FINANCIAL STRUCTURE

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UNIT 1

FINANCIAL STRUCTURE

OBJECTIVES

General Object !e

: To understand the structure of financial system in Malaysia.

S"ec # c Object !e$ At the end of the unit you will be able to: explain the evolution, function, role and structure of the financial system in Malaysia which consist of banking system, non-bank financial intermediaries and financial market. explain the role and function of financial institution and financial intermediaries in the country s development. explain the acts that regulate financial institution ! "A#$A %&'&, the (ffshore "anking Act %&&) and $slamic "anking Act %&'*. explain the role and purpose of regulatory body in Malaysian financial system. explain the characteristics, roles and ob+ectives of $nternational (ffshore #inancial ,entre -$(#,.. discuss the factors that contribute to the successful operation of the $nternational (ffshore #inancial ,entre s -$(#,.. describe the financial services which is offered by $nternational (ffshore #inancial ,entre -$(#,.. /iscuss the incentives given to the participants who operate in 0abuan. identify the challenges faced by the financial sector in the global economy.

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INPUT

1&1 EVOLUTION' ROLES AN( STRUCTURE OF T)E FINANCIAL S*STE+ $n this chapter, we will discuss about the Malaysian financial structure. 0et us begin with the: EVOLUTION OF T)E FINANCIAL S*STE+ The development of a sound and financial system is a necessary pre-condition for a stable and balanced economic and social development in Malaysia. $n this regard, "ank 1egara Malaysia -"1M. has consciously and systematically developed a modern and sophisticated financial system. The financial system has effectively mobili2ed and allocated resources for productive use in tandem with the rapid transformation of the economy. The development can be divided into four phases: First phase. The first priority of "1M in the early %&3)s was to create the basic infrastructure for the financial system. $t is also to develop a truly Malaysian-oriented banking system to complement the presence of strong foreign banking in the economy. Therefore, early efforts were focused on institutional building in order to develop an extensive domestic banking network and re-orientate the operations foreign banks branches to domestic needs. Second phase $n the %&4)s, "1M s efforts were focused on introducing other financial intermediaries. The establishment of merchant banks, the first of which was set up in %&4), satisfied the growing need for financial expertise in wholesale banking and

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corporate financing. This is caused by the expansion of the public and private enterprises which progressed towards more technology-oriented activities, involving more complicated forms of financing. $n addition, "1M was also instrumental in establishing a number of development finance institutions and the ,redit 5uarantee ,orporation to ensure a better position for the financial system to serve the financing needs of a more diversified economy. Another significant development during the decade was the enactment of a new legislation, the "anking Act %&4*, to strengthen the regulation and supervision of banking institutions. Third phase $n the %&')s, "1M s efforts were focused on further strengthening the regulatory and supervisory framework for the banking system. The latter part of the %&')s was a period of prudential re-regulation and significant structural changes in the banking system. These changes were comprehensive and prompted by lessons from domestic development as well as the global recession in the early %&')s. As a result, the Malaysian banking system was strengthened considerably, and was able to remain sound and intact despite the severe conse6uences of the sharp recession following the Asian financial crisis. Fourth phase The %&&)s was characteri2ed by rapid changes shaped by the forces of liberali2ation and globali2ation, aided by technology which broke new frontiers in the functioning of financial markets and in the development of financial products. The Asian crisis was a catharsis that cataly2ed national and international efforts to strengthen domestic financial system and the financial architecture. These issues will remain on the Malaysian agenda in the years ahead, including an acceleration of on-going efforts to consolidate the banking industry and to in+ect greater dynamism and competition into the system.

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ROLES OF FINANCIAL INSTITUTIONS AN( FINANCIAL INTER+E(IARIES IN T)E (EVELOP+ENT OF COUNTR*&

1) Intermediation function The financial system, comprising both financial institutions and markets, acts as an intermediary of resources in the economy. This intermediation function involves the mobili2ation of resources by providing the means for savers to hold monetary and financial assets, and allocating these resources for productive investment. An efficient financial intermediation system helps channel resources efficiently towards activities with high rate of return, as well as allow implementation of pro+ects that are larger in scale, and with longer gestation period and riskier prospects. $n addition, efficiency also means that information is processed well, allowing investment opportunities to be identified so that resources can be channeled to these activities. 2) Operation of the payment system A payment system essentially refers to a network of services that facilitates transactions involving the exchange a means of payment in return for goods, services, real assets and financial assets. The means of payment can take on many forms such as currency, che6ues and credit cards, as well as modern electronics means such as stored-value cards. The instruments, institutions and services that facilitate the transfer of value to discharge the payment obligation, serve as the payment system architecture. Therefore the payment system is a central element in the economic infrastructure that facilitates the efficient clearing and settlement process. Therefore, it has a significant effect on the operating efficiency of an economy. As key players in the payment system, strong and efficient financial institutions are essential for the efficient functioning of the payment system. 3) As a channel for transmission of monetary policy $n addition to its contribution to the development of the economy, a wellfunctioning and efficient financial system is vital for the effective conduct of

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monetary policy. This is because monetary policy is transmitted primarily through the banking system. (n the other hand, an inefficient banking system, usually characteri2ed by financially weak banking institutions and inefficient market mechanisms may render monetary policy less effectively in achieving its ob+ectives. $n an environment of emerging inflationary pressure, the ability of a central bank to raise interest rates would be constrained if the financial institutions are weak. This is because higher interest rates would weaken the health of the corporate sector and lead to the deterioration in the asset 6uality of the banking institutions.

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STRUCTURES AN( ROLES OF T)E FINANCIAL S*STE+ Bankin System

The banking system consists of "1M, the banking institutions and other financial institutions, namely the discount houses, the representative offices of foreign banks and offshore banks in the $nternational (ffshore #inancial ,entre in 0abuan -0abuan $(#,.. "1M, as the central bank, is at the apex of the banking system, and is responsible for the regulation and supervision of the banking system, with the exception of the offshore banks operating in the 0abuan $(#, which comes under purview of the 0abuan (ffshore #inancial 7ervices Authority -0(#7A.. The commercial banks are the main players in the banking system. They are the largest and most significant providers of funds in the banking system. The range of transaction accounts typically offered are savings account, current account, fixed deposits and negotiable instruments of deposits -1$/s.. They provide facilities for making payments or monetary transfers in domestic or foreign currencies, both locally and internationally8 makes commercial and industrial loans and trade finance. #inance companies form the second largest group of deposit-taking institutions in Malaysia. They provide finance -credit. , e.g. to operate hire purchase transactions on behalf of retailers of consumer goods such as cars and electronic and electrical e6uipment. Merchant banks filled the need for large corporations which re6uire bulky financing and complex banking services, by complementing the facilities offered by commercial banks which are more focused on providing shortterm credit for working capital and trade financing. They also play a role in the short-term money market and capital raising activities. /iscount houses speciali2ed in short-term money market operations and mobili2e deposits from the financial institutions and corporations in the form of money at call, overnight money and short-term deposits. The funds

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mobili2ed are invested in The Malaysian Treasury bills -T"., Malaysian 5overnment 7ecurities -M57., bankers acceptances -"A., negotiable instrument of deposit -1$/. and ,agamas bonds. !on"#ank financial intermediaries

These institutions are generally under the supervision of various government departments and agencies. All of them deal with funds. They mobili2e funds from certain sources and channel them to the deficit units. 0ike their sources, the uses of these funds varies.

/evelopment finance institutions help to promote the development of certain economic sectors through long-term investment financing. (n the other hand, provident and pension funds is designed to meet contingent financial needs of their clients and further assist the public sector s development efforts by subscribing to government securities. #inally, saving institutions are important to the small-time savers ant the rural population who usually have less opportunities to utili2e existing banking facilities.

9 -

Financial $arket The financial markets in Malaysia comprise the money and foreign exchange market, the capital markets, the derivatives markets and offshore markets. The money market is an avenue for the channeling of short-term funds with maturities typically not exceeding %:-month. $t provides a ready source of funds for market participants facing temporary shortfalls in funding, while at the same time, providing short-term investment outlets for those with temporary surplus funds.

;nlike the money market, capital markets are markets for raising long-term funds containing the e6uity and bond markets. The derivatives markets are for trading instruments that provide contingent claims on underlying assets, and whose values depend on the price of the underlying assets or securities.

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The 0abuan $(#, is aimed at enhancing the attractiveness of Malaysia as a regional financial centre, as well as to promote the economic development of 0abuan and its vicinity.

STRUCTURE OF T)E FINANCIAL S*STE+ The structure of Malaysian #inancial 7ystem is presented in #igure %.%. #$1A1,$A0 $17T$T;T$(17
Ban1 n2 S3$te4 "ank 1egara Malaysia "anking $nstitutions - ,ommercial "anks% - #inance ,ompanies - Merchant "anks 9 (thers - /iscount ?ouses - <epresentative (ffices of #oreign "anks - (ffshore "anks in 0abuan $(#,

#$1A1,$A0 MA<=>T7
+5ne3 8 F5re 2n E9c:an2e +ar1et$ 9 Money Market 9 #oreign >xchange Market

Ca" tal +ar1et 9 >6uity Market 9 "ond Market - @ublic /ebt 7ecurities - @rivate /ebt 7ecurities

N5n6Ban1 F nanc al Inter4e7 ar e$ 9 @rovident and @ension #unds 9 $nsurance ,ompanies: 9 /evelopment #inance $nstitutions 9 7avings $nstitutions - 1ational 7avings "ank - ,o-operative societies 9 (ther 1on-"ank #inancial $ntermediaries - ;nit Trusts - @ilgrims #und "oard - ?ousing ,redit $nstitutions - ,agamas "erhad - ,redit 5uarantee ,orporation - 0easing ,ompanies - #actoring ,ompanies - Aenture ,apital ,ompanies
% :

(er !at !e$ +ar1et 9 ,ommodity #utures 9 =07> ,$ #utures 9 =0$"(< #utures

O##$:5re +ar1et 9 0abuan $nternational (ffshore #inancial,entre -$(#,.

$ncluding $slamic banks $ncluding Takaful

F 2;re 1&1 F nanc al S3$te4

% Source& The 'entral Bank and the Financial System in $alaysia ( A )ecade of 'han e* B!$ 1+++)

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Act ! t3 1A

TEST *OUR UN(ERSTAN(ING ">#(<> B(; ,(1T$1;> C$T? T?> 1>DT $1@;TEF %.% /escribe briefly the structure of the financial system in Malaysia. %.: Chat are the roles of the financial institutions and financial intermediaries in the development of a countryG %.* 0ist down three sources and uses of the financial system funds.

Fee7bac1 T5 Act ! t3 1A

%.% a. #inancial institution i. "anking system ii. 1on-bank financial intermediaries b. #inancial markets i. Money and foreign exchange markets ii. ,apital market iii. /erivative market iv. (ffshore market %.: a. $ntermediation function b. (peration of the payment system c. As a channel for transmission of monetary policy %.* 7ources of fund: a. /eposits b. $nsurance, provident and pension funds c. ,apital, reserve and profit ;ses of fund: a. 0oans and advances b. 7ecurities c. /eposits with other financial institutions

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1&%

ACTS T)AT REGULATE FINANCIAL INSTITUTION T:e Ban1 n2 an7 F nanc al In$t t;t 5n$ Act 1<0< =BAFIA>

A ma+or event which took place in %&'& was the introduction of the "anking and #inancial $nstitutions Act %&'& -"A#$A. to replace the "anking Act %&4* and #inance ,ompanies Act %&3&. The introduction of "A#$A was intended to provide an integrated supervision of the Malaysian financial system and to moderni2e and streamline the laws related to banking and banking institutions. ,ationale for BAFIA The growing competition in the banking system had resulted in the blurring of lines of business between the three traditional groups of banking institutions under the ,entral "ank supervision, namely, commercial banks, merchant banks and finance companies. This had let to the extent that the methodology of supervision of these institutions had increasingly converged although the legislative basis for supervision was legally separated under the repealed "anking Act %&4* and repealed #inance ,ompanies Act %&3&. "A#$A placed all banking institutions supervised by the ,entral "ank, including discount houses and money and foreign exchange brokers which were previously supervised on an administrative basis, under one supervisory and regulatory scheme. "A#$A was built on the strength of the regulatory regime in the two repealed acts, while the prudential and structural regulatory features essential for ensuring the stability of the banking system have not been changed under the "A#$A. The Institutions under BAFIA a. 0icensed institutions ,omprising commercial banks, merchant banks, finance companies, discount houses, money brokers and foreign exchange brokers. b. 7cheduled institutions

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,omprising the ma+or non-bank sources of credit and finance and representative offices of foreign banks or foreign institutions which carry out the business or activities similar to the scheduled institutions. c. 1on-scheduled institutions ,omprising all other statutory bodies and institutions involved in the provision of finance and credit. T:e O##$:5re Ban1 n2 Act 1<<0 The (ffshore "anking Act %&&) -("A. governs the activities of offshore banking and offshore investment banking. "ank and financial institutions intending to operate as an offshore investment bank in 0abuan are re6uired to seek a license from the Minister of #inance through 0abuan (ffshore #inancial 7ervices Authority -0(#7A.. $n the amendments to ("A in %&&3, ma+or changes were made, among others, by expanding the definition of offshore banking business to include a wide range of financial services that could be undertaken by offshore banks instead of only providing credit facilities and accepting deposits. T:e I$la4 c Ban1 n2 Act 1<03 An act which came into effect on April 4 th %&'*, to provide for the licensing and regulation of $slamic banking business. The act inter alia has provisions on the financial re6uirements and duties of an $slamic "ank, ownership, control and management of $slamic banks, restriction of its business, powers of supervision and control over $slamic bank and other general provision such as penalties etc.

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ROLE AN( PURPOSE OF REGULATOR* BO(IES & Ban1 Ne2ara +ala3$ a

"ank 1egara Malaysia -"1M. is a regulatory body to have primary oversight of the monetary and banking system in Malaysia. To enable "1M to meet its ob+ectives, it is vested with comprehensive legal powers under various Acts and (rdinances to regulate and supervise the financial system. "1M was also as agent of the government on exchange control matters. #urthermore, effective % May %&'', "1M was also responsible for the supervision, regulation and development of the insurance industry as part of the financial system. & Sec;r t3 C544 $$ 5n

To streamline the regulatory structure of the capital markets, the 7ecurity ,ommission -7,. was established under the 7ecurities ,ommission Act %&&*, as a self-funding statutory body with investigate and enforcement powers. The mission is to promote and maintain fair, efficient, secure and transparent securities and futures markets and to facilitate the orderly development of an innovative and competitive capital market. The 7, s many regulatory functions include: 7upervising exchanges, clearing houses and central depositors8 <egistering authority for prospectuses of corporations other than unlisted recreational clubs8 Approving authority for corporate bond issues8 <egulating all matters relating to securities and futures contracts8 <egulating the take-over and mergers of companies8 <egulating all matters relating to unit trust schemes8 0icensing and supervising all licensed persons8 >ncouraging self-regulation8 and >nsuring proper conduct of market institutions and licensed persons.

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Act ! t3 1B

TEST *OUR UN(ERSTAN(ING ">#(<> B(; ,(1T$1;> T( T?> 1>DT $1@;TEF %.H 0ist down five ma+or sectors in the economic fund flow. %.I 1ame three special mechanisms which are established to overcome the serious increas 1@0s banking industry. %.3 1ame the regulatory bodies in Malaysian financial system.

Fee7bac1 T5 Act ! t3 1B

%.H i. ?ouseholds ii. >nterprises iii. 5overnment iv. #inancial institutions v. >xternal sectors %.I /anaharta, /anamodal and ,orporate /ebt <e-structuring ,ommittee -,/<,. %.3 "ank 1egara Malaysia and 7ecurity ,ommission

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INPUT

1&3 C)ARACTERISTICS' ROLES AN( OBJECTIVES OF IOFC T:e C:aracter $t c$ 5# an IOFC An offshore is basically a small territory or +urisdiction that imposes low or no taxes on income, profit, dividend and interest earned or derived from the offshore business activities or transactions carried out by offshore multinational corporation in or from those +urisdictions. 5enerally also, it does not have any exchange control or limitation or transboundary movement of funds into and out of the +urisdiction by the offshore company, no stamp death, inheritance or estate duties and no value added tax. An $(#, maintains a high degree of secrecy through limitation on public inspection of company files, prohibition from disclosure of the shareholding or beneficial ownership and management of the business, financial or other affairs of the company other than in compliance with the law. T:e r5le$ an7 5bject !e$ 5# IOFC $n summary, the ob+ectives of establishing 0abuan $(#, are as follows: a. to enhance the attractiveness of Malaysia as an investment centre. b. to supplement the onshore financial system centre in =uala 0umpur by tapping the growing demand for tailored financial and related services. c. to strengthen the contribution of broad financial sector to the progress of diversified economic growth. d. To form part of the broad national strategy to spread out and diversify the growth opportunities of the nation, focusing attention on the further development of >ast Malaysia in terms of industrial and services -including tourism. development.

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FACTORS T)AT CONTRIBUTE TO T)E SUCCESSFUL OPERATION OF IOFC There are some factors that contribute to the success of the existing $(#,: a. @olitical stability in the country which is a crucial factor in the investment decisions of the potential players. b. 7table currency with minimum or no exchange control. c. "anking secrecy and confidentiality coupled with minimum rules and regulations. d. A competitive tax regime. The tax rate imposed on offshore companies is among the lowest in the world. e. 0ower operating costs compared to other financial centres in the region. f. 5ood infrastructural support facilities such as excellent communications and transportation system with other financial centres. g. @rofessionally 6ualified and experienced workforce. FINANCIAL SERVICES ?)IC) IS OFFERE( B* IOFC AN( INCENTIVES GIVEN TO T)E PARTICIPANTS F nanc al $er! ce$ 5##ere7 n Lab;an IOFC

7ome of the international business activities that can be conducted in 0abuan $(#, are: a. offshore banking operations b. offshore insurance and offshore insurance-related businesses c. corporate funding d. investments and trust management e. offshore investment holding companies f. professional services and other related services.

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Incent !e$ t5 5"erate n Lab;an IOFC

7ome of the incentives offered to financial institutions to attract them to operate in 0abuan $(#, are: a. 0ow or no taxes on income, profit, dividend and interest earned from offshore business activities or transactions carried out by the offshore multinational corporation in or from the territory. b. 1o limitation or exchange control on the movement of funds in or out of the territory -other than the standard exchange control re6uirements on resident and nonresident institutions.. c. 1o levy stamp, inheritance, death or estate duties and no value added tax. d. 7trict rules on confidentiality in the territory or accounts in the territory s banks.

1&,

C)ALLENGES OF T)E FINANCIAL SECTOR IN GLOBAL ECONO+* The rapid intensification of globali2ation in recent years has significantly affected the structure and operations of financial institutions all over the world, including Malaysia. 5lobalisation is rapidly and irreversibly changing the way business and policy are conducted. #or instance, the global trend towards liberali2ation in the financial system has led to the blurring of traditional demarcation lines separating the activities of the different groups of financial institutions and removed artificial barriers to competition. As a result, the array of activities that can be undertaken by different groups of financial institutions is converging. Technological advances in telecommunications, information processing and computing have been a key factor in integrating financial markets across the globe, and in enabling the design of innovative and complex financial instruments that have helped to improve risk management and shifted risks to those who are better able to manage them. ,onse6uently, economic agents have become willing to assume greater risk, while

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short-term capital funds have flowed rapidly in large amounts from developed economies into emerging economies since the late %&')s. The measures that have been undertaken so far would serve as the foundation to further enhance the capability and capacity of the domestic financial system, and to achieve the agenda for the financial system, as follows: To create strong, efficient, competitive and resilient banking system that would be better able to withstand future shocks, thereby, minimi2ing the adverse implications on macroeconomic stability. To accelerate implementation of measures to broaden and deepen financial markets and strengthen the financial infrastructure. $n particular, efforts will be intensified to increase the proportion of non-bank financing in the economy and diversify risks away from the banking system. $n this regard, the further development of the bond market and securiti2ation would be accelerated. To inculcate strong risk management skills in order to ensure that there is no excessive risk taking that could result in adverse implications, given the increasing volatility of the financial environment. To promote dynamism in developing new products and management systems.

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Act ! t3 1C

TEST *OUR UN(ERSTAN(ING ">#(<> B(; ,(1T$1;> T( T?> 1>DT $1@;TEF %.4 %.' Chat are the main ob+ectives of establishing $nternational (ffshore #inancial ,entre -$(#,.G Chat are the challenges faced by the financial sectors in global economyG

Fee7bac1 T5 Act ! t3 1C

%.4 To complement =uala 0umpur as a regional financial centre, strengthen the contributions of the financial services sector to the gross national product of Malaysia and promote the economic development of 0abuan and its vicinity. %.' i. 0iberali2ation in the financial system ii. Technological advances in telecommunications, information processing and computing.

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@E* FACTS
%. "riefly the structure of the financial system is as follow: a. #inancial institutions i.i "anking system i.ii 1on-bank financial intermediaries b. #inancial markets i. Money and foreign exchange markets ii. ,apital market iii. /erivative market iv. (ffshore market :. The roles of financial institutions and financial intermediaries in the country s development: a. $ntermediation function b. (peration of the payment system c. As a channel for transmission of monetary policy *. The main assets of the financial system: a. ,ommercial banks b. @rovident and pension funds c. "ank 1egara Malaysia d. #inance companies

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H. #inancial intermediaries primarily operate in two markets. #irst in the saving market where they operate as borrowers while meeting the demand for financial assets by surplus units. The other one is the credit market where financial intermediaries supply the financial resources re6uired by the deficit units. I. The main ob+ectives of establishing $nternational (ffshore #inancial ,enter -$(#,. are to complement =uala 0umpur as a regional financial center, strengthen the contributions of the financial services sector to the gross national product of Malaysia and promote the economic development of 0abuan and its vicinity.

SELF6ASSESS+ENT 1

-ou are approachin success. Try all the questions in this self"assessment section and check your ans.ers .ith those i/en in the Feed#ack on Self"Assessment 1 i/en on the ne0t pa e. If you face any pro#lems1 discuss it .ith your lecturer. 2ood luck. %. The Malaysian financial system can be broadly divided into banking system and nonbank financial intermediaries. /istinguish the groups of institutions that fall into the two categories.

Fee7bac1 T5 Sel#6A$$e$$4ent 1
%. a. #inancial $nstitutions The banking system which is the ma+or component of the financial sector consists of: - "ank 1egara Malaysia - ,ommercial banks -include "ank $slam Malaysia "erhad and "ank Muamalat Malaysia "erhad.

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- #inance companies - Merchant banks - /iscount houses - #oreign bank s representative offices They are regulated and supervised by the central bank. b. 1on-bank financial intermediaries The non-bank financial intermediaries are mainly supervised by other government agencies. These institutions can be divided into five ma+or groups consisting of: i. @rovident and pension funds ii. $nsurance companies iii. /evelopment financial institutions iv. 7aving institutions v. (ther non-bank financial intermediaries comprising ;nit trusts, @ilgrims #und board, ?ousing ,redit $nstitutions, ,agamas "erhad, ,redit 5uarantee ,orporation, 0easing ,ompanies, #actoring ,ompanies and Aenture ,apital ,ompanies.

CONGRATULATIONS!!!! ..May success be with you always.