Information about Asia and the Pacific Asia y el Pacífico
Chapter

VI Financial Sector Issues

Author(s):
Yougesh Khatri, Il Lee, O. Liu, Kanitta Meesook, and Natalia Tamirisa
Published Date:
August 2001
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In response to the Asian crisis, Malaysia undertook a number of policy measures to curtail the deterioration in the financial sector and assist in its recovery. These actions were initiated early and, supported by better domestic and regional economic conditions, have led to substantial improvement in the sector’s performance. This section gives a brief background of the financial sector, discusses its performance up to end-2000, and examines key elements of the reforms under way to strengthen its structure and regulatory regime in the context of the Financial Sector Masterplan.1 Reform aspects that are highlighted include a bank merger program that aims at creating larger and more efficient domestic institutions, and the upgrading of the prudential supervision system.

Background

The financial crisis in Malaysia was comparatively well contained, attributable in part to bank restructuring efforts and the Development of domestic capital markets in the 1980s. The country’s low foreign debt at the outset also placed it in a relatively good position to confront the crisis. The country’s traditional policies to limit short-term borrowing, encourage foreign direct investment inflows, and rely on equity capital prevented the corporate sector from building up excessive unhedged foreign exchange exposures and very high debt/equity ratios that were so damaging in the other crisis countries.

Like the other countries, however, a decade of strong growth prior to the crisis fulled governments and creditors, both foreign and domestic, into complacency. Easy access to bank credit contributed to speculative price bubbles in the real estate and securities sectors, and credit growth in the years leading to the crisis rose substantially, reaching 25 percent annually in 1996 and 1997. As a result, the level of credit in relation to GDP was high (160 percent), and financial institutions were exposed to those vulnerable sectors. There was, nevertheless, the sentiment that the banking sector in Malaysia was more sound than those in the other crisis countries, because its financial institutions had lower amounts of nonperforming loans and higher capital, and there was a stronger banking culture, with a better supervisory environment, higher standards of accounting and auditing practices, and superior prudential supervision.

Three categories of financial institutions are authorized to take deposits: commercial banks, finance companies, and merchant banks (Table 6.1)2

Table 6.1.The Banking System (Depository Financial Institutions)(In billions of ringgit; as of February 2001)
Number of Depository Financial InstitutionsPercent of TotalAssetsPercent of TotalLoans1Percent of TotalDepositsPercent of Total
Commercial banks2957516783057636577
Domestic-owned banks1529391592335827859
Foreign-owned banks14271251972188718
Finance companies12241101777198418
Merchant banks1020386174276
All depository financial institutions51100664100398100475100
Source: Bank Negara Malaysia.

Excludes loans sold to Cagamas, the national mortgage corporation.

Source: Bank Negara Malaysia.

Excludes loans sold to Cagamas, the national mortgage corporation.

  • Commercial banks engage in retail and corporate banking, and are the only institutions authorized to take demand deposits.3 Through subsidiaries, commercial banks provide other financial services, including merchant banking, stockbroking, insurance, and finance company activities. Foreign banks have operated in Malaysia prior to its independence in 1957. Current regulation limits to 30 percent new equity holdings by foreigners in domestically controlled banks4 and restricts existing foreign banks from opening new branches.

  • Finance companies are able to offer hire purchase lending and other types of installment credit to consumers and small businesses, with funding provided primarily from time and savings deposits. Facing diminishing returns from traditional business lines, finance companies went into riskier real estate and share purchase lending, making them more vulnerable to an economic downturn. Because of the vulnerability, Bank Negara Malaysia began consolidation of the finance company sector early in the crisis, and the process is expected to be accomplished with the completion of the bank merger program.

  • Merchant banks are involved primarily in fee-based activities, such as syndication of loans, corporate advisory services, securities underwriting, and portfolio management. They can only accept time deposits greater than RM 200,000. In past years, lending by merchant banks grew to be a key—and at the time profitable—activity, but the diversion proved very costly with a weakening economy. Bank Negara Malaysia has redirected merchant banks back to the traditional fee-based activities by limiting their loan exposures.

Recent Financial Sector Performance

The financial sector, which suffered losses in 1998, has recovered along with the rest of the economy. In 1999–2000, the banking system recorded pretax profits. The recovery can be attributed in part to the restructuring of the banking sector that took place (see below), and in part to a more stable interest rate environment that led to a sharp reduction in loan loss provisions. Nonperforming loans were reduced to 15.3 percent of total loans at end-2000 (Table 6.2). Although asset growth averaged only 4 percent in 1999–2000, there is no evidence of constraints on the supply of credit to the economy, as witnessed by information on loan approvals and disbursements.

Table 6.2.The Trend in Nonperforming Loans1
1997199819992000
DecemberDecemberDecemberMarchJuneSeptemberDecember
(In billions of ringgit)
Commercial banks14.244.940.941.741.642.341.6
Finance companies10.024.919.118.118.317.917.7
Merchant banks1.17.25.65.15.25.34.3
Total25.277.065.564.965.065.563.6
Total including loans sold to Danaharta290.0100.9101.3101.7102.3101.3
(In percent of total loans)
Commercial banks4.915.013.814.113.713.713.2
Finance companies9.227.023.622.422.521.721.1
Merchant banks4.832.229.629.029.730.524.7
Total6.018.616.616.416.216.115.3
Total including loans sold to Danaharta20.021.825.525.625.325.124.3
Source: Bank Negara Malaysia.

Loans are classified as nonperforming if payments are overdue for three months or more; prior to January 1, 1998 this period was six months. Total loans include housing loans sold to Cagamas.

Loans were first sold to Danaharta (national asset management agency) beginning in the third quarter of 1998.

Source: Bank Negara Malaysia.

Loans are classified as nonperforming if payments are overdue for three months or more; prior to January 1, 1998 this period was six months. Total loans include housing loans sold to Cagamas.

Loans were first sold to Danaharta (national asset management agency) beginning in the third quarter of 1998.

  • Following a pretax loss totaling RM 8.5 billion during the 12-month period ending March 1999, the banking system began to generate profits in line with the turnaround of the overall economy. The system recorded an aggregate pretax profit of RM 4.7 billion during 1999 and RM 9.7 billion in 2000, with major banking institutions turning profitable.

  • The interest margin of the banking system also widened in 1999, reversing the trend of the previous year, and leveled off in 2000. For the commercial banks, the interest margin declined to a low of 3.2 percent in September 1998, owing to locked-in deposit funds in the face of more variable loan rates. The margin improved as interest rates began to fall, reaching 4.5 percent in the final quarter of 1999, but declined slightly to 4.3 percent by end-2000. The margin for finance companies reached a low point of 1.7 percent in June 1998, as deposit rates rose against a high volume of fixed rates for hire purchase loans: since then, the margin grew substantially from the declining interest rates, to about 6.5 percent in 1999 and 7 percent by end-2000.

  • Loan growth was flat in 1999 and picked up slowly to 5.4 percent by end-2000. However, taking into account the large amount of loans sold to, or managed by, Danaharta,5 bad debts written off, and loans converted into private debt securities, the increase in total bank financing has been much larger.

Box 6.1.Danaharta: Asset Management and Recovery

Danaharta, a wholly government-owned agency, was established in June 1998 to acquire and manage banks’ impaired assets. It has RM 1.5 billion in capital provided by the Finance Ministry, and is authorized to issue up to RM 15 billion (face value) in zero-coupon bonds. RM 11.4 billion in such bonds has been issued.

Danaharta was to purchase nonperforming loans with face values of RM 5 million or more. Financial institutions seeking recapitalization from Danamodal were required to sell their nonperforming loans in excess of 10 percent of total loans to Danaharta as a precondition.

Legislation has vested Danaharta with special power over borrowers, including insulation of the agency (and of subsequent purchasers) from undisclosed claims made after the initial purchase of assets by Danaharta; the ability to appoint special administrators without having to go to court; and the power to abrogate underlying contracts when it forecloses on collateral.

In late 2000, when its window for acquiring non-performing loans was closed, Danaharta had purchased loans with face values totaling about RM 20.5 billion at market value, as determined by independent auditors, and averaging 45 percent of the face values of the loans. Financial institutions were allowed up to five years to amortize the difference between the book value and the sale price, thereby avoiding immediate recognition of the total loss. In addition. Danaharta has been managing RM 26.2 billion worth of assets owned by the government in connection with government-assisted bank mergers.

Resolution has been reached for 74 percent of the RM 46.7 billion worth of nonperforming loans acquired or managed by Danaharta, involving various workout processes. For viable loans, these include loan restructuring, settlement, and special administration; for nonviable loans, these include sales of collateral, sales of business, foreclosures, liquidation, and special administration via a bid process. The average recovery rate of the loans was 66 percent.

Barring severe external shocks, Malaysian banks are expected to recover at a faster pace than from the previous recession because of less erosion of their asset quality, and because of the authorities’ rapid support for, and proactive restructuring of, the banking system (Table 6.3), There are, however, potential vulnerabilities that could slow the recovery. Substantial increases in interest rates could trigger further credit problems for weaker borrowers and create additional nonperforming loans.

Table 6.3.Asset Quality Indicators1(As of January 31, 2001)
Nonperforming Loans2Nonperforming Loans to LoansTotal Bad-Debt Provision to Nonperforming Loans3
3-month6-month3-month6-month3-month6-month
(In billions of ringgit)(In percent)
Commercial banks40.932.513.010.357.366.4
Finance companies17.913.521.216.051.962.1
Merchant banks3.93.022.417.241.052.6
Banking system62.749.015.111.854.864.3
Source: Bank Negara Malaysia.

Including loans sold to Cagamas with full recourse.

Nonperforming loans are shown gross of interest in suspense, Malaysian accounting calls for the continued accrual of interest on nonperforming loans with an offsetting provision to the interest-in-suspense account. The interest-in-suspense balance is a provision equal to the amount of interest accrued but not collected from nonperforming loans. Indicators are shown here for classifications of loans as nonperforming after payments are overdue for three months and six months.

Total bad-debt provision equals the aggregate of provisions for general, specific, and interest in suspense.

Source: Bank Negara Malaysia.

Including loans sold to Cagamas with full recourse.

Nonperforming loans are shown gross of interest in suspense, Malaysian accounting calls for the continued accrual of interest on nonperforming loans with an offsetting provision to the interest-in-suspense account. The interest-in-suspense balance is a provision equal to the amount of interest accrued but not collected from nonperforming loans. Indicators are shown here for classifications of loans as nonperforming after payments are overdue for three months and six months.

Total bad-debt provision equals the aggregate of provisions for general, specific, and interest in suspense.

Financial Sector Restructuring: Comparative Perspective

In response to the Asian crisis, the affected countries—despite different initial conditions and the approaches they used—adopted similar policies aimed at improving the structure of the financial sector and lessening its vulnerability (Table 6.4). To prevent a collapse of the system, all countries provided a blanket deposit guarantee and liquidity support to financial institutions. Subsequently, each country adopted some form of asset management strategy to address nonperforming loan problems, assigned high priority to upgrading supervisory and regulatory standards to international best practices, and sought to recapitalize financial institutions based on those norms. In the process, bank closures or merger programs were undertaken to establish stronger financial systems. Also, standards of corporate governance were upgraded.

Table 6.4.Financial Sector Restructuring in Malaysia, Korea, and Thailand
MalaysiaKoreaThailand
Initial government response
Establishment of an overarehing restructuring authorityYes1YesYes
Establishment of a separate bank restructuring authorityYes (Danamodal)NoNo
Liquidity support (in billions of U.S. dollars)9.223.324.1
(In percent of GDP)13520
Introduction of a blanket guaranteeYesYesYes
Deposit insurance2NoNoNo
Financial distress resolutions
Bank closures001 of 15
Elimination or dilution of current shareholder stakes of insolvent banksYesYesYes
Closure of other financial institutions0Over 20057 of 91
Mergers or interventionsYes, 54 to be merged into 10 groups by 12/00Yes, 8 of 26 absorbed by other banksYes, 5 banks and 13 finance companies,3 also 3 banks privatized
Bank recapitalization strategies
Public funds for recapitalizationDanamodal injected $7.1 billion into 10 institutionsGovernment injected $36 billion into 9 commercial banks: 5 out of 6 major banks now 90 percent controlled by stateGovernment injected about $11 billion into public banks
Majority foreign ownership of banksControl of domestic banks not allowed; foreign bank share is, however, significant41 announced; 2 pending64 completed; 1 pending5.
Instruments used to recapitalize and purchase nonperforming loansBonds or cashBonds or cashDebt-to-equity conversions
Asset resolution strategies
Establishment of a centralized asset management corporationYes (Danaharta)7Yes (KAMCO)8No. but an asset management company is planned9
Operational autonomy of restructuring agenciesYesYesNot applicable
Centralized asset management companies purchased assets at subsidized pricesPurchased assets are valued by independent outside auditorsAssets initially purchased above market-clearing prices with recourse, Since 1998, purchase endeavors at market pricesNot applicable
Nature of agency: restructuring or dispositionRestructuringNot clearly defined; mostly disposal of assetsNot applicable
Eligibility of loansAll financial institutions, including Labuan subsidiaries of Malaysian banks and Development financial institutionsAll financial institutionsFinance companies thus far, but also banks subject to intervention
Sources: Information provided by country authorities; Claessens and others, 1999, “Financial Restructuring in East Asia: Half way There?” Financial Sector Discussion Paper No. 3 (Washington: World Bank); Lindgren and others, 2000, “Financial Sector Crisis and Restructuring: Lessons from Asia,” IMF Occasional Paper No. 188 (Washington: International Monetary Fund).

Steering committee chaired by the central bank.

Under consideration in Malaysia and Korea.

Between government-owned institutions in which the government has intervened.

Foreign banks are allowed to purchase up to 30 percent equity of domestic banks.

From 15 percent to 100 percent.

Approval required from Board of Investment.

Assets transferred; loans larger than RM 5 million and mostly loans secured by property or shares.

The powers and resources of a preexisting asset management company were substantially increased; worst assets were to be transferred.

Nonperforming loan workout is decentralized, Three banks have established private asset management companies and more are being considered. Bybrid approach to reprivatization of banks subject to intervention is evolving. Thailand has announced that it with establish a centralized asset management company.

Sources: Information provided by country authorities; Claessens and others, 1999, “Financial Restructuring in East Asia: Half way There?” Financial Sector Discussion Paper No. 3 (Washington: World Bank); Lindgren and others, 2000, “Financial Sector Crisis and Restructuring: Lessons from Asia,” IMF Occasional Paper No. 188 (Washington: International Monetary Fund).

Steering committee chaired by the central bank.

Under consideration in Malaysia and Korea.

Between government-owned institutions in which the government has intervened.

Foreign banks are allowed to purchase up to 30 percent equity of domestic banks.

From 15 percent to 100 percent.

Approval required from Board of Investment.

Assets transferred; loans larger than RM 5 million and mostly loans secured by property or shares.

The powers and resources of a preexisting asset management company were substantially increased; worst assets were to be transferred.

Nonperforming loan workout is decentralized, Three banks have established private asset management companies and more are being considered. Bybrid approach to reprivatization of banks subject to intervention is evolving. Thailand has announced that it with establish a centralized asset management company.

Malaysia has achieved considerable progress in implementing these reforms in comparison to the other crisis countries. The approach adopted by Malaysia (and also by Korea) in resolving bad loan problems and restructuring banks involved a high degree of government involvement, which had the advantages of speed and coherence, notwithstanding the possibility that it could also raise expectations of future government bailouts. Malaysia’s efforts also benefited from the country’s relatively strong initial position, including its well-developed legal and institutional frameworks. Reflecting these efforts, the financial sector indicators, as measured by nonperforming loans and capital adequacy ratios, have improved in all countries, but those in Malaysia compare favorably (Table 6.5).

Table 6.5.Selected Financial Indicators of the Asian Crisis Countries
Malaysia1Indonesia2Korea3Philippines4Thailand5
Nonperforming loans of the banking system (as a percent of total loans)
December 19976.08.46.14.722.6
December 199818.648.67.410.445.0
December 199916.632.98.312.338.9
December 200015.325.65.615.117.9
Risk-weighted capital ratio(s) of the banking system
December 199710.58.07.015.99.9
December 199811.8-11.68.217.510.9
December 199912.5-2.410.817.015.3
December 200012.412.710.315.812.4
Total outstanding bad-debt provision(s) of the banking system (as a percent of nonperforming loans)
December 199766.239.623.742.1
December 199842.440.459.636.421.8
December 199950.229.075.445.132.2
December 200053.884.743.6
Sources: Data provided by the country authorities; and IMF staff estimates.

Nonperforming loans include those with interest in suspense and specific provisioning, and are defined as loans for which payments are overdue for three months or more.

Including Rp 254 trillion worth of nonperforming loans transferred to the Indonesian Bank Restructuring Agency; nonperforming loans of the banking system totaled 65.1 percent at end-March 2000. The capital ratio data are equity (as declared by banks) as a percent of total (unweighted) assets (data for 2000 relate to October).

For nonperforming loans, commercial banks’ data are used (based on delinquency); December 1997 data include past-due loans over six months and bankruptcy loans; December 1998 data include past-due loans over three months and bankruptcy loans; December 1999 data include past-due loans over three months and non-accrual loans reflecting forward-looking criteria. Risk-weighted capital ratio for December 1999 also reflects the application of new forward-looking criteria. Total outstanding bad-debt provisions of the banking system data show total provisions on balance sheet as a percent of nonperforming loans.

Nonperforming loan data are commercial banks’ data. Capital ratios of the banking system are not risk weighted, based on Basel guidelines. Regulations are being drafted in order to bring the practice into line with the guidelines, in accordance with recently passed legislation. The 2000 nonperforming loan data are for September 2000.

Nonperforming loans include those for That private and state-owned banks. Capital ratios for Thailand are based on phased-in provisioning rules, as allowed by Bank of Thailand, scheduled to be fully met at end-2000. Total outstanding bad-debt provision data for December 1998 and December 1999 are balance sheet loan-loss provisions, and do not include surplus capital in excess of the regulatory minimum.

Sources: Data provided by the country authorities; and IMF staff estimates.

Nonperforming loans include those with interest in suspense and specific provisioning, and are defined as loans for which payments are overdue for three months or more.

Including Rp 254 trillion worth of nonperforming loans transferred to the Indonesian Bank Restructuring Agency; nonperforming loans of the banking system totaled 65.1 percent at end-March 2000. The capital ratio data are equity (as declared by banks) as a percent of total (unweighted) assets (data for 2000 relate to October).

For nonperforming loans, commercial banks’ data are used (based on delinquency); December 1997 data include past-due loans over six months and bankruptcy loans; December 1998 data include past-due loans over three months and bankruptcy loans; December 1999 data include past-due loans over three months and non-accrual loans reflecting forward-looking criteria. Risk-weighted capital ratio for December 1999 also reflects the application of new forward-looking criteria. Total outstanding bad-debt provisions of the banking system data show total provisions on balance sheet as a percent of nonperforming loans.

Nonperforming loan data are commercial banks’ data. Capital ratios of the banking system are not risk weighted, based on Basel guidelines. Regulations are being drafted in order to bring the practice into line with the guidelines, in accordance with recently passed legislation. The 2000 nonperforming loan data are for September 2000.

Nonperforming loans include those for That private and state-owned banks. Capital ratios for Thailand are based on phased-in provisioning rules, as allowed by Bank of Thailand, scheduled to be fully met at end-2000. Total outstanding bad-debt provision data for December 1998 and December 1999 are balance sheet loan-loss provisions, and do not include surplus capital in excess of the regulatory minimum.

Financial and Corporate Debt Restructuring

Malaysia’s initiatives to restructure financial and corporate debt in a coordinated way entailed the establishment of Danaharta to acquire nonperforming loans and help banks clear their balance sheets. Danamodal to recapitalize banks (Box 6.2), and the Corporate Debt Restructuring Committee to facilitate debt workout by large borrowers (Box 6.3)6 This multipronged approach has proved to be a credible plan in the restructuring of Malaysia’s financial sector.

Danaharta’s broad legal mandate helped ensure that nonperforming loans would be dealt with promptly. While its setup under the Companies Act meant that it would be managed as a private entity, subject to normal auditing, The key issue in asset purchases by Danaharta was realistic valuations to ensure that it did not become a tool for indirect bailouts of existing shareholders, which would undermine the incentives for private sector recapitalization and proper governance of the agency and the banks. There are indications that loan valuations by Danaharta were reasonable, although some latitude was given to banks in that the losses on the sales of their assets to the agency could be amortized over five years rather than recognized immediately.

Overall, the plan for Danaharta was well conceived, with nonperforming loans being taken over to case bank operations. Concentration on larger nonperforming loans (involving only 2,000 to 3,000 accounts) meant that the process was manageable. Furthermore, the emphasis on resolution of nonperforming loans—and not simply their disposal—assisted in the restructuring of the corporate sector. There are, nevertheless, risks of the agency becoming a warehouse for nonperforming loans unless assets are upgraded and sold before long.

The mandate Of Danamodal inspired confidence that all domestic financial institutions would be recapitalized to the required standards, maintaining the safety and soundness of the banking sector. The requirement that institutions seeking Danamodal’s capital would have to sell nonperforming loans in excess of the specified proportion to Danaharta gave banks the incentive to deal with their had assets in a timely and coherent manner. Danamodal achieved its goal of restoring the financial industry’s capital level to above precrisis levels. Also, no systemic banking failure was encountered, and the payment system functioned smoothly throughout the crisis.

Box 6.2.Danamodal: Bank Recapitalization

Danamodal was established in July 1998 with the main objective of recapitalizing the banking system. Capital injections from Danamodal were destined to enable institutions to restore their capital adequacy ratios to 9 percent. To fund its needs, Danamodal raised RM 10.7 billion, comprising RM 3 billion in paid-up capital from Bank Negara Malaysia, and RM 7.7 billion raised through the issuance of zero-coupon bonds to financial institutions.

Selection of candidates for recapitalization was initially guided by Bank Negara Malaysia’s watchlist, based on stress tests of banking institutions. Danamodal’s participation was also determined by the non-feasibility of market solutions, the systemic impact of the failure, and the future viability and competitive positioning of concerned institutions. The “first loss” principle, by which original shareholders’ equity is written down, is applied strictly to all transactions.

Institutions requesting capital injections must submit recapitalization plans and are subject to monthly reporting of performance against a list of targets, Danamodal exercises control over management by appointing at least two members to the boards of directors, of which one is to be an executive director or chairman of the board.

Ten institutions received a total capital injection of RM 7.1 billion, initially in the form of tier-two subordinated debt that, per definitive agreement, is to be convened into equity; irredeemable, noncumulative convertible preference shares; and/or subordinated loans, depending on the cash flow characteristics of the instrument and circumstances of the banking institution. Eight of the ten institutions receiving assistance have fully repaid their loans, Danamodal’s excess funding has gone unneeded because undercapitalized institutions were able to restore capital on their own.

Box 6.3.Corporate Debt Restructuring Committee

The Corporate Debt Restructuring Committee was established in July 1998 to help mediate voluntary out-of-court restructuring of large debt involving a number of major creditors, following the London Rules model. Debt restructuring under the Committee is reserved for viable businesses and not those in receivership or liquidation. Aggregate bank loans must be RM 50 million or more, with at least three lending institutions participating, and the creditor committees representing the interests of at least 75 percent of total debt of all creditors.

The Corporate Debt Restructuring Committee has no legal status, but debt restructuring under its auspices is facilitated by a joint public-private sector steering committee appointed by Bank Negara Malaysia, which is assisted by a secretarial set up in Bank Negara Malaysia. Over 70 companies applied to the Committee for workout arrangements, with debts totaling RM 39.4 billion. The majority were property, construction, and diversified holding companies. At end-2000, 21 of these applications with debts of RM 7.8 billion had been withdrawn or rejected; 42 applications with debts of RM 27.3 billion have been completed or resolved with assistance from Danaharta; and 12 applications with debts of RM 12.1 billion are outstanding.

Debt restructuring in Malaysia has taken a number of forms. The approach taken by the Corporate Debt Restructuring Committee was intended to minimize losses to creditors and company shareholders through coordinated debt workouts that avoid placing viable companies into liquidation or receiverships, and to have banking institutions play a greater role in the financial rehabilitation of the corporate sector.

Prudential Accounting Standards

Prudential accounting standards have been brought closer to compliance with international best practices for all crisis countries. The valuation of nonperforming loans was hampered by the lack of clear market values and continuously changing economic conditions. To better support the valuation process, all countries lightened their rules for loan classification, loss provisioning, income recognition, and collateral valuation, and they have substantially Strengthened supervisory scrutiny of compliance by bankers and auditors with these rules. In the case of Malaysia, these changes took place in early 1998 (Table 6.6).

Table 6.6.Changes in Prudential Standards in Malaysia, Korea, and Thailand
MalaysiaKoreaThailand
Date when changes look effect1/1/986/30/983/31/98
Loan classification: days elapsed before considered past due180 days, with parallel classification of 90 days for supervision purposeReduced to 90 days from 180 daysReduced to 90 days from 360 days
Present criteria for classifying
substandard6 months3 months3 months
doubtful9 months3 months6 months
loss12 months12 months12 months
Loan-loss provisioning (in percent)
substandardto 20 from 020to 20 from 15-20
doubtful50to 50 from 75to 50 from 100
loss100100100
Interest accrualNo change, that is, accrual for 6 months maximumReduced to 3 months maximum from 6 months maximumReduced to 3 months maximum from 6 months maximum
Source: Data provided by the country authorities
Source: Data provided by the country authorities

Toward a More Resilient Banking Sector

As the next step in reforming the financial sector, the Financial Sector Masterplan was issued in March 2001. The plan has a long-term vision “to develop a more Resilient, competitive, and dynamic banking system with best practices, that supports and contributes positively to the growth of the economy throughout the economic cycle, and has a core of strong and forward-looking domestic financial institutions that are more technologically driven and ready to face the challenges of liberalization and globalization.7 The plan with be a blueprint for the financial sector for the next ten years and with focus on a series of best practices for the industry, as well as initiating a process of corporate governance based on effective risk management. In addition, the capital market is to have a more important role in the allocation of resources.

The main thrust of the plan is to develop strong domestic banking institutions that form the core of an efficient, effective, and stable financial sector. They with be expected to operate in an environment of emerging new technological advances and more differentiated and demanding consumers, and to provide a more diversified range of financial services. The banking sector with not only serve a more internationally integrated and dynamic economy, it should also have a leading role within this economy.

The broad strategies for the banking sector within the plan are to manage the process of liberalization, including the positioning of domestic financial institutions vis-à-vis foreign institutions; to strengthen the financial sector in the wake of globalization and technological advances; and to identify the optimal supervisory philosophy to be adopted within the existing structure, where Bank Negara Malaysia remains the sole regulatory authority of the banking system. Two key components of the plan are the bank merger program and significant changes to regulation and supervision, in line with best practices.

The Bank Merger Program

For all crisis countries, the strategies for systemic restructuring have sought to restore the financial systems to soundness as soon as possible. The process involves the introduction of the legal, institutional, and policy frameworks necessary for dealing with nonviable financial institutions, strengthening viable ones, and resolving value-impaired assets in the system.

Malaysia has undertaken to deal with its banking problems through a comprehensive bank merger program, designed to take advantage of economies-of-scale, to tap potential synergies, and to determine an exit strategy for the weakest banks. In the process, domestic banks were given broad flexibility to form their own merger groups, which total ten, each comprising a commercial bank, a finance company, and a merchant bank (with the exception of one group). Each group is required to have a minimum capitalization of RM 2 billion by end-2001, implying the asset size of most banking groups to be in excess of RM 25 billion (Table 6.7).

Table 6.7.Proposed Banking Groups(Mergers and acquisitions completed or close to completion as at December 31, 2000)
Anchor BanksCommercial BanksFinance CompaniesMerchant BanksAssets of Anchor Banks (in RM billion)Post-Merger Assets (in RM billion)1Percentage of System Assets
MaybankPacific BankMayban FinanceAseambankers Malaysia10614528.2
PhileoAllied BankKewangan Bersatu Sime Finance
Bumiputra-Commerce BankBumiputra-Commerce FinanceCommerce International Merchant Bank586613.2
RHB BankInterfinance RHB Delta FinanceRHB Sakura Merchant Bankers495310.3
Public BankHock Hua BankPublic Finance Advance FinancePublic Merchant Bankers335210.1
Arab-Malaysian BankArab-Malaysian FinanceArab-Malaysian Merchant Bank11418.0
Hong Leong BankWold BankHong Leong Finance Credit Corporation23407.8
Alliance (MultiPurpose) BankInternational Bank Malaysia Sabah BankSabah Finance Botton FinanceBumiputra Merchant Bankers Alliance Merchant Bank15203.9
Affin BankBSN Commercial BankAsia Commercial Finance BSN FinancePerwira Affin Merchant Bankers BSN Merchant Bank23326.2
Southern BankBan Hin Lee BankPerdana Finance Cempaka Finance United Merchant FinancePerdana Merchant Bankers172549
EON BankOriental BankEON Finance City Finance Perkasa FinanceMalaysia International Merchant Bankers15254.9
Others not yet mergedBank UtamaMBf FinanceUtama Merchant Bank132.5
Source: Bank Negara Malaysia.

As at February 28, 2001.

Source: Bank Negara Malaysia.

As at February 28, 2001.

The merger and acquisition phase was largely completed by end-2000, but much remains to be done. Cultural adaptation alone could present barriers to a quick and smooth progression of the process. Selection of management teams will be critical where there is no clear choice of chief executive officer or chief operating officer already in place. Bank Negara Malaysia requires that each banking group employ an independent consulting firm to advise and recommend individuals best qualified to manage the company. Bank Negara Malaysia with also closely monitor the performance of the banks’ management teams to ensure that any identified weaknesses are addressed in a timely manner. In this regard, strategic plans and integration issues for each banking group are important.

  • Integration plans, An important segment of integration is “cultural changes,” namely, blending the cultures of two or more entities.

  • Strategic plans, Such plans are needed to prevent several banking groups from concentrating on the same market sectors.

  • Staffing, This issue deals not only with over-staffing and retraining and/or early retirement of excess staff, but also with keeping and devetoing key individuals to manage the “new” banking system for the future.

  • Information technology, The integration of two or more data systems must be compatible and efficient, resulting in little or no turmoil to internal operations and consumer interests.

The bank merger program in Malaysia, ambitious in nature and timing, presents short-and longer-term challenges. The reduction to 10 groups from over 60 banks (precrisis) is significant, but the distribution in terms of asset size will initially be disproportionate. Three of the new banking groups with each comprise 5 percent or less of total banking assets, less than one-fifth the size of the May bank group. Some of the smaller banking groups may not achieve the desired efficiencies or economies-of-scale, creating competitive mismatches with their larger counterparts.

The possibility for additional mergers in the future could also be triggered by a liberalization of the financial services industry to allow for more foreign competition and competitive factors, that is. for larger companies to dominate specific segments.8 This possibility needs to be watched closely because the improved ability to compete is a key goal of the bank merger program and the Financial Sector Masterplan. There is also a concern regarding the management of some of the new banking groups, namely, depth of experience and strengths to manage a more complex and larger entity in a highly competitive environment.

Prudential Supervision and Regulation

Malaysia moved rapidly to strengthen the framework of prudential supervision and regulation (Table 6.8). In particular, the requirement that banks establish internal systems to manage risks, including for cross-border transactions, and Bank Negara Malaysia’s move toward risk-based and consolidated supervision are major steps to enhance the soundness of the financial system, especially as the merger program is completed and financial innovations are embraced by banks in Malaysia.

Table 6.8.Steps to Improve Prudential Supervision and Regulation in Malaysia, Korea, and Thailand
MalaysiaKoreaThailand
Development of an overall plan and/or strategy for the supervision and regulation of the industryYes Masterplan1Under consideration2Yes3
Steps to develop and implement consolidated supervisionIn process4Under consideration5Under consideration6
Steps to develop and implement risk-based supervisionYes7Yes8Yes9
Requiring banks and holding companies to develop and implement formal risk management processesYes10Unknown11Early stages of Development12
Source: Information provided by country authorities.

The Financial Sector Masterplan was released in March 2001; it sets broad goals for the supervision and regulation of the industry.

Through the refinancing of a World Bank loan, Korea is in the process of securing an outside consulting firm to assist in Developing a plan to bring its supervision and regulation function in step with current worldwide standards.

A complete re-engineering of the supervision group is under way. As part of the re-engineering process, actions to ensure compliance with international standards and the Core Principles are under way.

Bank Negara Malaysia is moving toward consolidated supervision. A change to existing banking law with be required to give Bank Negara Malaysia the authority.

Consolidated supervision is to be considered as part of an overall plan.

Through the proposed Financial Institutions Law and new supervisory policies and procedures, consolidated supervision is being considered.

Risk-based supervision was in the implementation stage when the crisis emerged, and is now being reintroduced into the examination process.

Risk-based supervision with be part of an overall plan for the supervision and regulation of the financial services industry.

Risk-based supervision approach is embodied in all new policies, procedures, regulations, and other supervisory guidelines that are developed. A risk-based supervisory approach for on-site examination is in the testing stage.

Bank Negara Malaysia is moving the industry toward formalized risk-management processes. This is evidenced by the implementation of mandated risk-management practices for derivatives, liquidity, and credit.

The consultant’s plan does not specifically address this issue

New regulations to accompany the proposed Financial Institutions Law with require appropriate risk management processes.

Source: Information provided by country authorities.

The Financial Sector Masterplan was released in March 2001; it sets broad goals for the supervision and regulation of the industry.

Through the refinancing of a World Bank loan, Korea is in the process of securing an outside consulting firm to assist in Developing a plan to bring its supervision and regulation function in step with current worldwide standards.

A complete re-engineering of the supervision group is under way. As part of the re-engineering process, actions to ensure compliance with international standards and the Core Principles are under way.

Bank Negara Malaysia is moving toward consolidated supervision. A change to existing banking law with be required to give Bank Negara Malaysia the authority.

Consolidated supervision is to be considered as part of an overall plan.

Through the proposed Financial Institutions Law and new supervisory policies and procedures, consolidated supervision is being considered.

Risk-based supervision was in the implementation stage when the crisis emerged, and is now being reintroduced into the examination process.

Risk-based supervision with be part of an overall plan for the supervision and regulation of the financial services industry.

Risk-based supervision approach is embodied in all new policies, procedures, regulations, and other supervisory guidelines that are developed. A risk-based supervisory approach for on-site examination is in the testing stage.

Bank Negara Malaysia is moving the industry toward formalized risk-management processes. This is evidenced by the implementation of mandated risk-management practices for derivatives, liquidity, and credit.

The consultant’s plan does not specifically address this issue

New regulations to accompany the proposed Financial Institutions Law with require appropriate risk management processes.

  • Risk-based supervision—with supervisory attention for weak institutions—will allow Bank Negara Malaysia to focus its resources on the most critical areas in the individual institutions, as well as on the stratification of risk areas across the financial sector. The impending requirement for banking institutions to have formalized risk-management systems is most important in that it with create an environment of self-supervision for the industry and enhance risk-based supervision. Stronger risk-management capabilities of banking institutions, in turn, with render risk-based supervision more effective. Implementation of formalized risk management at the holding company level with further improve the systems.

  • Improvements of the systems’ risk management have so far included requirements related to derivative products management and liquidity framework (implemented), and credit risk management (scheduled to be formalized by mid-2000). Internal risk-management systems would entail guidelines for other types of risks, in connection with interest rates, foreign exchange, transactions, strategy, reputation, prices, and other types of risks deemed significant to the oversight of each bank’s risk propensity.

  • A bank-by-bank early warning system currently being developed by Bank Negara Malaysia with provide leading Indicators for supervisory attention and allow for preventive measures against the catastrophic deterioration of individual institutions and the overall financial sector. The system, based on an individual bank failure model, will serve to enhance confidence in the financial sector.

  • Consolidated supervision is expected to play an important role as the bank merger program is completed, with the new banking groups becoming larger and more complex, and engaging in more varied activities. It will help contain over leveraging by financial institutions. For consolidated supervision to be operative. Bank Negara Malaysia will need to have supervisory mandates over financial institutions’ holding companies and other subsidiaries and affiliates. An amendment to the Bank and Financial Institutions Act would be warranted to include the scope of permissible activities for these entities, their minimum capital requirements, approval of dividends by the authorities, and approval for the publishing of reports and appointment of directors.

  • Increased transparency of macro-and microeconomic data and policies will help ensure more effective supervision. Similar to the other crisis countries, Malaysia is gradually implementing policies to foster improved corporate governance and lower corporate leverage. Ongoing attention is also needed to improve protection for outside investors through stronger enforcement of disclosure requirements and shareholder and creditor rights.

Other initiatives

In April 2000, the authorities announced a consolidation plan for the stockbroking industry to reduce the number of companies to 15 from the present 63, in conjunction with a reduction in transaction commissions, although the stipulation of the final number of brokers was subsequently abandoned, and the schedule revised. The objective of the consolidation is to form a group of well-capitalized universal brokers that can provide efficient and cost-effective intermediation for investors, and are robust enough to withstand the pressures of the stockbroking business. Furthermore, mergers between merchant bank sand stockbroking companies or discount houses are to be encouraged, with a view to Developing merchant banks into full-fledged investment banks. To facilitate this process, the legal and regulatory framework governing the banking and securities industries (supervised respectively by Bank Negara Malaysia and the Securities Commission) would need to be harmonized.

The Financial Sector Masterplan envisages that a deposit insurance fund be established to replace the current blanket deposit guarantee by The government that has been in place since January 1998. Contributions to the fund would be risk adjusted. Such a premium structure with avoid the moral hazard created by a blanket guarantee and create an incentive for prudent management in line with the move toward performance-based prudential regulation.

The 1999 amendment of the Labuan Offshore Financial Services Authority Act provides the authorities with the power to supervise offshore banking activities in Labuan. The agency is allowed to perform on-site work in the branches where necessary and to require the submission of any information relating to specific activities within its supervisory mandate. The amendment also provides for home country supervisors, including Bank Negara Malaysia, to conduct on-site supervision of their country’s branches in Labuan. Beyond supervisory matters, the government’s objectives regarding the Labuan Offshore Financial Center include the promotion and diversification of the financial players in the center; the Development of Islamic banking; and the Development of capital market, e-commerce, and the ancillary activities.

An efficient, progressive, and comprehensive Islamic financial sector is also an element of the long-run vision for Malaysia’s financial system. To achieve this, efforts will be needed to enhance institutional capacity, and to develop financial infrastructure and the appropriate regulatory framework. It is envisaged that by 2010, Islamic banking could comprise 20 percent of the banking and insurance market share.

This section was prepared largely prior to the finalization of the bank merger program and the issue of the Financial Sector Masterplan (March 2001), and includes only a brief outline of those initiatives.

This structure may change further following the completion of the merger process.

Malaysia has two pure islamic banks, Bank Islam and Bank Muamalat, with total assets of RM 14 billion at end-2000;, representing around 2 percent of the banking system assets. They offer Islamic bank products such as interest-free leasing, hire purchase lending, profit sharing, and joint-venture financing. The total market share of Islamic banking assets increased to 6.9 percent in 2000 from 5.5 percent in 1999.

Foreign banks have minority interest in ten domestic commercial banks, three finance companies, and seven merchant banks.

See Box 6.1 for a description of Danaharta’s role in the restructuring of the banking sector.

Korea also adopted a centralized approach to asset resolution and bank recapitalization from the outset, with active government involvement. In contrast, Thailand aggressively liquidated the impaired assets of closed finance companies through a central agency, but it did not permit public sector purchases of impaired assets from private commercial banks. Instead, each bank was encouraged to establish its own asset management company. Following a change in the government in 2001, however, Thailand announced that it would establish a centralized asset management company.

Bank Negara Malaysia, 2001. “The Financial Sector Masterplan” (Kuala Lumpur), March.

The share of banking system assets Controlled by foreign banks increased to 19 percent in 2000 from around 15 percent in 1997. The government’s share of the banking system has also increased over this period, through increased government equity holding and the recapitalization process.

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