FINANCIAL SYSTEM IN MALAYSIA

TOPICS TO STUDY: 1. EVOLUTION OF THE FINANCIAL SYSTEM 2. DEVELOPMENT OF FINANCIAL SYSTEM IN MALAYSIA 3. ROLES OF THE FINANCIAL SYSTEM 4. STRUCTURE OF THE FINANCIAL SYSTEM 5. ASSETS, SOURCES & USES OF FUND OF FINANCIAL SYSTEM
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EVOLUTION OF THE FINANCIAL SYSTEM

BARTER TRADE TO MONETARY SYSTEM
When the economy moves from a barter trade

system into a monetary system, commodity money was used as the basic transmission unit. Under this system, tokens, often made of precious metals served as a standard unit of account and measures of value to facilitate trade.

EVOLUTION OF THE FINANCIAL SYSTEM

SAVING AND BORROWING PRACTICES
When the practice of borrowing began. Funds

accumulated by wealthy persons were loaned to other individuals or companies who were willing to pay for these funds for a fee or interest. This is where those economic units who are in need of funds deficit units came to terms with those who have excess funds to be lent out or called surplus units. At this stage, however, there are some problems such as the difference in amount, maturity and the element of risks.

EVOLUTION OF THE FINANCIAL SYSTEM

ESTABLISHMENT OF FINANCIAL INTERMEDIARIES
The establishment of financial intermediaries to

overcome the problems of primary debt in the direct borrowing-lending process. During this stage, financial intermediaries mobilize from the surplus units and reduce their risk of default by issuing relatively risk-free liabilities. At the same time, through their specialized knowledge of the credit market, they were able to supply funds to deficit units in the amount and terms that these units were willing to pay to meet its financing needs. The liabilities of these financial intermediaries are known as secondary or indirect debt.
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EVOLUTION OF THE FINANCIAL SYSTEM

VARIED FINANCIAL INSTRUMENTS In of Malaysia, the country can be considered to have arrived at the final stage of the evolution process in establishing a complete monetary system When a complete set of financial intermediaries were established A financial system which provide a variety of financial instruments as saving media for the surplus units As well as a varied range of credit and investment facilities to meet the financing requirements of the

DEVELOPMENT OF FINANCIAL SYSTEM IN MALAYSIA

First phase

1960s , to create the basic infrastructure for the financial system and to develop a truly Malaysian-oriented banking system to complement the presence of strong foreign banking in the economy
Second phase

1970s, BNMs efforts were focused on introducing other financial intermediaries such as Merchant bank and Credit Guarantee Corporation and also to strengthen the regulation and supervision of banking institutions through develop the enactment of a new legislation, the Banking Act 1973.
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DEVELOPMENT OF FINANCIAL SYSTEM IN MALAYSIA

Third phase 1980s, BNMs efforts were focused on further strengthening the regulatory and supervisory framework for the banking system by reregulation and significant structural changes in the banking system due to lessons from domestic development as well as the global recession in the early 1980s.
Fourth phase The 1990s was characterized by rapid changes shaped by the forces of liberalization and globalization, aided by technology which broke new frontiers in the functioning of financial markets and in the development of financial products.
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DEVELOPMENT OF FINANCIAL SYSTEM IN MALAYSIA *

Fifth phase ??
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ROLES OF FINANCIAL INSTITUTIONS AND FINANCIAL INTERMEDIARIES IN THE DEVELOPMENT OF COUNTRY

Intermediation function Operation of the payment system As a channel for transmission of monetary policy

THE FLOW OF FUNDS IN AN ECONOMY

SOURCES OF FUNDS
-SAVINGS / INVESTMEN TSURPLUS UNIT HOUSEHOLD
ENTERPRISE

GOVERNMENT

INTERNATIONAL

FINANCIAL INSTRUMENT S Currency Deposits Bills Loans Bonds Unit trusts Share capital Insurance premiums Provident funds Pension funds Foreign loans Investments

FINANCIAL INTERMEDIARI ES Central bank Commercial banks Finance companies Merchant banks Discount houses Industrial Fin. Inst. Saving inst. Provident funds Pension funds Insurance companies Unit trusts Building societies Cooperatives Other fin. inst.

USES OF FUNDS
FINANCIAL INSTRUMENT S Money at call Overdrafts Bills Term loans Hire purchase Bridging loans Leasing Securities Bonds Debentures External reserves

INVESTMENT/ EXPENDITUR EDEFICIT UNIT HOUSEHOLD

ENTERPRISE

GOVERNMENT

INTERNATIONAL

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FUNDS FLOW THROUGH THE FINANCIAL SYSTEM

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THE FINANCIAL SYSTEM STRUCTURE IN MALAYSIA

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IMPORTANCE OF FINANCIAL MARKETS

Financial markets improve individual participants by providing

investment returns to lender-savers and profit and/or use opportunities to borrower-spenders In the absence of FI, difficult to transfer funds from savers to entrepreneur status quo or even worse off. Financial markets are critical for producing an efficient allocation of capital, which contributes to higher production and efficiency for the overall economy Improve well being of consumers by allowing better timing of purchases.
Overall: Well-functioning financial markets improve the economic

welfare of every segment in the society

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5. STRUCTURE OF FINANCIAL MARKETS

How to categorize financial markets? In terms of: How to obtain funds: Debt and equity markets Type of markets: Primary and secondary markets
Types of secondary market trading: Exchange and Over-the-counter markets

Types of maturities: Money and capital markets

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STRUCTURE OF FINANCIAL MARKETS

How funds are obtain in the financial markets? Debt and equity markets
1.

Issue debt instrument A contractual agreement by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals until a specified date, when the final payment is made.

Buyers of debt instruments are suppliers (of capital) to the firm, not owners of the firm Debt instruments have a finite life or maturity date. Maturity: Number of years until the instruments expiration date Short-term (maturity < 1 year) = Money Market; Intermediate-term (maturity between 1 to 10 years); Long-term (maturity > 10 years) =Capital Market Advantage is that the debt instrument is a contractual promise to pay with legal rights to enforce repayment Disadvantage is that return/profit is fixed or limited
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STRUCTURE OF FINANCIAL MARKETS

How funds are obtain in the financial markets? Debt and equity markets 2. Issue equity - Claims to share in the net income and assets of a business Periodic payments in the form of dividends to holders and have no maturity date Example: Common Stock Own a portion of the firm and have voting rights on important issues to the firm and elect its directors Buyers of common stock are owners of the firm Common stock has no finite life or maturity date Advantage of common stock is potential high income since return is not fixed or limited Disadvantage is that debt payments must be made before equity payments can be made
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OTHER CLASSIFICATIONS OF FINANCIAL MARKETS

1.

Primary Market New security issues sold to initial buyers. Example: Government or corporation borrowing funds issuing bonds and stocks to buyers Investment bank assists in the sale of securities in the primary market. Involves underwriting: guarantees a price for a corporations securities and sells them to the public.

2.

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Secondary Market Securities previously issued are bought and sold (resell) Examples: KLSE, NYSE, NIKKEI and bond markets. Brokers: agents of investors who match buyers with sellers of securities. Dealers: link buyers and sellers by buying and selling securities at stated prices. 2 important functions: Make it easier to sell the financial instruments (liquidity) & Determine the price of the security thatMustaffa/2011 the issuing firm sells in the primary market by Snurazani

OTHER CLASSIFICATIONS OF FINANCIAL MARKETS

2 ways to organize a secondary market: 1. Exchanges Trades conducted in central locations: Buyers & sellers meet in one central location (e.g., New York Stock Exchange) Over-the-Counter (OTC) Markets Dealers at different locations buy and sell Have an inventory of securities to sell OTC to anyone who comes to them and is willing to accept their prices. Very competitive

2.

Basis of maturity: 1. Money market: financial market in which only short-term debt instruments are traded 2. Capital market: financial market in which long-term debt and equity instruments are traded
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ASSETS OF THE FINANCIAL SYSTEM

Banking system

Bank Negara Banking Institution (Commercial Bank, Finance Companies, Merchant Banks) Discount House

Non Banking system/ Non Bank Financial Intermidiaries

Provident and Pensions Funds Insurance Funds Development Finance Institutions Saving Insiutions Other Non-Bank Financial Intermidiaries

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SOURCES & USES OF FUNDS OF FINANCIAL SYSTEM

Capital, reserve & profit Currency Demand deposits Borrowings etc.

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Currency Deposits Bills Loan & Advances Securities

REGULATION OF FINANCIAL SYSTEM

Three main reasons for regulation

1. 2. 3.

Increase Information to Investors Ensure the Soundness of Financial Intermediaries Improve Monetary Control

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REGULATION OF THE FINANCIAL SYSTEM

1. To Increase Information Available to Investors
Asymmetric information in financial markets means that

investors may be subject to adverse selection and moral hazard problems that may hinder the efficient operation of financial markets and may also keep investors away from financial markets corporations issuing securities to disclose certain information about their sales, assets, and earnings to the public and restricts trading by the largest stockholders (known as insiders) in the corporation and moral hazard problems in financial markets and increase their efficiency by increasing the amount of information available to investors

The Securities and Exchange Commission (SEC) requires

Such government regulation can reduce adverse selection

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REGULATION OF FINANCIAL SYSTEM

2. To Ensure the Soundness of Financial Intermediaries Because providers of funds to financial intermediaries may not be able to assess whether the institutions holding their funds are sound or not, if they have doubts about the overall health of financial intermediaries, they may want to pull their funds out of both sound and unsound institutions, with the possible outcome of a financial panic that produces large losses for the public and causes serious damage to the economy To protect the public and the economy from financial panics, the government has implemented six types of regulations: Restrictions on Entry Disclosure Restrictions on Assets and Activities Deposit Insurance Limits on Competition Restrictions on Interest Rates

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Ensuring Soundness of Financial Intermediaries

Restrictions on Entry Regulators have created very tight regulations as to who is

allowed to set up a financial intermediary

Individuals or groups that want to establish a

financial intermediary, such as a bank or an insurance company, must obtain a charter from the state or the federal government
Only if they are upstanding citizens with impeccable

credentials and a large amount of initial funds will they be given a charter.

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Ensuring Soundness of Financial Intermediaries

Disclosure Requirements: There are stringent reporting

requirements for financial intermediaries Their bookkeeping must follow certain strict principles, Their books are subject to periodic inspection, They must make certain information available to the public. Deposit Insurance: The government can insure people providing funds to a financial intermediary from any financial loss if the financial intermediary should fail

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Ensuring Soundness of Financial Intermediaries

Restrictions on Assets and Activities: There are restrictions on

what financial intermediaries are allowed to do and what assets they can hold Before you put your funds into a bank or some other such institution, you would want to know that your funds are safe and that the bank or other financial intermediary will be able to meet its obligations to you One way of doing this is to restrict the financial intermediary from engaging in certain risky activities Another way is to restrict financial intermediaries from holding certain risky assets, or at least from holding a greater quantity of these risky assets than is prudent

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Ensuring Soundness of Financial Intermediaries

Limits on Competition: Although the evidence that unbridled

competition among financial intermediaries promotes failures that will harm the public is extremely weak, it has not stopped the state and federal governments from imposing many restrictive regulations
In the past, banks were not allowed to open up branches in other

states, and in some states banks were restricted from opening additional locations

Restrictions on Interest Rates: Competition has also been inhibited

by regulations that impose restrictions on interest rates that can be paid on deposits
These regulations were instituted because of the widespread belief

that unrestricted interest-rate competition helped encourage bank failures during the Great Depression on interest rates have been abolished

Later evidence does not seem to support this view, and restrictions

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REGULATION OF FINANCIAL SYSTEM

3. To Improve Monetary Control
Because banks play a very important role in determining the

supply of money (which in turn affects many aspects of the economy), much regulation of these financial intermediaries is intended to improve control over the money supply obligatory for all depository institutions to keep a certain fraction of their deposits in accounts with the Federal Reserve System (the Fed), the central bank in the United States control over the money supply

One such regulation is reserve requirements, which make it

Reserve requirements help the Fed exercise more precise

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To enable the Bank to meet the objectives of a central bank, it is vested with comprehensive legal powers under the following legislation to regulate and supervise the financial system. ***
Exchange Control Act 1953
Allows the bank to confer powers, and impose duties and restrictions in

relation to gold, currency, payments, securities, debts, and the import, export, transfer and settlement of property, and for purposes connected with the matters aforesaid.[
Central Bank of Malaysia Act 1958
Provides the establishment, administration and powers of the bank. This

act has been repelled with Central Bank of Malaysia Act 2009 starting on 25 November 2009.[
Central Bank of Malaysia Act 2009
Redefined the central bank roles which was not covered in the previous

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act. The central bank can now define monetary policy autonomously through Monetary Policy Committee. The bank also now have greater regulatory reach and oversight than before. The act also give recognition that conventional and Islamic Banking is running in parallel in Malaysia.
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 Takaful Act 1984 Provides regulation for takaful business in Malaysia Insurance Act 1996 Provides licensing and regulations for insurance business and

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financial advisory business. Money-Changing Act 1998 Gives the bank the power to license and regulate money changing business in Malaysia. Anti-Money Laundering and Anti-Terrorism Financing Act 2001 This act is actually renamed from a previous act. The act provides powers to the bank to prevent money laundering and terrorism financing. Development Financial Institutions Act 2002 Promotes the development of effective and efficient development financial institutions. Payment Systems Act 2003 Regulations of payment systems.
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 Islamic Banking Act 1983 Provides licensing and regulations of Islamic banking in Malaysia Banking and Financial Institutions Act 1989

(BAFIA)
Provides laws regarding licensing and regulation of banking

institutions in Malaysia.

The Offshore Banking Act 1990 Governs the activities of offshore banking and offshore investment banking.

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You should know these 3 acts, you may refer the by Snurazani Mustaffa/2011

STEPS TAKEN TO DEVELOP FINANCIAL SYSTEM IN MALAYSIA

1.

2.
3. 4. 5. 6.

7.

Leveling the playing field Interest rate reforms Institutional development Consolidation and restructuring of the financial system Payment system Prudential and regulatory reforms Liberalization of the financial sector

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STEPS TAKEN TO DEVELOP FINANCIAL SYSTEM IN MALAYSIA

1.

Leveling the playing field

Several measures were introduced during the period of 1989-99 to level the playing field to allow commercial banks, finance companies and merchant banks to compete on equal ground with each other. A standard ratio for Statutory Reserve Requirement (SRR) has been adopted as the uniform method of capital adequacy assessment of three groups of banking institutions. The aim is to enhance the competition among the three groups of banking institutions which essentially engaged in the same type of business.

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2. Interest rate reforms The pegged deposit rate arrangement was dismantled in 1987. Meanwhile, with effect from 1st February 1991, the base lending rate (BLR) of the banking institutions was completely freed from administrative control, with banking institutions allow to charge a maximum of 4 percentage points above their declared BLR.

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3. Institutional development
International Offshore Financial Centre (IOFC) was

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established on 1st October 1990 in Labuan. The IOFC conducts a variety of international banking, insurance and investment activities. As part of the institutional building to develop the capital markets, BNM initiated the establishment of the Securities Commission (SC) on 1 March 1993. BNM also developed the private debt securities market and the Rating Agency Malaysia Berhad (RAM) to rate debt issues by corporations. On 15th December 1995 - KLOFFEs stock index futures contract Free Banking Scheme in March 1993

4. Consolidation and restructuring of the financial system

BNM to restructure the banking system following the

banking crisis in the mid-1980s. While the banking sector entered the financial crisis in 1997 from a position of strength, the severity of the crisis weakened the health of the banking sector, as reflected in the deterioration in capitalization and asset quality. BNM adopted a pre-emptive and comprehensive fourpronged plan to restructure the financial system.
a strategy to consolidate the finance company industry,

and establishing Danaharta, Danamodal and Corporate Debt Restructuring Committee to deal with the emerging problems of weakening asset quality and capitalization, as well as corporate debts, respectively.
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5. Payment system
BNM launched the payment system masterplan in

1996 to chart the development and implementation of payment system in Malaysia. The masterplan was formulated along the lines of the four major modes of payment instruments, namely, cash, cheques, card-based payment instruments and electronic-based payment mechanism. The forces of financial globalization and rapid technological advancements have also provided the momentum for the promotion for payment mechanism that are inexpensive, secure, reliable and efficient.
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6.Prudential and regulatory reforms

The introduction of the Banking and Financial

Institution Act 1989 (BAFIA) in October 1989 BAFIA provides a framework for an integrated supervision of the Malaysian financial system and enhances the powers and duties of the auditors of licensed institutions and made a director, officer or controller of a licensed institution liable to indemnify the institution in full for any loss or damage in any form arising from or caused by on offence committed by any person. Transfer of regulation and supervision of the insurance industry to BNM with effect from 1st May 1988
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7.Liberalization of the financial sector

Malaysia recognizes that the opening up of the

domestic financial sector to foreign competition would contribute towards a more efficient, competitive and market-driven financial sector, thus enabling the sector to play a more efficient and effective role in the economy. At the same time, it is recognized that for the benefits of liberalization to be fully realized, the pace of liberalization has to be in tandem with the capacity and ability of the system to absorb these changes without undermining financial stability. This policy has resulted in a high foreign participation in the Malaysian financial sector.
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Tutorial:
1. Find the history and functions in banking systems: Islamic Banking Act 1983 Banking and Financial Institutions Act 1989 (BAFIA) The Offshore Banking Act 1990

2. What are those steps involved to develop financial system in Malaysia? Explain briefly. 3. Explain and give 3 examples of institution under: Commerce Banks Merchant Banks Finance Companies Discount Houses

##Try to use variety resources (internet, library etc) and state the references in your answers.
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