INTRODUCTION TO

BANKING LAW

INTEGRATION INTO THE

INTERNATIONAL BANKING
AND FINANCIAL SYSTEMS
INTRODUCTION

The economic system of Malaysia is basically one of the private enterprises,

although the government plays an active role in economic planning and in assisting

economic development. The utilisation and development of the natural, mineral and

human resources, aided by the prudent fiscal and monetary management in an

environment of political stability, have made Malaysia one of the more progressive,

prosperous and fastest growing economies in Asia.

In discussing about the integration into the international banking and financial

systems, we have focused on the co-existence between conventional and Islamic

banking and financial systems. We have also discussed about challenges and future

of the Malaysian banking systems besides retaliating on the current issues of the

banking and financial system in Malaysia.

CONVENTIAL BANKING

&

ISLAMIC BANKING
CONVENTIONAL BANKING:

Conventional banking is based on the principle that the more you have, the more you

can get. In other words, if you have little or nothing, you get nothing. As a result,

more than half the population of the world is deprived of the financial services of the

conventional banks. Conventional banking is based on collateral. Conventional

banks look at what has already been acquired by a person Conventional banks go

into ‘punishment’ mode when a borrower is taking more time in repaying the loan

than it was agreed upon. They call these borrowers “defaulters”. When a client gets

into difficulty, conventional banks get worried about their money, and make all efforts

to recover the money, including taking over the collateral. In conventional banks

charging interest does not stop unless specific exception is made to a particular

defaulted loan. Interest charged on a loan can be multiple of the principal, depending

on the length of the loan period.

ISLAMIC BANKING:

Islamic banking refers to a system of banking or banking activity that is consistent

with Islamic law (Sharia’h) principles and guided by Islamic economics. In particular,

Islamic law prohibits usury, the collection and payment of interest, also commonly

called riba. Generally, Islamic law also prohibits trading in financial risk (which is

seen as a form of gambling). In addition, Islamic law prohibits investing in

businesses that are considered unlawful, or haraam. Islamic finance has been

gaining momentum on a global scale for thelast 30 years. Many Islamic Banks have

sprung up over the last few years. These changes are occurring both in Muslim and

in western countries, and are driven by a global trend amongst Muslims to become

more observant of their faith. It might have been the reason why Islamic Banking
emerged, however, today Islamic Banking is sought by Muslims and non-Muslims

due to the benefits it offers. Industry size is currently estimated at more than $400

billion, with projected growth of 15% per annum. Financial institutions around the

globe are trying to keep pace with the growing demand for Sharia’h compliant

products and services.

MAJOR DIFFERENCES BETWEEN CONVENTIONAL AND ISLAMIC BANKING

SYSTEM

CONVENTIONAL SYSTEM ISLAMIC SYSTEM

Money is a product besides medium of Real Asset is a product. Money is just a

exchange and store of value. medium of exchange.

Time value is the basis for charging interest Profit on exchange of goods and services

on capital. are the basis for earning profit.

Interest is charged even in case, the

Loss is shared when the organization
organization suffers losses. Thus no
suffers loss
concept of sharing loss

While disbursing cash finance, running The execution of agreements for the

finance or working capital finance, no exchange of goods and services is must,

agreement for exchange of goods and while disbursing funds under Murabaha,

services is made Salam and Istisna contracts

Due to non existence of goods and

Due to existence of goods and services
services behind the money while disbursing
no expansion of money takes place thus
funds, the expansion of money takes place,
no inflation is created
which creates inflation.

Due to inflation the entrepreneur increases Due to control over inflation, no extra
 prices of his goods and services due to price is charged by the entrepreneur.

incorporating inflationary effect into cost of

product.

Bridge financing and long term loans

Musharakah and Diminishing
lending are not made on the basis of
Musharakah agreements are made after
existence of capital goods. Rather, they are
making sure the existence of capital
disbursed on the basis of Windo Dressed
good before disbursing funds for a capital
project feasibility and credibility of the
project
entrepreneur.

Government very easily obtains loans from Government cannot obtain loans from

Central Bank through Money Market the Monetary Agency without making

Operations without initiating capital sure the delivery of goods to National

development expenditure. Investment fund.

The expanded money in the money market

Balance budget is the outcome of no
without backing the real assets, results
expansion of money.
deficit financing.

Real growth in the wealth of the people

Real growth of wealth does not take place, of the society takes place, due to

as the money remains in few hand s. multiplier effect and real wealth goes into

the ownership of lot of hand s.

Due to failure of the project, the

Due to failure of the projects the loan is
management of the organization can be
written off as it becomes non performing
taken over to hand over to a better
loan.
management

Debts financing gets the advantage of Sharing profits in case of Mudarabah and
 leverage for an enterprise, due to interest sharing in the organization of business

expense as deductible item form taxable venture in case of Mushrakah, provides

profits. This cause huge burden of taxes on extra tax to Federal Government. This

salaried persons. Thus the saving and leads to minimize the tax burden over

disposable income of the people is affected salaried persons. Due to which savings

badly. This results decrease in the real and disposable income of the people is

gross domestic product. increased, this results the increase in the

real gross domestic product.

Due to decrease in the real GDP, the net Due to increase in the real GDP, the net

exports amount becomes negative. This exports amount becomes positive, this

invites further foreign debts and the local- reduces foreign debts burden and local

currency becomes weaker. currency becomes stronger.

RELATED CASES FOR CONVENTIONAL BANKING:

Malayan Banking Ltd v Raffles Hotel Ltd

The question raised by this appeal is whether the defendant company`s appointment

of itself as a director of the plaintiff company in exercise of the power purporting to

be given to it by the plaintiff`s articles of association is invalid.

The facts are not in dispute and are as follows. On 31 December 1925 the owners of

part of the property known as Raffles Hotel, Singapore, leased it to A Sarkies and

MS Arathoon for a term of 70 years. The lease provides as follows:

And the lessees hereby covenant with the lessors as follows, that is to say:
Not without the previous licence in writing of the lessors to assign or sublet the said

premises or any part thereof such licence not to be unreasonably withheld provided

nevertheless that (a) if the assignee or sub-lessee be a limited company no consent

shall be given unless the articles contain a provision that from time to time during the

continuance of this demise the lessors shall have power to appoint a director not

subject to retirement by rotation, but any director so appointed shall not be a person

interested in or connected with any business of a similar nature to the lessees (b) in

the case of a sub-lease no consent shall be given unless the sub-lessee shall

become tenant of the lessors at the rent hereby reserved.

On 11 September 1931 MS Arathoon was adjudicated bankrupt. And on 27

November 1931, an order was made for the administration in bankruptcy of the

estate of A Sarkies, deceased.

By a deed of assignment dated 6 July 1933 the lease was assigned by the proper

parties to the plaintiff company, subject to all the covenants and conditions contained

in the lease.

The memorandum and articles of association of the plaintiff company were

registered and the company was incorporated in Singapore on 28 February 1933.

Article 77 of the plaintiff`s articles of association empowers the lessors and their

assigns to appoint a director of the plaintiff company. The article is in these terms:

(1) The lessors to the company of part of the property known as Raffles Hotel

Singapore under a lease dated 31 December 1925 and made between William

Joseph Mayson and Mirza Mohamed Ali Namazie of the one part and Arshak

Sarkies and Martyrose Sarkies Arathoon of the other part and the survivor of them
and their or his assigns for the time being lessors of the said property may from time

to time so long as the property so leased is held by the company appoint himself or

one of themselves or any other person to be a director of the company and may from

time to time remove any director so appointed and appoint another in his stead and

John Harold Phillips, chartered accountant of Singapore, shall be deemed to have

been appointed pursuant to this power.

(2) Any such appointment or removal shall be in writing served on the company and

signed by the persons authorised to make the appointment or removal or by their or

his agent authorised in writing.`

By a deed of assignment dated 25 June 1963, the reversion was assigned to the

defendant company. And on 11 June 1964, the defendant company, purporting to

act in pursuance of the power contained in art 77, appointed itself by a resolution of

its directors to be a director of the plaintiff company, and by a letter of the same date

served notice of the appointment on the plaintiff company.

The defendant company owns the Malayan Finance Corp Ltd. The latter owns more

than 65% of the issued share capital in the Goodwood Park Hotel Ltd. The majority

of the directors of Goodwood Park Hotel Ltd are directors or employees of the

defendant company or the Malayan Finance Corp Ltd or companies associated with

them. The Goodwood Park Hotel Ltd carries on the business of operating and

managing hotels in Singapore.

On 15 June 1964, the plaintiff company instituted this action claiming:

(i) a declaration that art 77 of its articles of association must be read in

conjunction with cl 14 of the lease;

 (ii) a declaration that the defendant company`s appointment of itself as a

director of the plaintiff company is in breach of cl 14 of the lease and

invalid;

(iii) Alternatively, a declaration that the defendant company cannot act as a

director of the plaintiff company and an injunction to restrain the defendant

company from purporting to act as such director.

The defendant company disputed the plaintiff company`s right to the relief claimed.

The action was heard by Winslow J, who gave judgment for the plaintiff company,

declaring that the defendant company`s appointment of itself as a director of the

plaintiff company was invalid. The learned judge decided:

(1) that art 77 of the plaintiff`s articles of association did not confer any

contractual right on the defendant company to appoint itself a director of the

plaintiff company;

(2) that cl 14 of the lease did not confer any such contractual right on the

defendant company;

(3) that, in the absence of a binding contract entitling the defendant company to

appoint a director of the plaintiff company, the right, given by art 77 to the

defendant company could not be enforced against the plaintiff company; and

(4) That cl 14 of the lease does not confer any contractual right on the lessees.

The defendant company appeals against the decision of the learned trial judge as

regards the first and third points. The submission of counsel for the defendant

company proceeds as follows. Article 77 of the plaintiff`s articles of association gives

the defendant company the power to nominate a director for the plaintiff company.
The article contains no restriction on the power. It is immaterial whether the

defendant company has a contractual right to appoint a director for the plaintiff

company. The defendant company has exercised the power and made a valid

appointment under the article. It is not permissible to go outside the articles, look at

the lease, and write into the articles something which is not there but is in the lease.

The court has no power to rectify the articles of association under its equitable

jurisdiction even if it is proved that those articles do not accord with what is proved to

have been the concurrent intention of the signatories at the moment of signature:

Scott v Frank J Scott (London), Ltd [1940] Ch 794. Counsel relies on the following

passage from the case cited (at p 803):

Further the effect of registration of the memorandum and articles of a company

under s 14 of the 1929 Act is to bind the company (which, as already stated, only

comes into existence after the registration is effected) and the members thereof to

the same extent and in the same manner as if they had respectively been signed

and sealed by each member and contained covenants on the part of each member,

his heirs, executors and administrators to observe all the provisions of the

memorandum and of the articles subject to the provisions of the Act. It seems plain

that this section does not admit of any rectification of the memorandum and articles

apart from alterations under the express powers of the Act, for the only contract is a

statutory contract in which the company is included by reference to the registered

documents and to no other documents.

I will now deal with this submission. Section 14 of the Companies Act of 1929, which

is referred to in the passage cited, corresponds to s 22(1) of the Companies

Ordinance (Cap 174), which provides as follows:

Subject to the provisions of this Ordinance, the memorandum and articles shall,

when registered bind the company and the members thereof to the same extent as if

they respectively had been signed and sealed by each member, and contained

covenants on the part of each member his executors and administrators to observe

all the provisions of the memorandum and of the articles.

In considering this section, it must be borne in mind that the articles do not in any

circumstances, as between the company and a person who is not a member,

constitute a contract of which that person can take advantage: see 6 Halsbury`s

Laws of England (3rd Ed), p 129, para 270. As was said by Astbury J in Hickman v

Kent or Romney Marsh Sheep Breeders` Association [1915] 1 Ch 881 at pp 897 and

900 respectively:

An outsider to whom rights purport to be given by the articles in his capacity as such

outsider, whether he is or subsequently becomes a member, cannot sue on those

articles treating them as contracts between himself and the company to enforce

those rights. Those rights are not part of the general regulations of the company

applicable to all shareholders and can only exist by virtue of some contract between

such person and the company, and the subsequent allotment of shares to an

outsider in whose favour such an article is inserted does not enable him to sue the

company on such an article to enforce rights which are res inter alios acta and not

part of the general rights of the corporators as such.

I think this much is clear, first that no article can constitute a contract between the

company and a third person; secondly, that no right merely purporting to be given by

an article to a person, whether a member or not, in a capacity other than that of a

member, as, for instance, as solicitor, promoter or director, can be enforced against
the company; and, thirdly, that articles regulating the rights and obligations of the

members generally as such do create rights and obligations between them and the

company respectively.

Counsel for the defendant company does not quarrel with the decision of the learned

trial judge as regards the second point, namely, that the defendant company has no

contractual right under cl 14 of the lease to appoint a director for the plaintiff

company. It is, however, suggested that art 77 constitutes an offer capable of

acceptance and that nothing beyond mere nomination of a director is required by the

article. I am unable to accede to this suggestion. It is further suggested that as the

defendant company is in the position of a defendant and not of a plaintiff it can rely

on art 77 without depending on a contractual right. I am unable to accept this

suggestion for the reason that the defendant company cannot, even as a defendant,

take advantage of the power purporting to be given by art 77 without having recourse

to some contract between the defendant company and the plaintiff company confers

on the former a right to appoint a director of the latter. As regards the suggestion that

the court has no power to rectify art 77, it must be said that the plaintiff company is

not asking the court to rectify the article.

Counsel for the defendant company supports the decision of the learned trial judge

as regards the fourth point, namely, that cl 14 of the lease confers no right in contract

on the plaintiff company. Counsel`s submission on this point proceeds as follows.

Clause 14 contains a covenant on the part of the lessees not to assign without the

previous licence in writing of the lessors. The phrase `such licence not to be

unreasonably withheld` does not amount to a covenant on the part of the lessors but

is merely a qualification of the lessees` covenant: Treloar v Biggs (1874) LR 9 Ex

151. The words in the proviso cannot create a new obligation and can only qualify
the main part of cl 14. I accept this submission. And I take the view that the learned

trial judge was right in deciding that cl 14 of the lease confers no contractual right on

the plaintiff company.

For the above reasons I come to the conclusion that art 77 of the plaintiff`s articles of

association is not binding on the plaintiff company as between the plaintiff company

and an outsider; that without having recourse to a contractual right the defendant

company, being an outsider, cannot take advantage of a power purporting to be

given by art 77; and that the defendant company`s appointment of itself as a director

of the plaintiff company in exercise of the power purporting to be given to it by art 77

is invalid, that is, has no legal effect. In the result, I would dismiss this appeal with

costs.

RELATED CASES OF ISLAMIC BANKING:

Bank Islam Malaysia Berhad v Azhar Osman & Other Cases

The Court of Appeal, presided by a panel consisting of YA Datin Paduka Zaleha binti

Zahari, YA Datuk Zainun binti Ali and YA Datuk Clement Allan Skinner, heard three

related appeals on 13 Oct 2010 arising from the High Court decision in Bank Islam

Malaysia Berhad v Azhar Osman & Other Cases [2010] 5 CLJ 54.

The case involved proceedings commenced by writ of summons and originating

summons for Islamic banking matters.

The High Court held, inter alia, that:

(1) A Bai Bithaman Ajil (“BBA”) contract is not a sale transaction simpliciter;
(2) Upon premature termination, Bank Islam Malaysia (“Bank”) must grant an ibra

(rebate);

(3) ibra is to be granted based on unearned profit;

(4) The court should not allow the Bank to enforce payment of the full sale price in

a premature termination;

(5) The court must intervene on equitable grounds; and

(6) In an order for sale application, the Bank must deduct unearned profit as at the

day on which the order for sale is made.

The Court of Appeal initially reserved its decision, and allowed the Bank’s appeal on

20 Oct 2010.

The Court of Appeal’s oral grounds, in summary, were as follow:

(1) BBA contracts are sale contracts and the court must give full effect to the same;

(2) Ibra is applicable in early settlement cases and not in default cases;

(3) Ibra is not unearned profit;

(4) The Bank is allowed to claim the balance sale price; and

(5) The court should not interfere in the contract, as there are no vitiating factors to

do so.

The Court of Appeal granted judgment to the Bank for the balance sale price in the

writ of summons and originating summons matters.

CURRENT

ISSUES
 THE FINANCIAL AND CURRENCY CRISIS IN MALAYSIA AND STRUCTURAL

PROBLEMS THEREIN

THE CURRENCY CRISIS AND STRUCTURAL PROBLEMS:

Among the ASEAN countries, Malaysia was not only highly acclaimed for its

sustainable growth and stability but also its short-term foreign debts were smaller

than the other countries and the money influx through the banks was strictly

controlled. Nevertheless, it had to meet with stock plunges and the fall of its currency

through the rush to sell ringgit and the sudden capital flight.

In regards to the factors commonly shared by those Asian countries that are faced

with a currency crisis, two mistakes in policy-making have been recognized ; one is

their foreign exchange system that pegged to US dollars and the other, the

sequences in financial liberalization, which bring about the sudden inflows and

outflows of private capital. In addition to these, the blame has been laid on the

fragility of the financial sector that has resulted from the weak foundations of banking

business, the regulation / supervision system that is yet to be completed, and the

delay in building the basis for a capital market, which includes an inadequate

disclosure system, bankruptcy procedure and so on. These are mentioned as

the common structural problems; a prevailing view is that the banking crisis and the

currency crisis are two sides of the same coin.

The Malaysian government has hammered out one emergency policy after another

to deal with the currency crisis; it set forth measures to reduce the deficits of the

current-account balance of payment and to implement a tight fiscal squeeze, and

publicly announced that it would introduce a deposit insurance system. It also made
an effort to stabilize its economy and recover confidence in the market. Malaysia's

financial system, however, is not free from a structural problem of its own, which

must be addressed immediately. It is a financial issue that derives from Bumiputra

First Policy, or a social policy designed to treat native Malaysians more

favorably.Bumiputra, which means native children, has played a decisive role in

levelling off incomes, thus maintaining social stability and sustaining economic

growth. But the policy has created various inconsistencies in the financial sector.

THE BUMIPUTRA FIRST POLICY AND ECONOMIC GROWTH

Malaysia is a multiracial nation. Malays who occupy 60% of the population have

economically been in the shade, and to elevate their social position has become a

national policy since it was made a clear national goal in Malaysia's second five-year

plan that was initiated in 1971. Among the countries in East Asia, Malaysia's

uniqueness is considered to lie in the fact that it set out to build a financial system

from a relatively early stage in the 1960s soon after its independence, in order to

establish the basis of national savings for economic growth and realize

the equalization of incomes and of assets for social stability.

With the spontaneous savings based upon a nation-wide network of banks and the

compulsory savings whose basis was social welfare funds, Malaysia succeeded in

mobilizing domestic small savings, and in bringing its national savings rate to a

remarkable height. The Malaysian government, at the same time, worked wonders

achieving its goal to improve native Malays' social status. The domestic savings rate

recorded only a gradual increase in the early 1970s but since the late 1970s it has

started to grow rapidly and the average rate reached as high a level as 34% in 1991-

1995. It can safely be said from either of the indexes, the GNP growth rate or per
capita income, that Malaysia entered the phase of taking-off in the late 1970s after

the preparatory period of the 1960s.

The trade-off between stability and efficiency in the economic growth process is one

of the biggest problems a developing country is faced with. Taking this into

consideration, Malaysia's choice is noteworthy in building a financial system. But the

successful Bumiputra First Policy begot inefficiency in financial intermediary because

of the strictest restrictions the government had to impose on competition with a view

to protect the domestic banking business, the favorable loans to Malaysians'

businesses and housing loans favorable to Malaysian families, diverse measures in

pension funds and the national investment trusts scheme instituted in order to let

Malaysians form their personal assets. These favorable measures distorted the

growing capital market and resulted in a fragile banking sector.

FACTORS THAT SUPPORT THE HIGH SAVINGS RATE

The mainstay of domestic savings was household savings, a greater part of which

exist in the form of bank deposits. Domestic banks contributed a great deal in

mobilizing small household savings. But, in the 1980s as household incomes

increased and consumption permeated, the savings rate in the private sector

became unstable. The instability should be attributed mainly to the fluctuating

spontaneous savings, and the money allocated to the pension funds or compulsory

savings contributed to maintaining the national savings level as a built-in

stabilizer for household savings.

In addition to this, it should be noted that the savings by the government have

worked to supplement private savings in Malaysia. Malaysia's savings rate has long
been stable at a high level through such governmental complementation. The

governmental savings are chiefly composed of the general budget surplus and the

surplus from Non-Financial Public Enterprises (NFPEs). From the late 1970s to the

early 1980s there took place a hike in the prices of primary products, and the policy

aimed to equip the country with chemical and heavy industries such as oil-well

drilling increased surplus; these resulted in greater governmental savings during the

period. The increase of the governmental savings seen during the period from the

late 1980s to the early 1990s is due to such measures as the privatization of public

businesses, restructuring for improvement of performance and setting up a

supervisory organization the government took in response to the reduction of the

fiscal budget and to the fall in prices of primary products.

However, when the restructuring of government and the privatization of public

businesses come to an end, the governmental savings will shrink and cannot be

expected to prop up domestic savings any longer. One lesson we have learned from

the recent financial and currency crises in Asia is that the dependence upon foreign

investment will amplify instability of the financial system. If the Malaysian economy

expects to sustain growth, how to mobilize domestic savings especially spontaneous

savings will be a more important challenge than it used to be.

A Turning Point in the Financial Policy

The most notable point in Malaysia's effort to build a financial system is its

aggressive encouragement toward the growth of domestic banks. Since the central

bank was established in 1959, it has been recognized as essential for stable, well-

balanced economic and social growth to establish a sound, strong domestic bank

system, and also to put into shape a nation-wide bank network and to nurture a habit
for saving money among people in order to expand the basis for savings. A series of

measures designed to let the domestic banks grow such as:

(1) The founding of two large size commercial banks financed by the government,

(2) Favours given to those who opened branches in local areas,

(3) The restriction of competition in the regional market through regulation of new

branches, and

(4) Strict regulation against foreign banks was implemented and established a

banking system dominated by domestic commercial banks.

Thus, between 1970 and 1995, the deposits of domestic banks multiplied 48 times,

and those of commercial banks grew 94 times. Domestic commercial banks have

constantly occupied about 40% of the total asset of the banking sector. Domestic

commercial banks serve a highly concentrated banking market, and there are large

discrepancies in size between a few larger banks and others. As of 1995, an

oligopolistic market structure prevailed as the largest bank occupied 23% of the total

balance, and the five top banks kept 48% of it. In addition, as of 1995, the main stock

holders of the top two banks were the organizations that were under the strong

influence of the government.

The restriction of competition, by assuring the banks of some rent, can be said to

have been intended as a goal to lead banks to re-invest their surplus for developing

a network of branches and expanding business. A nation-wide network of branches

could not be built without investing a great deal of money and prepare for an

uncertainty in profitability. To make banks feel like building up a branch network, just
to grant such favourable ante conditions as preferential tax treatment or facility in

obtaining permits would not be enough. Through guaranteeing rent and promising

them such post conditions as strict restrictions against entry by others and

regulations of branches, they had to heighten the franchise value of the network.

In Malaysia, however, while they strictly regulated against entry, they liberalized

interest rates on deposits so as to give incentives to depositors in a relatively early

time in the 1970s. The liberation was carried out at a time when banks were

protected heavily by government policy and a supervisory system was yet to come.

Competition for deposits, thus, took place and loose irresponsible lending operations

followed. As a result, quite a few banks fell into financial difficulties. The liberalization

was temporarily brought to a standstill. In the late 1980s control was tightened

seeking healthier bank operations, and then interest rates on deposits were set free

again.

Some consider that Malaysia is an example where the government interfered little

with the banking and finance world as the liberalization of interest rates on deposits

had been promoted from early times (cf. The World Bank The East Asian Miracles:

Economic Growth and Public Policy, 1993). I must say this view has room for doubts.

Under a series of regulations that controlled competition, banks in Malaysia have

been absorbing private savings while enjoying rent as a mobilization system for

spontaneous savings since the1960s. On the other hand, their expansion strategies

affected detrimentally their efforts to realize sound banking and after the late 1970s

bank failures materialized. The oligopolistic market structure created factors which

delayed construction of an efficient banking system.

CHANGES IN FUNCTION OCCURRED IN THE PENSION FUNDS

As I already pointed out, social security organizations centred around Employees'

Pension Funds (EPF) which played a decisive role in mobilizing the long-term

household savings for political banking. But the real function of EPF has undergone

great changes in the 1980s.

Firstly, changes occurred in EPF's function of financial intermediary. Until the 1970s

as much as 90% of the EPF was invested in government securities, providing funds

for public finance. From the mid 1980s, restrictions imposed on EPF began to relax

gradually and the degree of the private sector initiative increased as the

government's operation went down in size. As of 1995, the percentage of investment

in government securities dropped to 33%. But it is not always right to interpret this

decline as the result of liberalized investment management, for the EPF was

burdened with a role of a receiving apparatus or buffer for privatized government

businesses. The deals were carried out in such expedient prices that it seemed that

there was eminently an aspect of income re-distribution to the EPF by the

government enterprises.

Secondly, the ability to mobilize long-term capital dwindled. As a means to stabilize

society, the government encouraged people to possess their own houses and

allowed them to draw money from their EPF before they retired. As a result, the

amount of money thus drawn came to occupy 30-50% of that paid in. The EPF, thus,

acquired a nature analogous to ordinary deposits and functioned less as a means for

pension savings since they shrank before retirement.

Thirdly, the problem of moral hazard rose because of the increased liabilities of

employers. The payment for EPF was originally equally divided between employers

and employees, but since 1975 the employers' burden has been relatively

increasing. As a result, I would like to point out, the employers who easily fall into

default are on the increase.

NEEDS TO MOBILIZE SAVINGS IN THE SECURITY MARKET

Obviously, the existing savings mobilizing system, whose principal targets are bank

deposits and pension funds, stands at a turning point. One possible solution for the

problems that have arisen in the course of re-directing the financial system toward

the private sector initiatives would be to utilize the capital market and thereby absorb

spontaneous savings. In order to achieve this, it will be necessary to make efficient

use of fund management industry, which is represented by investment trusts.

The introduction of unit trusts goes back to relatively early 1959, but they did not

begin to take root until the 1980s. In the late 1970s when the Bumiputra First

Policy was launched, a state owned investment trust company was founded, and

funds were designed to aid Bumiputra to acquire assets and equity capital. The aims

of the establishment of the company lied in (1) to familiarize Bumiputra society with

risk-taking involved in the possession of securities, and (2) to direct the savings thus

collected toward equity holding.

The unit trusts, though they took the form of stock-investment trusts, were actually

premium funds that could be bought back at fixed prices at any time, and guaranteed

high dividends and entitled their owners to tax benefits. Moreover, when a state

business was privatized, the unit trusts enjoyed a privilege to buy the company's
stocks at a special discount price just like the EPF. The unit trusts, thus, were

designed to become an asset because they were in fact a long-term, high interest

bond with a government guarantee.

In the greater trends that move toward the economy of the private sector initiative,

the EPF and the state-owned investment trust firm are still representative players in

terms of the percentage of the securities they own and are required to act as

institutional investors. While the EPF is, on one hand, expected to divert risks thanks

to relaxed investment regulations, on the other hand, it cannot help but comply with

demand for pre-retirement payments because of its role as a social security

organization. The state-managed investment trusts cannot outgrow the originally

imposed role of a means of re-distribution of incomes to Malaysians.

THE SOCIAL HARMONY POLICY AND FINANCIAL REFORMS

The government takes the risks involved in investment trusts and the pension funds

in reality are being used as short-term assets; these schemes thwart the healthy

growth of capital markets. In the 1990s, they promoted private sector's mutual funds

business, and, as a part of the social harmony policy, introduced the funds that non-

Bumiputra people can buy. With that, private investment funds began to grow.

Malaysia must deal with two problems; they have to refine the basic structure in

order to secure people's confidence in the banks, and they also have to strengthen

the function of capital markets which will facilitate to mobilize long-term capital. In

order to achieve these goals, it is possible to say that they have come to a stage in

development when they have to outgrow gradually the Bumiputra First Policy, which

has effectively worked to stabilize society. A reform of national investment trusts

scheme, privatization included, cannot be avoided. More efficient management of

pension funds must be aggressively pursued.

The growth of fund management industry, including that of pension funds and

investment trusts, is important because it provides a means to mobilize spontaneous

savings in the capital market. For these organizations to act rationally as institutional

investors will reinforce securities markets and enhance their function as capital

market, and promote competition both in procurement and management of money.

These are the essential conditions for strengthening the banking sector and capital

market. It, however, takes time to change the financial structure. Taking this into

consideration, I would like to keep observing how reform will be implemented in

Malaysia's financial system.

ISLAMIC FINANCE AND ALTERNATIVE DISPUTE RESOLUTION

Emergence of dispute resolution in the Islamic Banking system which serves as an

alternative to litigation is questionable. Many Malaysian cases still go to court but

Islamic finance disputes can be referred to arbitration by specialists in many

countries. The International Shariah Research Academy (ISRA) was established in

March 2008, with a mandate on researching Shariah issues on Islamic finance, with

special focus on contemporary matters under the auspices of the Malaysia

International Islamic Finance Centre which was setup in 2006. One project currently

undertaken by the ISRA includes avenues in alternative dispute resolution in Islamic

banking.

The KLRCA caters specifically to disputes on Islamic bank and finance and employ

the use of Rules For Arbitration Of Kuala Lumpur Regional Centre For Arbitration

(Islamic Banking And Financial Services), holds itself out as “applicable for the

purposes of arbitrating any commercial contract, business arrangement or

transaction which is based on Shariah principles” and propose a model arbitration

clause for contracts , with additional prerogatives offered as to the number of

arbitrators, law applicable etc. One drawback on the matter might be taken as Rule 1

of therefore mentioned Rules which state that only in cases where the disputed

agreement in writing calls for the auspices of the KLRCA, would these rules apply.

Based on Shariah principles out of this agreement or contract shall be decided by

arbitration in accordance with the Rules for Arbitration of Kuala Lumpur Regional

Centre for Arbitration (Islamic Banking and Financial Services)”, disputes brought for

“Any dispute, controversy or claim arising from Islamic banking business, takaful

business, Islamic financial business, Islamic development financial business, Islamic

capital market products or services or any other transaction business out of this

agreement .Due to lack of necessary legal foundation and could not thus be legally

arbitrated ,The Paradox Struggle Between Islamic and Conventional Banking

Systems 222 arbitration by both of them were lacking. Any award made in such

arbitration was not enforceable. In short, the system was vulnerable. The country’s

solution was to amend the laws to enable Shariah Courts with jurisdiction over the

matter. In the perspective of alternatives to dispute resolution this may have been an

unwelcomed move.However, it shall be noted here that arbitration is not free from

problems. At one stage or the other reference needed to be made to the common

law and even after the arbitration award is given, if parties want to enforce the award

they still have to go to court. And this does not lessen burden of the courts.
 CHALLENGES

&

FUTURE OF THE

MALAYSIAN BANKING

SYSTEM
THE CHALLENGES:

There are many challenges faced by the Malaysian banking system. Demographic

shifts are one of them as they cause changes in profile, changes in income and as

well as changes in users. Human resource is also one of the challenges as it

requires skill set and professional approach. Another challenge is by marketing and

services, which could be because of new innovative products such as wealth

management, credit card, and fee based services. Marketing services could also

include customer oriented services. Internal assessment is also another challenge as

it involves credit rating, risk management and as well as short term borrowing.

Example of risk management involves credit, market or either operational. It

compliances with RBI and other institutes.

An ineffective regulation is another challenge faced. There are also investment

related challenges such as where credit derivatives did not protect from counterparty

risks and also hedge funds where investment strategies were made based on strong

leverage. Another challenges faced is the Asset Liability Management where asset

distribution is based on volumes, mixes, maturities, yields and costs. Competition is

also another one of the challenges faced. Another challenges faced is technical

expertise. Acquiring the technical expertise should be the focus of the future human

resource management given the changing paradigm of banking sector regulations.

For example, the implementation of the new Capital Accord where the capital

adequacy requirements have been made more risk-oriented by linking capital to

operational risk and changing the risk measurement approaches for credit and

market risks. However, its implementation is not going to be an easy task mainly in
countries like Pakistan where risk management systems are at nascent stage. This

is because of one of the prerequisite for Basel II implementation which requires that

the banking institutions should have a robust risk management setup which is

capable of effectively managing all major risks that an institution is exposed to.

Similarly, the banking institutions are also required to carry out stress testing, a

technique that is used around the globe by financial institution.

This technique is used to assess risk exposures across the institution and to

estimate the changes in the value of the portfolio, if it is exposed to various risk

factors. Initially, although, SBP has advised banks to carry out the simple sensitivity

analysis keeping in the view the varying levels of skill and available resources

among banks. However, going forward more sophisticated techniques will be

adopted.

Certainly, this process would require technical expertise at least in three areas which

are identifying, analyzing and proper recording of the assumptions used for stress

testing in adjusting the situation or shocks applied to the data and as well as

interpreting the results and an effective management information system that

ensures flow of information to the senior management to take proper measures to

avoid certain extreme conditions.

Infrastructure Development is also one of the challenges faced. All around the world

the share of private sector participation is increasing tremendously in the area of

infrastructure development. Through most of 1990s, the investment in infrastructure

projects with private participation rose steadily and of these the most successful
projects were implemented in 136 low and middle income countries. For example,

Development Programme has resulted in congestions and bottlenecks that have

raised the need to find alternative way of fostering private-public partnership in the

areas of infrastructure development.

This success story of private sector in infrastructure development has also set

challenges to the local banking industry to learn from the experience of other

emerging market economies and innovate and design the different modes of

infrastructure financing and the associated risk management systems. Another

challenge is the Development of Liability Products. Although new products have

been introduced in preceding three years on asset side, including, consumer finance

and SME finance, but little attention has been paid on developing and innovating the

liability products. This one sided approach has proved adverse for the local banking

industry as these are the savers and depositors that provide financial resources to

the banks to perform their intermediation business.

The stagnant financial savings in the economy for last few years is an outcome of

this neglect and this has raised the need to design the lucrative savings products in

the country so as to look after the interest of the small savers and mobilize their

savings in an efficient way. Anti-Money Laundering is another example of another

challenge. As a result of increased integration in the global financial industry, the

misuse of banking industry has been observed in recent years. These include the

use of banking services for activities like, terrorist financing, drug trafficking and

money laundering. In few countries although there is a comprehensive legislative

systems and well defined enforcement mechanism but there are a number of
countries where the entire regulatory framework is at initial stage. In such countries,

banking institutions are exposed to adverse consequences of these activities in the

form of reputational, operational, legal and concentration risks. For example, the

institutions have to pay the investigations or the penalty charges, decline in the stock

value, assets seizures, or temporary termination of correspondent banking facilities.

The tackling of this issue requires a coordinated effort of the banking institutions,

regulators, and law enforcement agencies. In this regard, SBP has already taken

some viable steps to prevent the use of banking institutions for illegal activities.

Operational Aspects is another one of the challenges faced. It has been observed

over time that banks put their focus on treasury and corporate business while the

operational side is often ignored. Another challenge faced is the Human Resource

Development. Based on the Labor Force Survey 2003-2004, the overall labor force

participation rate is 30.41 percent. In today’s era human resources are as important

as financial resources to any organization.

The Banks need to develop their human resources for future challenges and produce

professionals having the desired expertise for specialized banking like Treasury

functions, SME financing and Islamic Banking. This is the need of the hour that

banks should develop their own Human Resources. To deal with this issue, Banks

may enhance their collaboration with the educational institutions. There are also a

number of challenges that have emerged following the most recent macroeconomic

developments in the domestic and global economy which are called as external

challenges. Interest Rate Variations is another challenged faced. Interest rates have

been at historic low levels during the last three years and were therefore providing a
conducive environment for the expansion of overall real economic activities. More

importantly, smaller business entities which earlier could not afford bank financing

were able to do so in this environment. Low financial charges were one of the major

factors for credit demand in the economy. Another challenge faced is the Consumer-

Durable Demand.

The robust growth of auto and mortgage finance in preceding years has significantly

increased the prices of these assets, and thus has created inflationary pressures in

the economy. The probability of default on these loans has a direct relation with the

value and the nature of the underlying collateral as most of the consumer lending is

secured. This said, asset prices play a crucial role in determining the size of the

losses incurred by banks in case of default. In order to avoid such problems, banks

have to rely more on the future income streams of the borrowers in making their

credit assessment instead of the collateral value, until such time that the asset prices

are rationalized. Equity Stock Investment is another challenges faced as the

investment in equity stocks need a cautious approach. Another challenged faced is

E-Banking.

It’s another area where there is still a lot of progress that should be made. Although

small and medium banks are now offering on-line services to their customers, the

large banks, with more expanded branch network and number of customers, are

required to move more expeditiously so as to optimally utilize the E-banking network.

This will not only lower the transaction costs but will also help in improving the

customer services. The ATM penetration ratio is still quite low and the efforts are

needed to not only further expand the ATM network more aggressively but also to
improve upon the security standards. Lastly there are a few ways to cope with all

these challenges. Which are fundamentally upgrading organizational capability to

stay in tune with the changes, by adopting value, and by implementing organizations

wide initiatives involving people, process and technology to reduce the fixed cost.

The banking system, comprising commercial banks, investment banks, and Islamic

banks, is the primary mobiliser of funds and the main source of financing which

supports economic activities in Malaysia. The non-bank financial intermediaries,

comprising development financial institutions, provident and pension funds insurance

companies, and takaful operators, complement the banking institutions in mobilising

savings and meeting the financial needs of the economy.

Malaysian financial system performs an important intermediation function as well as

plays a critical role in promoting economic growth. The intermediation function of the

financial system can be analyzed by looking at the structure of the sources and the

uses of funds mobilized as financial resources in the economy. Regarding to this, it

has been taking a long time for the economists to claim that financial institutions

perform an important allocation function to the productive sectors in the development

process of an economy.

The allocation role of financial institutions was first recognized by Schumpeter

(1912), who conjectured that bankers help to identify entrepreneurs with good growth

prospects, and therefore help to reallocate resources to their most productive uses.

In addition, the relationship between financial sector development and economic

development has been the subject of a booming literature (Shaw, 1973; Demetraides

and Hussein, 1996; Levine, 1997; Arestis et al., 2001).

According to Gallego et al. (2002), financial systems can develop in terms of

financial depth, which includes bank liquid liabilities to GDP (or M2) or bank credit to

the private sector to GDP. Fisman and Love (2004) found support for the finance and

growth primarily when the level of financial development is measured as domestic

credit provided by private sector banking institutions. Moreover, Hsu and Lin (2000)

found that banking development is positively related to the short and long term

economic growth. Demerguç-Kunt and Huizingha (2001) found that in the context of

developing economies, too rapid and uniformed liberalization of the banking industry

might not bring optimal outcomes.

Specifically, the higher banking sector development is related to lower banking

sector performance mostly due to the tougher competition. However, a study done

by Shirai (2001), Isik and Hasan (2003) suggest that financial liberalization may

strengthen the banking sector by taking steps of liberalizing the banking sector

development. Therefore, well-functioning and developed financial institutions,

specifically the banking sector, are vital in ensuring effective and efficient resource

allocation for the economic growth of a country. In pursuit of such financial system,

many developing countries have implemented numerous financial reforms including

lifting restrictions on bank lending, the provision of market-based systems of credit

allocation, lowering of reserve requirements, and the easing of entry restrictions to

the banking sectors and privatization of state owned banks. In light of this proposed

function, it is important to know the determinants in the banking sector development.

The global banking industry, within the past year, has faced some of the roughest

moments in its history

The subprime mortgage fiasco in the United States sparked a financial tsunami

worldwide causing some of the financial giants, chiefly Lehman Brothers and Bear
Stearns, to collapse. Heavyweights, among others, Citigroup, Morgan Stanley,

Goldman Sachs Group Inc and JPMorgan Chase & Co were bailed out with billions

of dollars from the US government. Central banks worldwide pumped in trillions – at

last count US$24 trillion – to save their banking systems from collapsing.

Malaysia, fortunately, was not that badly hit. Unlike during the Asian financial crisis of

1997–1998, the country was on a stronger footing, thanks to Bank Negara’s

initiatives and built-in buffers to strengthen the domestic financial system. Some of

these measures included ensuring sufficient capital in the banking system, better

supervisory and risk management systems, and improvement in loan quality.

Measures put in place by the Government such as the stimulus packages, the

reinvigorated Corporate Debt Restructuring Committee, providing blanket

guarantees on all bank deposits, and guarantees on bonds for small and medium

enterprises, has further fuelled confidence in the banking system.

The liberalization of the financial services sector is expected to heat up competition

in the banking industry as more new licenses are expected to be issued to foreign

players. With more foreign players coming into the local market, the domestic

banking industry would need to be far-sighted and focus on some key areas to

remain competitive to face future challenges. These, among others, include talent

development, specialization, information and communications technology,

consolidation and customer “centricity”.

TALENT DEVELOPMENT:

Deloitte Malaysia country managing partner, says while most banks may have their

respective talent development and management models, the key to make these

models work as robust systems is their ability to execute them properly.

This is one area most banks find most challenging as talent development often

requires a balance between short-term business gains and long-term organizational

benefits in addition to securing business leaders’ commitment across the

organization. Its success also depends largely on the ability of the banks to identify

and articulate competencies that are required to support future business needs,

particularly in the future, as banks no longer find it tenable to just remain as players

in the domestic market without venturing beyond Malaysia’s shores.

To succeed, banks need to rethink their sourcing strategy and create a pool of

seasoned “international” professional bankers instead of just relying on the traditional

approach of mobilizing resources from within the domestic boundaries. It is also

necessary to review existing legislation and regulations to make them more business

friendly to support the industry in facing the new challenges by making it easier to

mobilize talent from other non-traditional and global sources.

Besides that, local banks should forge partnerships with foreign parties as this would

enhance the transfer of knowledge and expertise, especially in staff mobility and

talent attraction. Strategic alliances with foreign players could also potentially bring

other benefits such as risk management practices, retail and SME banking, product

innovation, training and development, as well as regional and global presence. Apart

from ensuring sufficient liquidity in the banking system, talent management is also

critical for a bank to succeed in the future.

There is an urgent need in the industry for skilled professionals who can exercise

seasoned judgments across functions and on frontlines.PricewaterhouseCoopers

Malaysia tax financial services leader, says although talent development in the

industry has improved to an extent, more needs to be done. There is a need to

expose Malaysians working in local financial institutions to how the financial sector

works and operates overseas, to form linkages and networks.

There is also a need to attract talent back to Malaysia and to retain existing talent by

ensuring local financial institutions offer competitive packages and advantages.

Malaysia cannot be a hub without the people to drive the industry.

Although the gap between local and foreign banks has somewhat narrowed,

especially in the past few years, local institutions still have a lot of improvements and

advancements to make before they can be on par with foreign players, especially in

expertise and knowledge.

ROLE OF ICT

On electronic payment channels and usage of ICT, local players need to invest more

in this area as foreign banks have greater technology and have invested far more in

ICT.Leveraging on technology to effectively support the strategic management

function is another key challenge. In a survey done worldwide, over 90% of the

respondents believe they will have a long road ahead to fully mobilize their IT

resources to support enterprise-wide risk and decision-making,”

Many financial specialists, foresees demand for Internet banking to grow as the

current younger generation enters the workforce. They say that Malaysia’s

broadband penetration needs to grow exponentially to support wider usage of e-

banking and to put the industry on a stronger footing. For local banks to compete

effectively, they should consolidate further or merge with bigger institutions, or

become niche players in certain market segments.

SPECIALIZATION

In terms of specialization, PricewaterhouseCoopers’, it has worked out well,

especially in the area of Islamic finance.

Owing to strong competition from other countries with keen interest to expand their

reach into this area, Malaysia’s financial institutions need to innovate to stay ahead,

she says.PricewaterhouseCoopers assurance financial services leader says areas of

potential specialization that banks could look into are agriculture and infrastructure

as they are relatively under-served in the country.

In view of rising competition from foreign players, greater specialization is essential

to build expertise in specific areas or market segments. It is important that domestic

banks see the merits of specialization and stick to their core expertise.

For example, in the United States, State Street Bank is well-known for its custodial

services, while National Westminster Bank (Natwest), a high-street bank in the

United Kingdom, specializes in retail banking, he adds.

CUSTOMER FOCUS

The challenge today for many local banks is to evolve from a banking model that

places emphasis on transaction processing and operational capabilities to one that is

customer-centric.
While some have made strong progress in improving their customer experiences,

such as leveraging customer data to deliver a better product mix, creating a distinct

brand image, and improving service operations, he believes the challenge for local

banks is to be able to adopt customer and product strategies that will allow them to

capitalize on the potential for growth and profitability.

One area is to recognize that customer behavior and expectation often vary across

different segments, and banks would do well to develop appropriate channel,

marketing and product strategies that would deliver an enhanced experience and

better customer relationship.

The banking industry, which has been resilient despite the financial crisis, has to be

forward-looking and focus on some of the above key areas that would bring it to the

next level of growth to face future challenges.

THE FUTURE:

Contemporarily in this current decade, the Malaysian banking sector has been

suggestively transformed and reinvented. The placing of the financial sector on a

stronger foundation obviously has been effected by the reformation, amalgamation

and justification done. This decade has also been a period of favourable

performance and increased flexibility. This has been achieved with the successful

incorporation of business processes and the redeployment of resources to support

new areas of growth.

Financial reforms have also changed the environment. Progressive deregulation and

liberalization have increased the flexibility to financial institutions, while also resulting

in new business opportunities and increased competition. These developments have

also further strengthened the incentives for improved performance. Significant

structural changes during this period have also reshaped the landscape. The

introduction of capital market intermediaries, investment banks, an increasing

presence of new international players in Islamic finance, and a significantly more

developed bond market, has resulted in a significantly more diversified financial

system.

At the moment, the financial sector has evolved from being an enabler of growth to

become a vital source of growth in its own right. The sector, in the banking and

insurance industries, now provides employment to more than 123,000 Malaysians.

Despite conditions that have remained challenging for a large part of the decade, the

banking system remained consistently on solid financial ground with a risk-weighted

capital ratio of over 13%, low NPL ratios, and continued profitability for eight

consecutive years. Substantial progress has been made towards consumer retail
finance and access to banking services. Such consumer lending has increased from

RM134 billion to RM343 billion while loans disbursed to small and medium

enterprises have increased from RM71 billion in 2000 to RM108 billion in 2007.

Domestic banking institutions are also building on their strong domestic performance

to expand beyond Malaysian borders. Today, six domestic banks have presence in

10 countries around the region. The current encouraging state of the banking

system, however, should not make us complacent on the need to continually

transform and reinvent. The road in front of us is likely to be significantly different

from the one we have travelled on. As our previous experience has shown, we need

to constantly recognize that strategies that serve well in today's environment would

not necessarily be a formula for success in tomorrow's environment.

In looking at the future terrain of the financial sector in Malaysia, six trends are

particularly important – first, the changing configuration of the global economy and

global financial markets; second, regional economic and financial integration; third,

financial sector development amidst increased liberalisation in the Asian region;

fourth, increased role of domestic demand in the Asian economies; fifth, growing

significance of Islamic finance in the international financial system; and finally,

developments in the regulatory structures and approaches. It can be expected that

all these trends will have a significant bearing on the future of the banking industry.

First, the global economic configuration has been altered by the emergence of

several large emerging economies into the global economy. This is especially

evident in Asia, where the BIS Review 83/2007 1rise of China, India and the South

East Asian economies have increased Asia's global role.

The region is also a significant net exporter of capital, holding two-thirds of the

world's foreign exchange reserves and is the largest holder of the developed

economies' sovereign bonds. One-quarter of Fortune's top 500 global companies are

Asian corporations. This opens up tremendous business opportunities for Malaysia

as a part of this dynamic growth region. Accompanying these changes has been the

prevalence of abundant liquidity in the global financial markets, resulting in an

intensified search for higher yields. These trends are encouraging flows into the

capital markets of emerging economies, presenting new opportunities for wholesale

banking and capital market related financial services. These flows, however, also

pose potential risks of reversals in financial market conditions. This increases the

need to ensure that we have the capacity to absorb or adjust to changing financial

flows.

A second significant trend shaping the future financial landscape is the intensification

of regional economic and financial integration. Economic integration through trade is

already well-advanced in Asia, with the share of intra-regional trade already more

than half of the total trade in Asia. More recently, however, greater financial

integration at the regional level has been an important development, bringing

complementary and mutually-reinforcing benefits to the economies in the region.

Intra-regional investments among the Asian economies have increased with an

accompanying rise in cross-border financing activities.

There has already been an increase in cross-border mergers and acquisition activity

among Asian financial institutions in order to reap emerging opportunities. The

transformation in the financial landscape in the current environment has not been

confined to the Asian region but has also involved growing ties with other emerging

regions. Of significance is the rising trend of trade and financial linkages between
Asia and the Middle East and other parts of the world. Malaysian banks now have

the capacity to take advantage of these trends.

The trends towards regional financial integration also present significant

opportunities to tap into the enlarged pool of savings in Asia. Besides institutional

pools of wealth, the rapidly expanding middle class has been a key factor sustaining

the high savings rate. In Asia alone, we now have more than 2.6 million high net

worth individuals who collectively control an estimated USD8.4 trillion in financial

assets. These trends underpin the increasing demand for more sophisticated

consumer finance and wealth management products.

There is also potential to tap the appetite for growing international diversification

among the more developed economies in Asia, to meet the rising demand for

regional financial assets.Furthermore, the continued growth momentum in the region

has created demand for infrastructure. It is estimated that Asia needs USD 1 trillion

worth of infrastructure investment over the next 5 years, offering huge potential for

financing opportunities.

Besides that, reinforcing the move towards regional financial integration, authorities

across the region have encouraged greater financial sector development and

progressively liberalised their capital accounts. Many regional countries are moving

beyond financial restructuring to promote more diversified and vibrant financial

systems that embrace a broad range of service providers and asset classes,

including private equity, hedge funds, structured products and Islamic finance.

In Malaysia, the gradual but progressive liberalization of foreign exchange

administration rules undertaken since 2003 has led to significant benefits. The

change in demographic structure of the population will also have an indirect impact
on the domestic financial landscape. While Malaysia's population is still relatively

young, an increasing segment of the population is in the group aged 64 and above.

This development will have implications for human capital, business and product

strategies of banking institutions in terms of savings behaviour and demand for

different types of products.

Next, a new area of growing significance in the international financial system is

Islamic Finance as a viable and competitive form of financial intermediation. The

Malaysia International Islamic Financial Centre, or MIFC, initiative, launched in

August 2006, has taken Malaysia's liberalisation strategies to a new level with the

aim of positioning Malaysia strategically in this new growth area. Islamic banking

institutions are allowed to undertake a broader array of Islamic financial activities that

include commercial banking, consumer banking, investment banking as well as

international currency business under the MIFC initiative. Financial institutions need

to consider their own competitive positioning in this area and to have the appropriate

strategies to participate in this dynamic growth sector.

Finally, the regulatory and supervisory paradigm will also continue to evolve. Indeed,

we have over the recent decade witnessed significant global shifts in the approaches

to regulation and supervision across many countries. These have ranged from

radical policy responses in some countries that led to the introduction of costly

regulatory systems to address the problems have emerged, to bold deregulatory

measures pursued in other countries, especially during times of exuberance and

strong market conditions. A convergence towards the middle ground between these

two extremes now seems to be emerging.

Two dimensions of regulatory change will be relevant to the context of the new

environment;

- First, the emphasis on creating a strong risk management culture that is

fundamental to sound banking operations will become significantly more

pronounced. The transition to Basel II and the implementation of the risk-

based supervisory regime are important elements of this change.

- Second, regulations will continue to focus more on facilitating market-led

adjustments that will allow the industry to evolve in response to market

developments, while maintaining a sufficient degree of regulatory oversight to

maintain financial stability and public confidence.

This also includes the adoption of principles-based regulations and an increased

focus on harnessing market forces and discipline, as well as internal oversight

functions, to reinforce prudential regulation and supervision. The aim is to promote a

more efficient and responsive financial system.

In this connection, Bank Negara will soon introduce a more facilitative process for

product innovations with revisions to the new product approval framework. The

changes are aimed at improving time to market for the introduction of new products

by financial institutions, while ensuring that institutions put in place a sound product

management programme within their respective institutions. The new framework will

provide for more simplified regulatory processes and allow greater flexibility for well-

managed banks and insurers to introduce new BIS Review 83/2007 3products more

quickly in the market. Qualifying banks and insurers are expected to exercise this

flexibility responsibly and in particular, with due regard to the interests of consumers.
The realignment of the regulatory and supervisory structures within the Central Bank

in November 2006 has marked a significant turning point in consolidating these

regulatory changes. As a result of the realignment, the Bank is better positioned to

conduct effective surveillance of the financial system; to address regulatory overlaps

and duplication within the system; to deal more strategically with the weight of

multiple objectives and range of issues confronting the financial system, and more

importantly, to preserve regulatory neutrality in the management of similar risks

between different financial service providers.

In addition to that, these emerging trends in the international and regional

environment will have an important bearing on the changing climate shaping the

banking sector. While it brings new opportunities, it will also bring challenges. Let me

return to the theme of this summit – the continued reinvention and transformation

that needs to be considered for the industry going forward. I would like to focus on

three main areas.

The first concerns human capital development. This is indispensably important for

the future development and growth of the financial sector. Going forward into the

future this will become the pivotal factor determining the capacity to reinvent and

transform. Financial institutions have two broad options. One would be to “buy

talent”. This remains a viable option as long as productivity growth remains aligned

with wage increases. Banks, however, need to be wary of bidding up wages without

commensurate efficiency improvements or increases in value-add. This would not be

sustainable and given the prevailing competitive market conditions, such a strategy

will eventually erode the banks' competitiveness resulting from the additional costs.
The other option is to “build talent”. This can be achieved through strategic

partnerships with training providers, actively contributing towards industry-wide

efforts to support the training agenda and continuous improvements to internal

learning programmes.

This is also the option that is by far more challenging, but ultimately the one that

provides the optimal payoff for individual institutions, for our financial sector, and the

economy. The magnitude of the task, however, demands our collective efforts to

secure a sustainable pool of talent that will serve both the present as well as future

needs of the industry. The industry also needs to participate in the formal learning

programmes by the institutions of higher learning. It is encouraging to note that

several have volunteered following the recent dialogue earlier this year organised by

Bank Negara Malaysia and the Ministry of Higher Education.

The area also relates to financial inclusion. Strategies that are aimed towards

consumer outreach and promoting financial inclusion will serve to increase access to

financial services for all segments of society, promote more balanced growth, while

at the same time, providing 4 BIS Review 83/2007new sources of revenue for the

financial industry. Significant efforts have been taken to strengthen the elements that

support financial inclusion. This includes various outreach initiatives, including the

consumer education programme, development of small and medium enterprises,

increased public accessibility to financial information and greater access to advice

and assistance.

Part of this effort is the development of a sustainable and commercially-driven

microfinance industry in Malaysia. In Malaysia, there are at least 435,000 micro

enterprises, but only 13% rely on financial institutions for funding. Of importance is
promoting commercially viable microfinance ventures. In this connection, greater

flexibility has been provided for foreign banks to enhance their presence in non-

urban areas. Given the objectives of financial inclusion, it is hoped that foreign banks

support this initiative given the flexibility that is being accorded to widen the outreach

to segments of the economy which are currently underserved. Also embedded within

the financial inclusion agenda is the responsibility that banking institutions have

towards their customers, and to ensure that adequate information is provided to

consumers and investors to make informed judgments.

In the area of product development, both the interest of consumers and businesses

will be taken into account. Financial institutions that demonstrate their ability to act

responsibly can look forward to greater business flexibility to innovate. Financial

institutions that uphold the necessary principles in their business strategies stand to

reap long-term gains from enhanced franchise value, a strong reputation and

positive association with socially responsible values that will engender public trust

and confidence.

The last area of influence relates to communication strategies. With increasing

market discipline, effective communications has become more critical. Institutions

will need to be more active in responding to consumer and business expectations

and the building of long term customer relationships in order to be able to implement

longer term business strategies.

This is a significant challenge which demands deliberate, planned and well-designed

communication strategies and resources dedicated for this effort. In conclusion, this

decade has demonstrated the capacity of the banking sector to reinvent and

transform.
CONCLUSION

With the changes sweeping through the industry, the question is whether the

Malaysian financial industry has the manpower and expertise to meet the challenges

competently and responsibly. The healthy development of the financial industry calls

for a well-balanced and sensible regulatory regime, which is receptive to changes

and adaption within the bounds of prudence.

Once viewed as a small segment of the financial world, Islamic banking and finance

has emerged as a key player in global financing in recent years, gaining worldwide

recognition around the world. Today, even global financers such as HSBC are

offering Islam compliant products, such as the Shariah compliant mortgages the

Bank introduced in 2003, in order to attract Muslim customers with reservations.

Today, with products such as HSBC Amanah, they have gone much further in

offering Shariah based banking products, as a clear sign of its creeping influence.

And today, Malaysia has a full-fledged Islamic system operating parallel to the

conventional financial system.

Nevertheless, practicality of the system was a challenge that faced the Islamic

sibling in its endeavor to replicate the products and services offered by its

conventional brother. Unlike conventional Banking’s conviction on interest, Islam

Aishath Muneeza, Ismail Wisham, Rusni Hassan, International Islamic University

Malaysia 223 argues for a fair distribution of profit and loss and bans purely

speculative activity. On a more positive note, amendments brought to the Bank

Negara Act in 2009 serves itself as encouraging on the maturity of Malaysia on the

issue of Islamic finance, with the recognition of the Shariah Advisory Council as the

apex authority on Islamic finance, with its decisions binding upon the Courts. This
opens the door to uniformity and informed decision making in cases of resolving

disputes.

Instances where both parties may benefit from each other are created when greater

alliances with international financial institutions are forged which raises financial

innovation and refinery of already established practices. A fresh perspective is

provided for the National Shariah Advisory Council as well Alliances with other

Islamic financial institutions which creates diversity of views with regard to the

already prolific debate on specific products. Islamic finance cases are being

adjudicated throughout the world under the purview of the respective national Courts

in line with the respective systems of law.

The scope and implications of the phrase would be witness to its large scale but a

specialized bench might not be an idea unfeasible which would also give the

opportunity to place skilled judges who are knowledgeable in Islamic law. A

specialized bench would be expedient disposal of cases, a factor which is already of

concern for lawmakers. The same sentiments were spoken of by Mohamed Ismail

Shariff (1998), in his article, The Paradox Struggle between Islamic and

Conventional Banking Systems 224 The Development of Islamic Banking Law in

Malaysia 1However, Shariff spoke of creating a specialized division within the

framework of the civil High Court. The amendment of laws which afford them

jurisdiction over the matter as well, creating a specialized bench at the civil high

Court may be a shorter approach as creation of such benches in the Shariah court

system.

The lack of a globally accepted qualification as a Shariah scholar which complicates

the matter as there are no globally accepted standards for Shariah rules, which are
to some extent open to interpretation. Since Shari’ah Advisors are the backbone of

the industry, it is put forward here that the composition of these Councils need to be

reformed and standardized globally. Since the scholars of Islamic law have

monopolized the Islamic Banking system and this might lead to abuse. The scholars

with only Islamic knowledge might jeopardize the competitive development of Islamic

Banking products. Therefore, it is our suggestion that the appointment of scholars

with parallel knowledge of Islam and finance would make Islamic banking more

competitive in the system. However, it should be noted here that it would be very

hard to get scholars of this nature. So, until we get a supply of such scholars, it is put

forth here to appoint financial consultants and Islamic scholars to the Councils which

can solve the financial aspect and the Shari’ah issues simultaneously. Therefore, the

contact between the market players and the Islamic scholars need to be improvised.

The future faced by the Malaysian financial system will be challenging and these

institutions are expected to provide the main thrust and impetus towards bringing

about innovation, creativity and dynamism to the various facets of the financial

system in Malaysia.
BIBLIOGRAPHY:
Dr Nik Norzrul Thani, Legal Aspects Of The Malaysian
Financial System, 2nd Edition, Petaling Jaya, Sweet &
Maxwell Asia, 2001.

R. Chalmers, A History of Currency Reform In The Straits

Settlements, HMSO, London, 1893.

http://www.japss.org.com

http://www.bis.org/review.com

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