41-55.
Poon, W. C. (2008). Malaysian economy (2nd ed.). Selangor, Malaysia: Pearson

Education, Prentice Hall. Chapter 6: The Financial Sector.
The Star. (1999). Bank Negara explains rationale for bank mergers, 11 August.
The Star. (1999). Bank Negara to ensure mergers go through, 23 October.
USTR Office of the United States Trade Representative. (2005). 2005 National
trade estimate report, Retrieved June 5, 2007 from http://www.ustr.gov.
Zeti, A. A. (2004). Enhancing the soundness of the banking sector The new
capital accord. Ekonomika, April-June, pp. 10-12.

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Topic X The Financial

Copyright © Open University Malaysia (OUM)

8.1 THE EVOLUTION

Copyright © Open University Malaysia (OUM)

Have you heard of Securities Commission (SC)? It was established to

Copyright © Open University Malaysia (OUM)

(b) The non-bank financial intermediaries consist of provident and pension

1. Describe the evolution of the financial sector.

2. What is the role of the Securities Commission?

3. What is the role of the International Offshore Financial Centre

Copyright © Open University Malaysia (OUM)

8.3 RESTRUCTURING OF BANKING SECTOR

Copyright © Open University Malaysia (OUM)

BNM announced on 14 February 2000 that the consolidation programme of the

Table 8.1: Summary of the Bank Merger Programme

The Bumiputra-Commerce Bank led the establishment of the

Copyright © Open University Malaysia (OUM)

Discuss to what extent the restructuring of the banking sector helps

Describe the restructuring process of the banking sector.

By merging, sellers can reduce informational problems by standardising product

Copyright © Open University Malaysia (OUM)

concentrating on productive assets. Another source of scale and scope economies

Other factors which contributed to a merger were to create additional value to

Copyright © Open University Malaysia (OUM)

(a) Protection of the Public

(b) Licensing Requirement

(c) Prevention of Monopoly and Anti-Trust Practices

(d) Ensuring Equality of Treatment of Shareholders

Form a small group. Analyse the benefits of merging programmes and

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Apart from that, strategy integration of IT systems and streamlining of operating

Next, we discuss the issue of unemployment. According to the BNM Annual

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8.5 LIBERALISATION AND FINANCIAL

x Removal of banksÊ interest rate ceilings;

x Reduction of reserve requirements and entry barrier;

x Reduction of government interference in credit allocation; and

x Development of the local stock market.

However, financial liberalisation was accompanied by the reduction of controls

The 2007 budget demonstrates the GovernmentÊs pro-business stance. The

Explain how financial liberalisation impacts the banking sector in Malaysia.

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8.6 FOUR KEY PRINCIPLES FOR BASEL II

(a) Accommodate capacity-building efforts with strong emphasis on enhancement

(b) Allow a flexible timeframe for capacity-building measures to be implemented;

(c) Emphasis on strong business justification instead of the regulatory mandate

(d) Enhance supervisory methodology to assess internal models and advanced

According to Dr Zeti, Malaysia adopted these four principles in a two-phase

(b) The second phase of implementation commenced in January 2010, whereby

8.7 ISLAMIC FINANCE

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in Islamic finance is Mudarabah. Under Mudarabah, there is a need for

With regard to the disclosure of investment risks, according to Chapra and

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Under Islamic banking and financing, why is it important to enhance

x The Security Commission was established to complement BNM and be

x Government policies are guided by the Banking and Financial Institutions

x The banking industry experienced an unprecedented level of consolidation.

x Issues in the merging process included bank or finance institutions facing

x Unemployment was an inevitable effect of retrenchment.

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x The sale of non-performing loans (NPL) to Danaharta resulted in banking

x Danamodal was established to address capital erosion and recapitalise weak