During rapid economic growth of the 1990s, many banks and depository
institutions were able to manage high loan growth and generate significant fee income,
while building a productive asset base, increasing profits, making provisions for
losses, and expanding their capital base. However, since the start of the regional
contagion effect, the Malaysian banking system has been under considerable strain
following the collapse in the stock market and the depreciation of the ringgit. In
the fourth quarter of 1997, there had also been a flight-to-quality by depositors
who moved substantial funds into foreign and largest domestic banks, thereby creating
liquidity problem for some banks. A number of finance companies and stockbrokers
experienced financial problems.
Events of the past year have highlighted some of the deficiencies
and weaknesses inherent in the financial system. The weaknesses are related to the
- Rapid credit growth and high exposure to property and stock
- High leverage, with large short-term domestic debt
- Increasing non-performing loans.
The relatively high leverage coupled with the heavy reliance
on short-term debt increases the overall solvency risk profile of both the corporate
and financial sector, especially when interest rates are increased. The ratio of
non-performing loans (NPL) has risen from 3.5 per cent in March 1997 to 9.1 per cent
in March 1998 (Figure 7).
In an environment of rapid economic growth, the corporate sector
would be able to service the increasing amount of debt through increased cashflow.
However, with falling economic growth, the corporate sector would face increasing
problems in servicing their debts, especially when coupled with a liquidity squeeze,
a credit crunch, and an asset price deflation.
The Government has introduced various measures to reform the
financial sector. This include strengthening finance companies through assisted merger,
pre-emptive recapitalisation of core banking system, greater disclosure of information
to facilitate better market judgements, and strengthening of prudential regulation
and supervision. However, some additional policy measures are required to strengthen
the financial markets.
The stabilisation of financial markets is an important condition
to restore market confidence. Weaknesses in the financial sector should be given
urgent attention. Weak but viable institutions should be restructured and recapitalised.
The Government will improve prudential regulation and supervision to strengthen banking
practices and enforce discipline on individual institutions.
The following are other broad measures required to bring stability
in the financial markets:
- Preserve the integrity of the banking system
- Establish agencies along the lines of RTC
- Recapitalise the banking sector
- Monitor closely overall credit expansion
- Improve the capital market
- Develop the private debt securities market
1: Preserve the Integrity of the Banking System
One should not overlook the negative impact on the asset quality
of the banking system resulting from slower economic growth, higher interest rates,
and the depressed stock market on corporate financial position. The slump in the
property and construction sector can also create difficulties for some developers
who are highly geared to default on their bank loans. The increase in short-term
interest rates to which most developersí financing is tied will compound their difficulties.
The banking system seems to be able to withstand the current
crisis better than those in the region. However, they will be weighted down by their
exposure to property, especially loans provided for the construction of condominiums,
hotels and shopping complexes. Low demand and falling prices may cause some developers
to default on their loans. The high level of domestic debt renders the corporate
sector vulnerable to the current economic developments. Difficulties in the corporate
sector will raise the banksí non-performing loans as a percentage of total loans
and may cause difficulties to the weaker banks.
The authorities should continue to apply the highest standards
in reporting and carrying out prudential supervision. The measures aimed at preserving
the integrity of the financial system are as follows:
- The public has been reassured that the government guarantees
the principal amount and accrued interest of deposits placed with banks, finance
companies and merchant banks.
- There should be closer surveillance of banks and improvement
in non-performing loans (NPL) reporting for increased transparency and disclosure
- Mergers are encouraged to consolidate the banking sector in
order that they become more competitive internationally. However, the exercise must
not be seen as an indirect bail-out of individual institutions with infeasible fundamentals.
- Deteriorating collateral and non-performing assets in banks
would be addressed in order to avoid distortions in the financial sector and a structural
2: Establish Agencies Along the Lines of FDIC/RTC
The present economic crisis has raised concerns on the vulnerability
of Malaysiaís financial sector. Several measures have been taken to strengthen and
instil confidence in Malaysiaís financial sector such as Government guarantee of
deposits, and mergers and consolidation in the financial sector. Despite these measures,
there is general uncertainty over the soundness of the banking system.
It is, therefore, suggested that the Government establish agencies
along the lines of the Federal Deposit Insurance Corporation (FDIC) or the Resolution
Trust Corporation in the United States to maintain stability in the financial sector.
In the United States, the FDIC was established by the Banking Act of 1933 to insure
deposits at commercial and mutual savings banks, following bank failures
in the 1920s and 1930s. The FDIC has three major responsibilities: insurance,
supervision and liquidation. The Resolution Trust Corporation (RTC)
was established in 1989 to administer the closing or merging of insolvent thrift
institutions and was dissolved in 1993 with FDIC assuming its functions.
The FDIC continues to play a significant role in maintaining
stability in the US financial system. By insuring deposits under the auspices of
the US Federal government, backed by the implied support of the US Treasury, the
FDIC has successfully eliminated the ërun on the bankí problem by depositors.
Currently there is no insurance facility for bank failures.
Thus, a bank failure would mean depositors would have to wait to get their deposits
until the bank has liquidated and at that time they would be paid only a fraction
of the value of their deposits. The FDIC-type of institution will, therefore, guarantee
that depositors would be paid off in full no matter what happens to the bank.
Malaysia should consider the feasibility of establishing a
new institution along the lines of FDIC/RTC to reduce Governmentís financial burden
in the case of a bank run.
- It is proposed that an agency be established along the lines
of FDIC/RTC concept but with modification to suit local needs. It will be an independent
agency created by Parliament to maintain stability and public confidence in the nation's
banking system. The main functions of the agency might include ensuring or guaranteeing
deposits of banks and other savings institutions; identify, monitor and address risks
to deposit insurance funds; and to take over bad loans and non-performing assets
from sick banks and financial institutions.
- The agency could be funded from the issuance of bonds and
securitisation of assets. Foreign equity up to a maximum of 20 per cent of total
assets may be considered.
3: Recapitalise the Banking Sector
While the indicators of the soundness of the banking system
in the country are satisfactory compared to other countries in the region, there
is a growing fragility in the system. In the near-term, fragility will increase due
to the economic slowdown, expected downturn in real estate prices, weakening financial
position of corporations and individuals, and distress among stock brokerage companies.
Bank Negara has implemented several measures to deal with the
growing fragility in the banking system such as mergers and strengthen the regulatory
regime. The Asset Management Company (AMC) and deposit insurance scheme
will raise confidence in the banks. While these measures can strengthen the banking
system, they may be insufficient to address potential fragility problems pre-emptively
and in quick time. Rather than intermittent regulatory interventions, recapitalisation
will restore public confidence quickly in the system by demonstrating that banks
A core consideration for recapitalisation is the restoration
of domestic and foreign confidence in our banking system. By demonstrating that our
banks, and especially the domestic banks, are well capitalised to withstand the rising
stress due to the increasing NPLs, confidence of Malaysians in domestic banks will
rise. The confidence of foreign financial institutions conducting counter-party businesses
with domestic Malaysian banks will also be raised significantly. Accordingly, the
cost of funds for domestic banks would be lower, thereby helping to reduce the burden
of interest rates on borrowers. It is estimated that the total NPL in the banking
system will be around RM74 billion (or 15.7 per cent NPL) at the end of 1998, and
rising to RM100 billion (19.7 per cent NPL) by end 1999, if nothing is done to address
Recapitalisation also promises to be a quick and effective
strategy to increase liquidity and allow Malaysian banks to start giving out loans
rather than being preoccupied with defending their capital base in the light of rising
NPLs. This will enable domestic banks to continue to play their rightful role in
the economy and compete with the foreign banks. Otherwise, while the domestic banks
are pre-occupied with managing the rising tide of NPLs and ensuring that their capital
adequacy ratios do not get eroded, the foreign banks are gaining market share at
the expense of domestic banks.
The creation of the AMC will have direct implications on the
management of NPLs and the rehabilitation of viable businesses. The AMC will buy
a portion of the non-performing assets away from banks. While relieving the banks
of the problems of managing non-performing assets and injecting cash into the banking
system, the banks will still have to make provisions for writing-off the shortfall
in loan value arising from the sale. This will hit their profit and loss statement
and balance sheet. The banksí portfolio of NPLs may be reduced, but their capital
adequacy ratios will still be eroded and, therefore, require recapitalisation.
The following measures are recommended:
- Recapitalise the banking system and in particular the domestic
banks. This measure is critical in restoring confidence in the banking system
and the support for the ringgit. The international financial community is aware of
the growing problems Malaysian banks will face and has accordingly imposed a very
high premium on the ringgit. This fear has prompted currency traders to short the
ringgit and cause the weakening of the ringgit exchange rate.
- The Government should issue RM20 billion worth of long-term
bonds to the Employee Provident Fund, PETRONAS and the Insurance Companies.
- The Government should inject the funds mobilised through the
bonds into the banks as subordinated long-term loans carrying the same interest
rate and maturity as the long-term bonds issued by the Government.
Recapitalisation through the issuance of bonds offers several
- The use of bonds to recapitalise banks will make foreign acquisition
of domestic banks unnecessary.
- Liquidity in the economy will start to flow and interest rates
should ease without the BNM forcing it down to the discomfort of the financial market
and with negative impact on the ringgit.
- Bond issuance will avoid the controversy of using EPF or Petronas
money to rescue ailing banks.
- The bond exercise can be presented as an immediate solution
that will assist the outlook of the currency and stock market.
- There will be no ëcrowding-outí since the money raised through
the bonds is channelled into the banking system for disbursement as loans to the
- Financial impact on the Government will be minimal as the
coupon rate on the bonds can be covered by interest earned on the loans extended
to the banks.
4: Monitor Closely Overall Credit Expansion
The Malaysian financial sector is much stronger than those
of the neighbouring countries, but there was a problem of rapid credit expansion
to the private sector, especially during 1995-96. In 1996, the lending to the broad
property sector as well as for the purchase of stocks and shares rose by 30 per cent,
The easy credit had not only inflated the private sector indebtedness,
but also raised the concern that the funds were channelled into activities such as
property development and share purchase, which were considered as less productive
sectors. As a prudential step, Bank Negara Malaysia had adopted some pre-emptive
measures in March 1997 to limit the extension of credit to these sectors. Following
the 1998 Budget speech, monetary policy had been tightened further in 1997. The interest
rates were raised and a Credit Plan was adopted to reduce the loan growth of the
According to feedbacks from the private sector and bankers,
there seems to be a mismatch between the providers and the users of funds. Bank Negara
has estimated that about RM62 billion of new loans will be available for 1998 (excluding
repayments). Despite the availability of undisbursed loans in the financial system,
many users of funds are unable to gain access to them. Compared to the level of outstanding
loans for the preceding month, there was very little credit growth (0.85 per cent)
in December 1997. Credit grew by 5.7 per cent in January 1998 before recording negative
growth for February, March and April 1998.
Some examples of the credit squeeze are as follows:
- Increasing interest spread. The spread of interest
for overdraft facilities has increased from 2.25 to 4 per cent; trust receipts for
the financing of purchases from 1.5 to 3.0 per cent; Bankerís Acceptance commission
from 2 to 3 per cent; and Bankersí Guarantee commission from 0.1 to 1.5 per cent
- Rescheduling of loan payments because the holding company
has construction arms
- Withdrawal of unutilised credit facilities or amending
limits on credit facilities
- Rejection of hire purchase financing on plant and machinery
and overdraft on working capital
The depreciation of ringgit and the drastic fall in KLSE have
severely affected business confidence and profitability. Those badly affected are
domestic-oriented industries without export activity and high import-content industries,
such as automotive, building materials, and metal-based industries. For the export-oriented
industries, the depreciation of ringgit should increase export opportunities and
provide manufacturers who are operating at full capacity with the incentive to expand
operations. A pre-requisite for business expansion is the availability of loans and
The credit squeeze has arisen
for the following reasons:
- Many banks have over committed their funds for 1997, with
very few new loans available for 1998 under the Credit Plan.
- Banks are trimming down their credit facilities as well as
increasing interest rates. This is in response to the Credit Plan submitted in accordance
with Bank Negaraís guidelines to reduce the rate of loan growth to 20 per cent by
March 1998 and 15 per cent by end 1998. While the 15 per cent target corresponds
with the broad guidelines, several banks have been instructed to reduce the targets
further to as low as 7.5 per cent in some cases.
- The high effective cost of loan funds places the real sector
- While many banks have already exceeded their lending limit,
some others are flushed with funds. Deposits moved to foreign and larger domestic
banks, which results in them having excess funds.
- Banks are cautious about providing new loans under current
- The crash in the stock market and depressed property market.
The emergence of the credit squeeze has serious implications
for the economy. It stifles private sector growth and dynamism, while preventing
the manufacturing sector from performing the much-needed role as the engine of growth
when the other sectors are in the decline and increasing exports to improve the balance
of payments position. Even more worrisome is that businesses are driven into deep
financial straits, which could result in widespread corporate bankruptcies and undermine
the stability of financial institutions.
Accordingly, the following measures should be adopted:
- Fine-tuning of policies or intervention by Bank Negara Malaysia
to ensure that financial resources go to the sectors that require them at the right
time and speed to ensure that particular sectors are not starved of credit. This
is to avoid the real sector from going into seizure for lack of funds.
- More flexible implementation of the overall Credit Plan target
- Increase the borrowing or lending guidelines to productive
- Given the current tight liquidity in the economy, the condition
of 40/60 to allow non-resident controlled companies to get more funds from locally-incorporated
foreign banks should be reviewed.
- Reclassify some of the urgent infrastructure projects that
do not require imports as productive rather than placing them under the broad property
- Develop a bond market for funding of large infrastructure
projects rather than using short-term loans to fund projects with long gestation
period. Local projects using fees in ringgit will not be subject to currency volatility
unlike raising loans in dollars or yen. Another factor favouring a local bond market
is that banks cannot keep pace in the large funding requirement of infrastructure
projects. Banks are also subject to the lending restrictions in terms of the amount
of loans that could be disbursed to a single customer or any one sector. The Government
should also consider issuing bonds in order to get money from the public and social
security and pension funds that could be recycled into the system to increase liquidity.
5: Improve the Capital Market
Although there are laws, rules and regulations governing the
operations of the equity market, it is important that investors are protected and
the market is not manipulated by unscrupulous players. There is a need to introduce
a framework for strengthening corporate governance. Malaysian corporations
and their advisors must raise the standards of disclosures.
To strengthen the regulatory framework, the recommended
medium-term measures are as follows:
- An institution such as the Financial Reporting Foundation
(FRF) should be entrusted to prepare a new framework for corporate governance within
a period of six months and submitted to the Minister of Finance.
- Market regulators, especially Kuala Lumpur Stock Exchange
(KLSE), Securities Commission (SC), and Registrar of Companies (ROC) must act firmly
and decisively against breaches of regulations. They must increase their monitoring
and enforcement activities.
- The functions of KLSE, SC, ROC and Foreign Investment Committee
(FIC) should be reviewed to streamline the regulatory structure for public listed
companies in order to reduce the areas of overlap.
- SC as the principal regulator of the capital market should
review the performance and capabilities of KLSE as a front-line regulator, with respect
to the governance of the Exchange as well as its management and enforcement capabilities.
- As part of the effort to enhance market integrity, KLSE on
its own initiative should ensure that the new client asset protection framework is
implemented as soon as possible. In addition, it should revise voluntary suspension
rules and strictly enforce their application.
- Controlling shareholders and owners who have committed malpractices
in the management of public-listed companies through fraud or manipulation of share
trading and asset stripping should be prosecuted expeditiously.
of Market Participants
Stockbroking companies are facing acute liquidity problems,
which could threaten the integrity of stockbroking business as a whole. There is
also continued high exposure of the market to the retail segment, which is unsophisticated
and highly speculative in behaviour. Current practices in the Malaysian stockbroking
industry have significantly increased the risk of a broker defaulting on its obligations.
Medium-term measures recommended to address the weaknesses of market participants
are as follows:
- The current stockbroking industry should be consolidated through
mergers, take-overs and closures. A more liberal stance should be taken regarding
foreign participation and ownership, while strong and well-managed local stockbroking
companies should be allowed to open branches.
- Greater efforts, including a relaxation of bureaucratic and
procedural controls, should be undertaken to realise the creation of a vigorous fund
management capability in Kuala Lumpur.
of Market Activities
The private sector and fund managers have expressed concerns
about the suspension of securities borrowing and lending and regulated short-selling.
Securities borrowing and lending programmes were aimed at improving settlement efficiency
in the securities market and assist in the development of the derivatives market.
The regulated short-selling programme is an integral function in Kuala Lumpur Options
and Financial Futures Exchange (KLOFFE) and enables risk management of derivatives.
- The securities borrowing and lending and regulated
short-selling. While the suspension of these activities is necessary under
the present market environment, they should be reintroduced when stability and confidence
are restored because they promote the long-term development of the capital market.
- The share buy-back scheme should be reviewed
and appropriate amendments made to provide the following:-
a. Companies are to utilise their share premium account;
b. No compulsion for companies to cancel shares bought back;
c. Allowing companies to keep shares as Treasury stocks;
d. Introduction of appropriate anti-manipulation rules; and
e. Prohibiting the use of financial assistance.
- Put and call transactions. It is recommended that the
relevant authorities, particularly the SC and ROC, should stamp out this abuse. They
should also seek to vigorously pursue and punish in the most severe manner all parties
involved in the abuse of "put and call" transactions to restore public
confidence and deter future recurrence.
- Gearing ratio for brokers. It is recommended that the
gearing ratio for stockbrokers should be relaxed slightly to not more than 2.5 times
of their shareholders funds to ensure sufficient liquidity in the equity market.
- Brokerage rates. To enable the KLSE to compete and
to regularise a rampant practice against KLSE rules, it is recommended that the regulated
rates currently enforced be liberalised.
- Problems with warrants and transferable subscription rights
(TSRs). It is recommended that the currently enforced restrictions on capital
raising be lifted.
- Circuit breakers. A broader based circuit breaker mechanism
should be considered to address the problem of excessive volatility in the market.
- Corporate exercises. In a dynamic market, corporate
exercises and restructuring should be allowed to continue, especially in the productive
and strategic sectors of the economy. Restrictions on initial public offerings (IPOs),
rights issues and corporate restructuring exercises should be lifted to allow public
listed companies to restructure and raise funds in the market.
- CLOB. As a matter of national interest, the
authorities must address the growing domination of Central Limit Order Book International
Market (CLOB). An Action Plan must be prepared to restore KLSE as the market place
for the trading of Malaysian equities.
- Restoration of banking custodian services.
Effort must be made to encourage custodian services to return to Kuala Lumpur.
- Review of the Second Board. There is a case
to be made for tightening qualitative criteria for admission to the Second Board
in order to restoring order, discipline and credibility as well as refocus upon original
intentions. Only companies with the best attributes and growth potential ought to
be given opportunity to the ëshort cutí route of raising public capital through the
Second Board. The authorities should consider reducing the number of companies on
the Board by weeding out companies that failed to perform up to the profit forecasts
etc. A consolidation and merger exercise can also be encouraged.
6: Developing the PDS Market
Presently, the total outstanding amount of corporate bonds
amounts to RM46 billion, while the worth of outstanding short-term corporate papers
is around RM13 billion. More than 200 companies engaged in a wide range of businesses,
including construction, manufacturing, engineering, retail, finance, and even stockbroking,
use the debt securities market to raise funds. The private debt securities (PDS)
market in Malaysia has the potential of meeting the financing requirements of infrastructure
projects. However, the development of the PDS market is hampered by the lengthy approval
process between 6 to 9 months and the illiquid secondary market due to selling restrictions
under the Companies Act.
The following measures are recommended to develop further
the PDS market:
- Reduce the inventory cost for the market makers. A
big boost to the PDS market can be given if the holdings of Government bonds and
PDS by the commercial and merchant banks could be exempted from the requirement of
statutory reserves and liquidity ratio.
- As a quid pro quo for this move, commercial and merchant
banks should play a more active role in trading of PDS. At present, when a commercial
bank arranges for a PDS issue, the PDS are traded for a while among the discount
houses but they inevitably end up quickly in the vaults of EPF and the insurance
- The PDS should continue to be promoted among foreign fund
managers, who should be allowed to purchase PDS irrespective of their sources of
ringgit. Foreigners have been active participants in the development of the PDS
market. Even PDS issued on an Islamic basis, for instance, the Petronas Islamic bonds,
used to be taken up by them.
- Some other measures include:
- introducing shelf registration for corporate bonds
- increasing institutional participation, such as the EPF, Khazanah,
Tabung Haji, LTAT and Police Cooperative.
- increasing liquidity in the secondary market by facilitating
a more active repurchase agreements (repo) market
- reviving the benchmark programme through Khazanah Nasional
- reducing the time taken to approve the issue of corporate
bonds to not more than 3 months.