The Financial Sector 4 Sources and Uses of Funds of the Financial System The full effect of the regional financial crisis was felt in the financial system where total assets declined by RM21.4 billion or 1.9% to RM1,093.1 billion at the end of 1998 (an increase of RM195.5 billion or 21.3% in 1997). This decline in the total assets of the financial system resulted mainly from a fall in the assets of the banking system by RM45.3 billion or 5.6% compared with an increase of RM180.2 billion or 28.5% in 1997. The decline in assets of the banking system partly reflected the non-performing loans (NPLs) sold to and managed by Pengurusan Danaharta Nasional Berhad (Danaharta), of RM13 billion. The banking system continued to be the largest financial intermediary, accounting for 70.1% of the total assets of the financial system at the end of 1998 (72.9% at the end of 1997). Within the banking system, the finance companies experienced declines in total assets resulting mainly from a fall in loans and advances, due to the tight liquidity conditions in early 1998, the higher interest rates, particularly during the first half-year, contraction in economic activity as well as more cautious lending policies as their balance sheets deteriorated. The lending activity of finance companies was also constrained by the merger and other restructuring exercises which were undertaken during 1998. The commercial banks (including Bank Islam), in turn, experienced declines in total assets reflecting the fall in deposit placements with other financial institutions. Consequently, their share of total assets in the financial system declined from 13.7% and 43.6% to 11.3% and 42% respectively at the end of 1998. The decline in the share of total assets of the commercial banks, however, was mitigated by the transfer of the assets of five finance companies which were absorbed by the parent commercial banks under the exercise to rationalise the finance companies. Total assets of the non-bank financial intermediaries (NBFIs) increased at a faster pace of RM23.8 billion or 7.9% in 1998, compared with a growth of RM15.3 billion or 5.3% in 1997. As a result, their share of total financial system assets increased from 27.1% at the end of 1997 to 29.9% at the end of 1998. The faster growth reflected mainly the sustained high growth of the assets of the provident, pension and insurance funds (RM22.6 billion or 11.9%), the significant increase (231.4%) in the assets of the Export-Import Bank of Malaysia (Exim Bank) due to the increase in loans extended by Exim Bank, following the transfer of the Export Credit Refinancing (ECR) Scheme from Bank 1997 1998 % share Banking system 180.2 –45.3 766.7 70.1 Bank Negara Malaysia 12.2 15.8 124.7 11.4 Commercial banks 1 121.4 –26.2 459.2 42.0 Finance companies 32.6 –28.8 123.6 11.3 Merchant banks 10.2 –5.1 39.2 3.6 Discount houses 3.8 –1.0 20.0 1.8 Non-bank financial intermediaries 15.3 23.8 326.4 29.9 Provident, pension and insurance funds 22.6 22.6 212.2 19.4 Employees Provident Fund 15.1 15.6 148.0 13.5 Other provident & pension funds 3.3 3.2 24.8 2.3 Life insurance funds 2.8 2.9 26.6 2.4 General insurance funds 1.5 1.0 12.8 1.2 Development finance institutions 2 2.0 4.5 19.8 1.8 Savings institutions 3 1.2 –1.1 18.3 1.7 Other financial intermediaries 4 –10.5 –2.2 76.1 7.0 Total 195.5 –21.4 1,093.1 100.0 1 Includes Bank Islam Malaysia Berhad. 2 Includes Malaysian Industrial Development Finance Berhad (MIDF),Bank Pertanian Malaysia, Borneo Development Corporation, Sabah Development Bank Berhad, Sabah Credit Corporation, Export - Import Bank Malaysia Berhad, Bank Pembangunan Malaysia Berhad and Bank Industri Malaysia Berhad. 3 Includes National Savings Bank, Bank Kerja sama Rakyat and co- operative societies. 4 Includes unit trusts (ASN, ASB, ASW 2020 and ASM Mara), building societies, Pilgrims Fund Board, Credit Guarantee Corporation, Cagamas Berhad, leasing companies, factoring companies and venture capital companies. p Preleminary RM billion As at end 1998p Annual change Table 4.1 Assets of the Financial System
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The Financial Sector4Sources and Uses of Funds of theFinancial System
The full effect of the regional financial crisis wasfelt in the financial system where total assets declinedby RM21.4 billion or 1.9% to RM1,093.1 billion atthe end of 1998 (an increase of RM195.5 billionor 21.3% in 1997). This decline in the total assetsof the financial system resulted mainly from a fallin the assets of the banking system by RM45.3
billion or 5.6% compared with an increase ofRM180.2 billion or 28.5% in 1997. The decline inassets of the banking system partly reflected thenon-performing loans (NPLs) sold to and managedby Pengurusan Danaharta Nasional Berhad(Danaharta), of RM13 billion. The banking systemcontinued to be the largest financial intermediary,accounting for 70.1% of the total assets of thefinancial system at the end of 1998 (72.9% at theend of 1997). Within the banking system, the financecompanies experienced declines in total assetsresulting mainly from a fall in loans and advances,due to the tight liquidity conditions in early 1998,the higher interest rates, particularly during the firsthalf-year, contraction in economic activity as well asmore cautious lending policies as their balance sheetsdeteriorated. The lending activity of financecompanies was also constrained by the merger andother restructuring exercises which were undertakenduring 1998. The commercial banks (including BankIslam), in turn, experienced declines in total assetsreflecting the fall in deposit placements with otherfinancial institutions. Consequently, their share oftotal assets in the financial system declined from13.7% and 43.6% to 11.3% and 42% respectivelyat the end of 1998. The decline in the share oftotal assets of the commercial banks, however, wasmitigated by the transfer of the assets of five financecompanies which were absorbed by the parentcommercial banks under the exercise to rationalisethe finance companies.
Total assets of the non-bank financialintermediaries (NBFIs) increased at a faster paceof RM23.8 billion or 7.9% in 1998, compared witha growth of RM15.3 billion or 5.3% in 1997. Asa result, their share of total financial system assetsincreased from 27.1% at the end of 1997 to 29.9%at the end of 1998. The faster growth reflectedmainly the sustained high growth of the assets ofthe provident, pension and insurance funds (RM22.6billion or 11.9%), the significant increase (231.4%)in the assets of the Export-Import Bank of Malaysia(Exim Bank) due to the increase in loans extendedby Exim Bank, following the transfer of the ExportCredit Refinancing (ECR) Scheme from Bank
Other financialintermediaries4 –10.5 –2.2 76.1 7.0
Total 195.5 –21.4 1,093.1 100.0
1 Includes Bank Islam Malaysia Berhad.2 Includes Malaysian Industrial Development Finance Berhad (MIDF),Bank
Pertanian Malaysia, Borneo Development Corporation, SabahDevelopment Bank Berhad, Sabah Credit Corporation, Export - ImportBank Malaysia Berhad, Bank Pembangunan Malaysia Berhad andBank Industri Malaysia Berhad.
3 Includes National Savings Bank, Bank Kerja sama Rakyat and co-operative societies.
4 Includes unit trusts (ASN, ASB, ASW 2020 and ASM Mara), buildingsocieties, Pilgrims Fund Board, Credit Guarantee Corporation, CagamasBerhad, leasing companies, factoring companies and venture capitalcompanies.
p Preleminary
RM billion
As at end1998p
Annual change
Table 4.1Assets of the Financial System
Negara Malaysia (BNM) to Exim Bank, and thesignificant increase in the assets of Bank IndustriMalaysia Berhad (78%) due mainly to the transferof deposits from Kewangan Industri Berhad followingits absorption by Bank Industri. The increase in theassets of the provident, pension and insurance fundsaccounted for 94.7% of the total increase in theassets of the NBFIs.
During the year, deposits placed with the financialinstitutions increased by RM28.4 billion or 5.7%(RM82.5 billion or 20% in 1997). Reflecting thecontraction in economic output, the bankinginstitutions (comprising commercial banks, financecompanies, merchant banks and discount houses)experienced a decline in deposits, mainly on accountof the decrease in demand deposits placed withthe commercial banks. Nevertheless, depositsmaintained its position as the main source of funds,
accounting for 47.9% of total sources of funds atthe end of 1998 (44.4% in 1997). Similarly, thebanking institutions continued to be the largestmobiliser of deposits, accounting for 86.6% of totaldeposits of the financial system (92.2% in 1997).In terms of holders, the deposits were held mainlyby the non-financial private sector (comprisingindividuals and business enterprises). During theyear, their deposits placed with the financial systemrose by only RM11.5 billion or 3.6% (RM62.2 billionor 24% in 1997), in tandem with the sharpslowdown in income. As in previous years, fixeddeposits continued to account for the bulk of thedeposits placed by the non-financial private sector,accounting for 118.7% of the increase in totaldeposits while demand deposits registered a declineof RM5.2 billion or 13.9%. By maturity, fixeddeposits continued to be concentrated in shorter-end maturities.
Contractual savings with provident funds andcontributions to insurance funds continued to be amajor source of funds for the financial system,
1997 1998
% share
Sources:Capital and reserves –3.1 –3.9 102.4 9.4Currency 3.5 –4.0 20.5 1.9Deposits1 82.5 28.4 523.1 47.9Borrowings 24.3 –18.3 14.4 1.3Funds from other financial
Gold and foreign exchangereserves –10.8 39.2 96.3 8.8
Other assets 21.6 –4.1 116.1 10.6
1 Effective 1998, the statutory reserves of banking institution have beenreclassified as "Funds from other financial institutions" rather than"Deposits". In this regard, data from prior years have also been revisedaccordingly.
p Preleminary
RM billion
As at end1998p
Table 4.2Sources and Uses of Funds of the Financial System
Annual change
Table 4.3Non-Financial Private Sector Deposits1 with theFinancial System2
Up to 1 year 42.3 19.0 201.4 60.5More than 1 year 5.0 –5.4 20.1 6.0
1 Refers to deposits of business enterprises (excluding NFPEs) andindividuals.
2 Excludes provident and insurance funds and other financialintermediaries.
3 Refers to demand, savings and fixed deposits, negotiable instrumentsof deposit and repos.
4 Refers to negotiable instruments of deposit.5 Refers to repurchase agreements.
p Preleminary
RM billion
As at end1998p
expanding by RM20.2 billion or 12% (RM21.6 billionor 14.7% in 1997), to account for 17.3% of totalfunds mobilised by the financial system in 1998.Funds obtained from other sources registered stronggrowth, reflecting mainly gains from foreignexchange revaluation experienced during the year.The increase in these sources of funds were offsetby the decline in funding from borrowings, as BNMreduced its lending to the banking institutionsfollowing the release of funds to the bankinginstitutions through the reduction in the statutoryreserve requirement (SRR). Similarly, the year alsosaw a significant decline in funds obtained fromother financial institutions reflecting mainly thereduction in interbank placements, consonant withthe slowdown in lending activity.
As at the end of 1998, the bulk of fundsmobilised were utilised to finance the loanoperations of the financial system, followed byinvestment in securities and deposits with otherfinancial institutions. Concomitant with the economiccontraction experienced in 1998, total loans andadvances extended by the financial system grewmarginally by only RM96.7 million. However,including the NPLs of the financial system sold toand managed by Danaharta during the year, totalloans and advances extended by the financialsystem would be higher amounting to RM505.4billion. Loans and advances to the non-financial
private sector declined by RM10.9 billion withsignificant declines recorded for loans and advancesextended for the purchase of shares (–20.5% orRM7.3 billion) and consumption credit (–11.4% orRM6.5 billion). However, loans and advancesextended to the broad property sector increasedby RM6.5 billion. The bulk of the increasewas absorbed by housing loans (RM6.1 billion).As a group, loans and advances extendedfor these purposes accounted for 52.7% of totalloans and advances extended to the non-financialprivate sector.
In contrast, investment in corporate securities bythe financial system recorded a stronger growth ofRM9.6 billion or 7.2% (RM7.8 billion or 6.2% in1997). In particular, the banking institutions’ holdingsof corporate securities increased by RM7.5 billiondue mainly to investments in Danaharta andDanamodal bonds during the year. Holdings ofcorporate securities by pension and provident fundsalso increased in 1998. Deposits placed with otherfinancial institutions, however, declined significantlyby RM67.5 billion or 30.8% (increase of RM72.5billion or 49.4% in 1997). This decline was mainlythe result of the reduction in statutory reservesplaced by banking institutions with BNM and thedecline in the placement of deposits by BNM withbanking institutions. In addition, interbank placementsalso registered a decline reflecting the slowdown inlending activity. Meanwhile, gross holdings of goldand foreign exchange reserves of BNM increasedsignificantly by RM39.2 billion to RM96.3 billion atthe end of 1998 (a decline of RM10.8 billion in1997), reflecting mainly Malaysia’s large tradesurplus in 1998, foreign currency loans from bothofficial and private financial institutions as well asthe revision in the accounting policy effectiveSeptember 1998, to recognise the foreign exchangerevaluation gain/loss.
Management of the Banking System
The year 1998 proved to be one of the mostchallenging period for the banking system. Thefinancial turmoil which hit the region in mid-1997following the devaluation of the Thai baht had itsfull effect on the economy in 1998. The thrust ofbanking policies in 1998 was, therefore, twofold,aimed at crisis management to stabilise the bankingsystem in the immediate term and building astrengthened and more resilient banking sector overthe medium and longer term. Short-term measureswere introduced to ensure the continued smooth
Table 4.4Direction of Credit1 to Non-Financial Private Sector
Investment in corporatesecurities 7.8 9.6 141.8 24.0
Total 102.3 –1.4 590.1 100.0
1 Excludes credit to non-financial public enterprises.2 Includes loans for real estate.
p Preleminary
As at end1998p
and efficient functioning of the intermediationprocess. At the same time, the consolidation,rationalisation and reform of the banking sector wereinitiated through mergers, the setting up of an assetmanagement company, a bank recapitalisationagency and a corporate debt restructuringcommittee. These measures were introduced aspart of the strategy to achieve the longer-termobjective of a well-developed and strengthenedbanking sector.
Stabilisation Measures
Stabilisation measures were introduced in March1998 to address key vulnerabilities in the bankingsystem. Even though the banking system was ina strong position at the onset of the crisis,weaknesses, some structural in nature, began toemerge as the crisis worsened particularly towardsthe end of 1997. During the early months of 1998,the turmoil in the regional markets resulted inincreased volatilities and uncertainties in thedomestic financial markets and economy. One yearinto the crisis and signs of recovery among theAsian countries were not in sight. At the sametime, inefficiencies in the distribution of liquiditywithin the system began to surface that affectedthe smooth functioning of the loan intermediationprocess. While the banking system as a wholeremained sound and resilient amidst the crisis, someindividual banking institutions were faced with severeliquidity constraints which caused them to bidinterest rates upwards to a level that would notjustify returns on investments for viable businesses.The fragmented finance company industry inparticular, became a potential source of vulnerabilitywhich could have posed a systemic threat to thehealth of the overall system if allowed to deterioratefurther. Priority was therefore given to rationaliseand consolidate the finance company industry intofewer but stronger institutions through mergers. Tofurther strengthen the resilience of the financecompanies to withstand shocks in the changingeconomic and financial environment, a larger capitalwas prescribed to give additional buffer for thefinance companies to absorb higher risks. A strongercapital base would accordingly enhance the risk-bearing capacity of the finance companies. In thisregard, the minimum capital funds of the financecompanies was increased from the existing RM5million to RM300 million by mid-1999. The minimumrequirement would be further raised to RM600million by end-2000. In addition, the risk-weightedcapital ratio of the finance companies was increasedfrom 8% as prescribed under the Basle Capital
Accord to 9% by end-1998 and to 10% by end-1999. Prudential regulations were also tightenedand supervisory efforts intensified, with emphasisplaced on early identification of problem loansand solvency issues. Efforts were also taken toenhance transparency on the financial positionof individual banking institutions as well as thebanking system.
As in any economy, the small- and medium-sized industries (SMIs) have an important role inproviding the linkages between the varioussubsectors within the Malaysian economy. Underthe prevailing difficult conditions, the SMIs werenot spared from the adverse effects of the crisis.Given the importance of their operations, the strainson their cashflows had affected their debt servicingcapability leading to deteriorating financial healththat had, in some cases, affected their viability.Access to financing also became increasingly limited.Thus, to ensure that viable SMIs continued to haveaccess to credit, a Fund for Small and MediumIndustries was set up with an initial allocation ofRM1 billion in January 1998 to provide financing tothe SMIs at a maximum lending rate of 10% perannum. Reflecting the commitment of theGovernment to resolve the financial problems facingthe SMIs, the allocation under the Fund wasincreased by RM500 million to RM1.5 billion inMay 1998. The list of participating institutions wasalso expanded to include all commercial banks, 10identified finance companies, all merchant banksand four development finance institutions, whilst themaximum lending rate under the Fund was reducedto 8.5% per annum in December 1998.
Efforts also continued to be directed to meet thenation’s socio-economic objective of promoting homeownership. Towards the end of the first quarter,the contraction in construction activities had alsoaffected the construction of low- and medium-costresidential properties, while the demand for suchresidential properties remained high. There wastherefore a need to ensure the continuous supplyof affordable houses to meet such demand.Towards this end, BNM and Syarikat PerumahanNegara jointly allocated RM2 billion for the SpecialScheme for Low and Medium Cost Houses in May1998 to provide bridging finance to developers forthe construction of residential properties costingRM150,000 and below at the maximum lending rateof 10% per annum. The maximum lending ratewas further reduced to 8.5% per annum inDecember 1998.
Economic Recovery Measures
By the end of the first half of the year, theregional financial markets continued to be volatileand uncertain and the effect on the domesticeconomy became evident as the economiccontraction became increasingly severe. WhileBNM had released liquidity into the system tosupport the financing needs of the economy, thebanking institutions had become reluctant to providenew lending thereby posing a threat to thefunctioning of the intermediation process. Theworsening economic condition coupled with theprolonged crisis had shifted the focus of thebanking institutions. Banking institutions became pre-occupied with preserving their balance sheet andmanaging the deterioration in the quality oftheir loan portfolio as well as erosion in capitalinstead of generating new businesses. Therising incidence of non-performing loans (NPLs)had also resulted in banking institutions beingoverly cautious in their lending activities. As aresult, many viable businesses were not able toobtain financing.
Access to financing is a crucial preconditiontowards economic recovery. Economic recoverymeasures were needed to create an environmentthat is conducive for business activities to operate.The need for a comprehensive solution was nevermore pressing and critical now than before.Measures were introduced to remove the risks andconcerns that have emerged in the system. In thesecond half of the year, Pengurusan DanahartaNasional Berhad (Danaharta), an asset managementcompany, was set up as a pre-emptive measure toremove the NPL distraction from the bankinginstitutions to enable them to refocus on their lendingactivities. Danaharta aimed to ensure that the levelof NPLs in the banking system remained atmanageable proportions. Danamodal Nasional Berhad(Danamodal) was subsequently set up to recapitalisethose banking institutions whose shareholders wereunable to raise the additional capital. These twoagencies were further complemented by the settingup of the Corporate Debt Restructuring Committee(CDRC) to provide a mechanism for the bankinginstitutions and debtors to work out feasible debtworkout solutions. Given that the cases dealt withby the CDRC involved those with loans exceedingRM50 million, special loan rehabilitation units wereestablished in individual institutions to managedistressed loans involving smaller amounts. (For amore comprehensive write-up, please refer to BoxVI on "Restructuring the Banking Sector")
Weaker business expectations and over-cautiouslending attitude of the banking institutions resultedin the outstanding loans of the banking systemdeclining sharper than expected. Meanwhile,activities in the real sectors contracted during thefirst three quarters of the year. Concomitant withthe slowdown in economic activities, it was evidentthat the initial estimate for loan growth of 15% for1998 as submitted by the banking institutions intheir credit plans had to be reassessed. Inresponding to the unfavourable developmentsprevailing in the domestic economy, the loan growthexpectations for the year was subsequently reviseddownwards to 8%. The 8% loan growth for thebanking system as a whole, would ensure thatsufficient resources would be provided to the realsector to generate new economic activities. Bankinginstitutions with financial constraints, however, werenot expected to meet the 8% growth.
Whilst the Fund for Small and Medium Industriesbecame a cheaper source of financing for the SMIs,these funds were extended primarily to fund theworking capital requirements of the SMIs. As alarge number of the SMIs was facing NPL problems,access to financing for this group of borrowersbecame limited. In view of this, the Governmenthas set up the Rehabilitation Fund for Smalland Medium Industries with a total allocation ofRM750 million to provide financing at a maximumlending rate of 5% per annum, where part of thefinancing could be utilised to restructure theNPLs of SMIs.
Revisions in prudential norms which have directinfluence on the credit behaviour of bankinginstitutions and borrowers were announced astemporary measures in response to the prevailingeconomic condition without compromising onprinciples of strong supervision and financialprudence. The earlier tightening of the classificationperiod for NPLs was relaxed from three months tosix months. While tightening the classification periodfor NPLs was beneficial in bringing forward therecognition of problem loans, its implementationduring periods of economic uncertainties and risingNPLs was not timely. The three-month rulingdeterred banking institutions from their prime roleof providing financing fearing that such course ofaction might undermine the quality of their balancesheets. As a result, viable businesses and activitieswere adversely affected. In addition, as theeconomic contraction resulted in many businessesexperiencing cash flow problems, borrowers stopped
Disclosure Requirements for the BankingInstitutions: The disclosure requirements in thebanking institutions’ half-year financial statementswere tightened in 1998. Individual bankinginstitutions are required to publish in greaterdetail the half-yearly income and expenditurestatement and provide information on capitaladequacy, non-performing loans (NPLs),breakdown of their commitments andcontingencies, movements in specific provision,general provision and interest-in-suspense as wellas sectoral credit exposure according toeconomic sectors. In addition, the bankinginstitutions are required to disclose thebreakdown of their off-balance sheet items andtheir respective on-balance sheet credit riskequivalents in their annual financial statements.
This disclosure requirement is intended topromote market discipline by encouraging prudentbehaviour by the management of bankinginstitutions so that their financial position wouldcompare positively with others. The informationpublished would also enable more timelymonitoring of the performance of the bankinginstitutions by all stakeholders.
Guidelines on the Classification of NPLs:With effect from financial year beginning 1January 1998, the default period for classifyinga loan as non-performing was lengthened fromthree months to six months. The treatment forrescheduled and restructured credit facilities wasalso clearly defined. A rescheduled credit facilityis one whose repayment terms have beenmodified but the principal terms and conditionsof the contract have not changed significantly.This would include lengthening the repaymenttenor of the facility. A restructured credit facilityis one in which the terms and conditions havebeen modified principally, including changing thetype or structure of facilities or other facilityterms mainly to assist projects or businesseswhich are still viable. Loans which have beenrescheduled can be reclassified as performingwhen repayments under the rescheduled termshave been complied with for a continuous periodof six months, instead of the previous
requirement of twelve months. Loans which arerestructured for the first time can be reclassifiedas performing immediately after the completionof the relevant documentation. For subsequentrestructuring, the loan will remain classified asnon-performing until repayments under therestructured terms have been complied with fora continuous period of six months.
The change in the classification requirementand treatment of rescheduled/restructured facilitiesis intended to provide some breathing space forborrowers to regularise their accounts beforebeing classified as non-performing, and willencourage borrowers to continue servicing theirloans to avoid their loans from being classifiedas non-performing. Given the close linkagesbetween the health of the banking sector andthe performance of the economy, the redefinitionof NPL would help strengthen the banking sectoras business activities are given the opportunityto recover, thereby improving the debt servicingcapacity of the corporate sector and ultimatelythe asset quality of banking institutions.
Guidelines on Provisions for SubstandardDebts: With effect from financial year beginning1 January 1998, banking institutions wererequired to provide 20% specific provisionsagainst the uncollateralised portion of sub-standard loans. Banking institutions were alsorequired to set aside provisions for off-balancesheet items where the banking institution facedcredit risk from the failure of counter parties tofulfil their contractual obligations.
These requirements are mainly to increasethe resilience of the banking institutions andensure the build-up of their reserves as additionalbuffer against potential loan losses for accountswhich exhibit some risk of loss due to adversefactors whilst, at the same time, streamliningthe provisioning policy with international bestpractices. However, banking institutions with highloan loss reserves as determined by BankNegara Malaysia (BNM) would not automaticallybe required to make provisions for their sub-standard loans.
Banking Measures in 1998
Guidelines on Single Customer Limit:With effect from 25 March 1998, the limiton single customer exposure was reduced from30% to 25% of total capital. Banking institutionswere also required to comply with thesingle customer l imit on a consolidatedgroup basis. The lowering of the limit wasto reduce the concentration of risk to asingle customer by taking into account theexposure of all institutions in the group to asingle customer.
Risk-weighted Capital Ratio - ComplianceRequirement: With effect from financial quarterended 31 March 1998, banking institutions wererequired to comply with the minimum risk-weighted capital ratio on a consolidated basisevery quarter rather than annually.
The prolonged regional financial crisis andweak domestic economy had resulted in strainson the financial position of some of the finance-related subsidiaries of domestic bankinginstitutions. If left unattended, losses experiencedby the subsidiaries will eventually erode thecapital base of their parent banking institutions.
This new requirement will enable BNM tomonitor the capital adequacy position of bankinginstitutions on a consolidated basis in a timelymanner. Early recognition of capital erosionwould also provide banking institutions ampletime to plan and work out recapitalisationsolutions.
Reduction of Liquid Asset Ratio: With effectfrom 3 September 1998, the liquid asset ratiorequirement for commercial banks was reducedfrom 17% to 15% of their total eligible liabilities.
The funds released from the divestment ofliquid assets can be used by banking institutionsto improve their funding position and increasetheir loanable funds. The reduction has alsoenabled the gradual phasing in of the newliquidity framework introduced by BNM.
New Liquidity Framework: In July 1998,BNM introduced a new liquidity framework toreplace the present liquid asset ratio requirementfor the banking institutions. To ensure a smoothtransition, banking institutions are given up to1 January 2000 to migrate to the newframework. All banking institutions will be
required to comply with the new framework by1 January 2000.
Under the new framework, the liquidity needsof a banking institution is assessed based onits ability to match its short-term liquidityrequirement arising from maturing obligations withmaturing assets. Banking institutions will berequired to make projections on the maturityprofile of their assets, liabilities and off-balancesheet commitments in a series of maturity ladderto assess their potential future liquidity surplusand shortfall. To ensure that there is sufficientliquidity to meet their liability obligations in thenear term, banking institutions will be requiredto maintain, as a minimum requirement, adequateliquidity surplus not only to meet expectedobligations but also to sustain unexpected heavywithdrawals for at least one month.
The new framework aims to create awarenessamong banking institutions of their fundingstructure and their ability to handle short tomedium-term liquidity problems. Besides providingBNM with better means of assessing the presentand future liquidity position of bankinginstitutions, the framework will encourage amore efficient and proactive management ofl iquidity among banking institutions. Theframework also recognises individual bankinginstitutions’ strengths and weaknesses inmanaging their assets and liabilities portfolio.Banking institutions that manage their liquidityprofile prudently and efficiently will no longerbe required to hold high amounts ofl iquid assets. The efficient matching ofassets and liabilities will allow better utilisationof funds.
The new liquidity framework will alsohelp reduce the existing price distortion onliquid assets, in particular, Malaysian GovernmentSecurities and Cagamas bonds, due to thecaptive demand created under the presentliquid asset ratio requirement. This willpromote a more market-oriented pricing ofsuch papers and eventually lead to amore active secondary market development.
Cagamas Securitisation Scheme on Hire-Purchase and Leasing Loans: On 12 December1998, BNM announced the implementation of asecuritisation scheme on hire-purchase andleasing loans with recourse by Cagamas. The
scheme will be subject to the following regulatoryrequirements:-
• Half of the proceeds from the sale of hire-purchase and leasing receivables will besubject to statutory reserve requirementwhile the new Cagamas debt securitiesissued to finance the purchase of hire-purchase and leasing debts will be regardedas Tier-1 Cagamas debt securities andaccorded liquid asset status under thepresent liquidity framework and Class Iliquefiable assets under the new liquidityframework.
• The recourse commitment by the sellinginstitutions for loans sold under the newscheme would be treated as an off-balance
sheet liability and be accorded a creditconversion factor of 100% while investmentby banking institutions in the Cagamas debtsecurities will carry a risk-weight of 10%.
With more than 50% of the financecompanies’ loan portfolio comprising of hire-purchase and leasing, the scheme is expectedto assist the finance companies in diversifyingtheir funding sources and create additionalliquidity to fund their lending activities. AsCagamas normally purchases loans on a 3- to5- year basis, the scheme would also providethe much needed long-term financing to thefinancial institutions in order to minimise theliquidity and interest rate mismatch that currentlyarise from the funding of these assets throughshort-term deposits.
servicing their loans once their accounts wereclassified as non-performing. Thus, the lengtheningof classification period for NPLs gave borrowerstime to regularise their accounts, which ultimatelybenefited the banking institutions in terms ofimproved asset quality. While the classificationperiod was lengthened to six months, otherprudential rules were retained. A non-performingaccount would continue to be classified as badwhen it had been in arrears for 12 months ormore, while accrued interest previously recognisedas income would be clawed back to day one ofdefault. In addition, as part of the effort to promotegreater transparency, the industry numbers for theNPLs based on both three-month and six-monthclassifications are published on a monthly basis.The lengthening of the classification period wasalso balanced with the mandatory requirement forall banking institutions with gross NPL ratios above10% to sell their NPLs to Danaharta at marketdetermined prices.
As the economy contracted and as activitiesin the capital market became extremelythin during the first three quarters of the year,the ability of shareholders to raise additionalcapital was also constrained. In this regard,compliance with the increased minimum capitalfunds of RM600 million by the finance companiesand risk-weighted capital ratio of 10% wasdeferred until such time when the economyhas recovered and the capital markethas stabilised.
In an attempt to enhance the degreeof transparency, banking institutions wererequired to publish key financial indicators on aquarterly basis. Nevertheless, as the crisisdeepened, more attention was accorded towardsmanaging sources of vulnerabilities arising from thecrisis. The quarterly publication posed a heavyadministrative burden on the banking institutions. Inthis regard, the requirement on the quarterlypublication of financial indicators was temporarilyuplifted so as to reduce the administrative burdenof the banking institutions and at the same time,enable banking institutions to shift their focus ontheir operations. Banking institutions are, however,still required to make public their financial indicatorson a semi-annual basis.
Measures were also put in place tocontain further accumulation in the supply of high-end properties through the restriction on theprovision of bridging finance to developers for thedevelopment of properties exceeding RM250,000.The prohibition includes the construction ofresidential properties, shop houses, hotels, resorts,office buildings, golf courses, clubs and shoppingcomplexes. However, financing to end-buyers forthe purchase of properties in both theprimary and secondary markets is not affected bythe prohibition. The restriction of financing wouldcontain the entry of new properties into the marketwhile at the same time assist in reducing theexcess supply in the respective segments in theproperty market.
Background
Against the background of changing externaland domestic conditions in the 1990s, BankNegara Malaysia (BNM) continued with effortsto develop and reform the banking system inorder to ensure that the banking system waswell-placed to meet the challenges arising fromthe changing environment. Policies were,therefore, directed at:
• creating a core of domestic bankinginstitutions which are well managed andhighly capitalised, to meet the challengesof liberalisation and to spearhead thedevelopment of the financial sector;
• broadening and deepening the financialmarkets as well as strengthening thefinancial infrastructure to enable the sectornot only to meet the changing needs ofthe domestic economy, but also to be asector of economic growth;
• improving the overall level of efficiency andcompetitiveness of the sector; and
• accelerating the development of the bondmarket.
Over this decade, the legislative framework forthe supervision of the banking institutions wasfurther strengthened, following the review of thevarious banking legislations in the aftermath ofthe 1985-86 recession. The Banking and FinancialInstitutions Act 1989 (BAFIA), which came intoeffect in October 1989, provided a framework foran integrated supervision of the Malaysianfinancial system. In addition, the Government hasadopted measures designed to increase theefficiency and soundness of the financial system,including measures to achieve credit growth thatis in line with the overall macroeconomic growth,while at the same time reducing excessivebanking institutions’ exposure to the vulnerablesectors of the economy. Other prudentialmeasures introduced include refining the capitaladequacy framework, greater information
Restructuring the Banking Sector
disclosure and improving the risk managementof banking institutions. The supervisory andregulatory framework has also constantly beenstructured to be consistent with internationalstandards and best practices. Compliance withthe Basle Committee’s “Core Principles forEffective Banking Supervision” was already at anadvanced stage before the onset of the crisis.
With the measures in place to achieve thelong-term objectives, the banking system was ina position of strength at the onset of thefinancial crisis. This was reflected in terms ofthe quality of the asset portfolio and the levelof capitalisation of the banking sector. As atend-June 1997, the net non-performing loan(NPL) ratio was at a low of 2.2% and the risk-weighted capital ratio (RWCR) of the bankingsystem was 12%, exceeding the minimumrequirement of 8%.
The regional crisis, however, exerted pressureson the currency and stock markets, causing theringgit to depreciate and the Kuala LumpurComposite Index to drop by about 35.1% and44.8% respectively in the second half of 1997.As the financial crisis persisted, the effects onthe economy and the financial system began tobe felt. While policies had already been put inplace to strengthen economic fundamentals aswell as to stabilise the financial system, it wasrecognised that pre-emptive action was necessaryto deal with the vulnerabilities of the bankingsector. While some banking institutions werefacing difficulties, the banking system as a wholeremained sound.
Structural weaknesses in the financial systemalso became more evident. Strong loan growthbetween 1994-1997, which averaged about 25%per annum, had led to the high loan exposureof the banking system. In addition, theunderdeveloped bond market has also resultedin the banking sector providing a significantportion of the private sector financing, therebyincreasing the concentration of risk in the
Box VI
banking sector. Although total financing of thenation amounted to RM722 billion at the end of1998, this was mainly by the banking system(about 57% of the total financing), mainlybecause of the privatisation programme. Theshare of public sector debt declined whileexternal debt was kept low by prudentialregulations. As such, financing private sectorgrowth was met mainly by the banking system.
In this environment of prolonged volatility inthe financial markets, the finance companiesbecame vulnerable given the highly fragmentednature of the industry (39 companies) andthe nature of their business which focusedmainly on hire-purchase financing andconsumption credit, which was adverselyaffected by the rising interest rates andslowdown in the economy.
The prolonged financial crisis and subsequentcontraction of the economy led to somedeterioration in the quality of the asset portfolioof the banking institutions, with the net NPL tototal loans ratio increasing to 8.9% as atend-June 1998. Banking institutions becameincreasingly preoccupied with managing theirexisting asset portfolio, self-imposing a creditsqueeze mentality in their lending activities. Thereluctance of the banking institutions to lendcombined with higher interest rates causedsevere difficulties for individuals and businesses,
including viable businesses to obtain financing.This slowed down the prospects of economicrecovery. At the same time, the rising level ofNPLs also eroded the capital base of a numberof banking institutions. While the RWCR for thebanking system as a whole remained wellabove the minimum of 8%, a number of bankinginstitutions required recapitalisation.
If these challenges were not addressed, theeconomy would be plunged into a vicious cycle,thus hampering economic recovery as illustratedin Chart VI.1 below.
Confidence needed to be restored rapidly inthe financial markets in general and the bankingsector in particular. If the lack of domestic and/or external confidence were to persist, economicdevelopment would be hampered. The longerthis behaviour persists, the more drastic themeasures would be needed to restore stabilityand the higher its costs would be. In view ofthe worsening economic and financial conditions,the priority of policy since May 1998 was tominimise the contractionary effects of thecrisis on the real sector and to furtherstrengthen the financial system, given thecritical role of the banking system in supportingthe economic recovery.
In order to achieve this, the Governmentimplemented a series of measures to promote
• Fall in currency value
• Fall in stock market
values
• Extreme volatility in
financial markets
• Health of companies
• Wealth of consumers
Chart VI.1The Vicious Cycle of the Current Crisis
Economic activities
Inefficiencies inintermediation process
• NPLs• Health of banks
economic recovery. These measures includedreducing interest rates, injecting greaterliquidity into the banking sector andformulating a comprehensive plan to restructurethe banking sector. The restructuring plan forthe banking sector, which was initiated by theGovernment well before the NPL ratio reacheddouble-digit levels, was comprehensive and pre-emptive in nature.
Banking Sector Restructuring
The restructuring plan was aimed at achievingthe objectives illustrated in Chart VI.2 below.
The Government adopted a four-prongedapproach to strengthen the resilience of thebanking sector through a merger programme,the setting up of an asset managementcompany, Pengurusan Danaharta Nasional
Berhad (Danaharta); a special purpose vehicle,Danamodal Nasional Berhad (Danamodal);and the Corporate Debt RestructuringCommittee (CDRC).
As the crisis had exposed the vulnerability ofthe finance companies, a merger programme forthe finance companies was announced inJanuary 1998 to consolidate and rationalise theindustry. While this was consistent with thelonger-term objective of creating a core ofdomestic banking institutions to meet thechallenges of increased liberalisation, it alsorepresented part of the overall pre-emptivestrategy to increase the resilience of the financecompanies to withstand risks arising from theeconomic slowdown. The merger exercise washowever, market-driven, with BNM facilitating theprocess. On completion of the exercise in 1999,the number of finance companies would bereduced by more than half from the original 39.
Chart VI.2Objectives of the Banking Sector Restructuring Plan
Short Term
• Halt the Vicious Cycle• Stimulate Economic Recovery
Long Term
• Create resilient banking system towithstand future shocks
• Develop efficient & competitivebanking sector to support economicgrowth & contribute as sector ofgrowth
• Provide foundation to broaden &deepen financial markets &strengthen financial infrastructure tomeet future challenges
• EncourageBanks to Lend
ManageNPLs
Capital Funding
SpecialFunds
Danamodal
Danaharta
CDRC
Reha-bilitation
Unit
• Finance companies mergerprogramme
• BNM to initiate mergers and useDanamodal to facilitateconsolidation of the banking sectorand to rationalise and revampmanagement where necessary
• Asset-backed securitisation• Plan to chart the direction of the
banking sector
▼
▼▼
▼ ▼
In view of the NPL problem in the bankingsector, the Government established Danaharta,an asset management company, to purchaseNPLs from banking institutions and managethese NPLs in order to maximise their recoveryvalue. The speed at which Danaharta was setup and the financial commitment extended bythe Government clearly demonstrated theserious intention of the Government to restructureand strengthen the banking sector. Danaharta,like the other asset management companies inthe world, operated within the broad conceptsof rehabilitation, restructuring and maximisingrecovery value of the assets.
While Danaharta would not purchase the entireNPL portfolio from the banking system, it wouldensure that the residual NPLs in the bankingsector remain at manageable levels at alltimes. To ensure that banking institutions utiliseDanaharta to remove their NPLs, bankinginstitutions with gross NPL ratio exceeding 10%are required to sell all their eligible NPLs toDanaharta, otherwise they would have to writedown the value of these loans and restructurethem. Banking institutions which requiredrecapitalisation from Danamodal are also requiredto sell their eligible NPLs to Danaharta. Theacquisition of NPLs by Danaharta would enableDanaharta to rehabilitate these loans in the mosteffective and efficient manner.
Danaharta would also assist the restructuringof the corporate sector. Once banking institutionshave sold their NPLs to Danaharta, Danahartawould then be able to impose conditions onthe borrowers which may include, amongstothers, the reconstruction or rehabilitation ofthe underlying assets and identified cashflows. Danaharta also has the powers toappoint Special Administrators into viablecompanies that faced temporary cash flowproblem. With the assistance from Danahartaand Danamodal, both the banking institutionsand corporate sector would then be restructured.
Once the banking institutions are relievedof their burden in managing their NPL portfolio,they would be in a better position to resumetheir lending activities. However, the sale ofNPLs to Danaharta would usually result inbanking institutions incurring losses asDanaharta would purchase the NPLs at fairmarket value. Hence, recapitalisation of certain
of these banking institutions became necessaryto enable banking institutions to undertakeadditional businesses and risks and toencourage these banking institutions to resumetheir lending activities. The recapitalisation, undernormal times, would usually be achievedthrough the effort of the banking institution’sown shareholders. Given the current economicenvironment, the ability of shareholders ofbanking institutions to raise capital on their ownwas not expected to be very forthcoming.Hence, to facilitate the recapitalisation exerciseof banking institutions, a special purposevehicle, Danamodal, was established to addressthe constraints faced by the shareholdersto recapitalise the banking institutions tohealthy levels.
Danamodal would only inject capital into viablebanking institutions on commercially viable termsand market principles. Due diligence reviewswould be conducted by international investmentbankers to determine the viability of thebanking institutions and recapitalisationrequirements. In all its capital injection exercises,Danamodal would adhere strictly to the“first-loss” principle where the existingshareholders would be required to bear alllosses before the recapitalisation by Danamodal.The “undercapitalised” banking institutions wouldalso have to sell all their eligible NPLs toDanaharta and comply with a comprehensiveset of performance indicators.
As a strategic shareholder in theserecapitalised banking institutions, Danamodalwould then be able to institute micro reformsthrough its nominees appointed on the respectiveBoards of these banking institutions. Suchreforms would include, amongst others, soundrisk management practices and credit culture,good corporate governance and higheroperational efficiencies. Danamodal, in its roleas a strategic shareholder, may also facilitatemergers in line with BNM’s objective toconsolidate and rationalise the banking sector.
As the health of the corporate sector andbanking sector are intertwined, the establishmentof Danaharta and Danamodal would not besufficiently comprehensive to arrest theproblems in the banking sector. In view ofthe severity of the financial crisis, manycorporates were also adversely affected. A
number of the corporate sector debts have eitherbeen classified as non-performing or exhibitingsigns of potential default. Hence, restructuringthese corporate debts to ensure that viablecorporates continue to receive financing is crucialin order to generate new economic activitiesand support the economic recovery process.
To facilitate the restructuring of corporate debt,a Corporate Debt Restructuring Committee(CDRC) was set up to provide a platform forboth the borrowers and the creditors to work outfeasible debt restructuring schemes without havingto resort to legal proceedings. An increasingnumber of borrowers in financial difficulties hadinitially sought legal protection under Section 176of the Companies Act 1965 rather thannegotiating for loan restructuring. With the settingup of CDRC, borrowers would be able to directtheir debt restructuring to CDRC. Under theCDRC debt restructuring framework, CreditorCommittees comprising banking institutions wouldbe formed to work out the debt restructuring.These restructuring efforts would be conductedbased on market-driven principles to ensure thatthere would be a win-win situation for both theborrowers and the creditor banking institutions.The restructuring of the corporate sector debtswould expedite the recovery of the corporatesector which would in turn strengthen the healthof the banking institutions. If the process underCDRC could not obtain consensus among thebanking institutions, Danaharta would assist bybuying over these NPLs from the dissentingbanking institutions, thereby facilitating therestructuring process. (Operational details ofDanaharta, Danamodal and CDRC are elaboratedin the Annex.)
Danaharta, Danamodal and CDRC areinterdependent and complementary, representinga comprehensive and coherent plan towardsstrengthening the banking sector. Thecomplementary nature of these measures isillustrated in Chart VI.3 below.
Given that the measures were interdependent,it was critical that the functions of Danaharta,Danamodal and CDRC were co-ordinated toensure that these institutions operated in acohesive and structured manner to achieve thedesired objectives. In this regard, a SteeringCommittee, chaired by the Governor of BankNegara Malaysia, was established to overseeand monitor the policies, operations and progressof Danaharta, Danamodal and CDRC. TheCommittee, which meets fortnightly, ensures thatthe operations of these institutions are wellco-ordinated and complement each other, andto keep track of their progress. In addition,mechanisms are also in place to ensure thatthe activities of Danaharta, Danamodal andCDRC are appropriately sequenced.
In addition to Danaharta, Danamodal andCDRC, the Government has also establishedseveral special funds to provide funds atreasonable cost to promote investment in thepriority sectors. These special funds includethe Fund for Small and Medium Industries(RM1.5 billion), the Special Scheme for Lowand Medium Cost Houses (RM2 billion) andRehabilitation Fund for Small and MediumIndustries (RM750 million). The RehabilitationFund for Small and Medium Industries wasestablished to provide financial assistanceto viable small- and medium-sized industries
Chart VI.3Overview of Danaharta, Danamodal & CDRC
SPECIALFUNDS
New loans/
Restructuredistressed
loans
BANK
DANAMODAL
DANAHARTA
Sell NPLs
Bonds Cash
BORROWERS
CDRC
Restructure debt
Loan and assetmanagement
InjectCapital
Bonds/Cash
▼
▼▼New loans
that are facing NPLs and temporary cashflow problems.
Progress of Restructuring Plan as at15 March 1999
DanahartaDanaharta has purchased and managed NPLs
amounting to RM21.7 billion from the financialsystem, of which RM15.1 billion was from thebanking system. These NPLs accounted for 20%of NPLs of the banking system as at end ofDecember 1998. With the removal of NPLs fromthe banking system, the net NPL ratio of thebanking system based on the 6-month classificationdeclined from 8.1% as at end-September 1998to 7.6% as at end-December 1998.
DanamodalDanamodal has injected capital into
10 banking institutions in the form ofExchangeable Subordinated Capital Loans (ESCL)amounting to RM6.15 billion. This increased theRWCR of the banking system from 11.2% asat end-June 1998 to 11.9% as at end-January1999, hence, increasing the capacity of bankinginstitutions to generate new lending.
Danamodal has also signed DefinitiveAgreements with seven banking institutionsto convert the ESCL into permanent Tier-1and/or Tier-2 capital. To strengthen themanagement of these banking institutions,Danamodal has appointed Chairmen, DeputyChairmen and Executive Directors intothe respective Boards of six recapitalisedbanking institutions.
CDRCCDRC has received 48 applications for
debt restructuring, involving debt of RM22.7billion. Two restructuring plans have beenimplemented thus far and 26 CreditorCommittees have been formed to oversee therestructuring efforts.
MergersEight finance companies have been absorbed/
merged, whilst another 14 finance companieswill be absorbed/merged this year. Five smallfinance companies have been allowed to operateon a stand-alone basis for the time being.Nevertheless, the plan to rationalise these smallfinance companies remains part of BNM’sagenda to further strengthen the financecompany industry.
Three merger plans among commercial bankshave been announced and expected to becompleted by end-1999.
Conclusion
Following the implementation of selectedexchange control measures and the fixing of theexchange rate at US$1=RM3.80, the stabledomestic environment has provided an opportunityfor the authorities to continue to undertakeeconomic recovery measures as well asaccelerate the necessary restructuring and reformin the financial and corporate sectors.
Signs of economic recovery have alreadyemerged in early December, observed from thegreater stability in the exchange rate, stockmarket, employment and in the financial sector.Borrowers now also have greater access to credit,and are less burdened by the high debt servicingcost. The strains on the banking system areexpected to lessen as the economy recovers andthe restructuring process continues. Therestructuring process would strengthen thebanking system and thus, place the bankinginstitutions in a position to perform theintermediation function more efficiently andeffectively to support the economic recoveryprocess. A stronger banking system wouldcontribute to a stronger and more developedfinancial system in the longer term, placing thefinancial system in a better position to meet thechallenges of the future.
Moving Ahead
Globalisation and liberalisation of the financialmarkets will continue to pose great challenges tothe banking sector. As the country graduates tobecome an industrialised nation, a resilient, dynamic,competitive and efficient domestic banking sectorbecomes highly critical in order to channel resourcesefficiently and effectively within the economy. Themeasures introduced thus far essentially serve asa short-term response to current challenges arisingfrom the crisis and to provide the foundation onwhich to broaden and strengthen the financialinfrastructure to enable the financial sector to meetthe growing challenges of the future. The lessonsthat can be drawn from the crisis will help chartthe strategic longer term plan for the bankingindustry. Efforts to further strengthen regulatory andsupervisory framework would also continue.Prudential regulations would be continuouslyreviewed to ensure that best practices are beingput to practice. The initiatives for the bankingsystem will continue to be an evolving process tomeet short-term challenges without detracting fromachieving the long-term objective of a sound andresilient banking system in order to generateincreased value-added in the financial servicessector to support and contribute towards the overallgrowth of the real economy.
Performance of Banking System
Profitability
The banking system recorded a pre-tax loss ofRM2.3 billion for calendar year 1998 as comparedwith a pre-tax profit of RM7.7 billion in 1997. Thispre-tax loss was due to exceptionally largelosses recorded by two commercial banks andone finance company. Excluding the lossesregistered by these three institutions, the bankingsystem recorded a pre-tax profit of RM793 millionwhich generated a marginal 0.1% return on totalassets and 1.7% on total equity. Although thecommercial banks as a group (excluding the twocommercial banks) recorded a pre-tax profit ofRM2.5 billion, this was, however, offset by thepre-tax loss of RM1.1 billion registered by thefinance companies (excluding the one financecompany) and the loss of RM641 million recordedby the merchant banks.
Losses recorded by the banking system in 1998were due to the economic contraction which gave
rise to negative loan growth, rising NPLs andhigher loan loss provisions. Before factoring in theloan loss provisions, the banking system as awhole registered a pre-tax profit of RM11.8 billion,lower than the RM13.3 billion recorded in theprevious year. Loan loss provisions and interest-in-suspense charged rose significantly by RM12.8billion (+208%) to RM19 billion in 1998, mainly asa result of increased net specific provisionscharged of RM9.3 billion. Of the total loan lossprovisions and interest-in-suspense, RM5.1 billionor 27% was contributed by the three institutionswhich registered significant losses. The higher loanloss provisions recorded in 1998 was also partlydue to the adoption of more stringent provisioningrequirements under the revised Guideline on theSuspension of Interest on Non-Performing Loansand Provision for Bad and Doubtful Debts whichshortened the period during which bankinginstitutions are required to make loan provisionsfor doubtful and bad loans.
Table 4.5Banking System: Unaudited Income and Expenditure
For the calendar year
1997 1998 Annual changeRM million %
Interest income net ofinterest-in-suspense 50,125 60,325 10,200 20.3
Return on assets 1.3% –0.3%(excluding 3 institutions)1 1.7% 0.1%
Return on equity 17.5% –4.5%(excluding 3 institutions)1 22.1% 1.7%
1 Excluding 3 banking institutions that made exceptional loss.
The reduction in interest rates and the higherincidence of NPLs saw the banking system earninglower net interest income of RM14.8 billion. Althoughinterest rates in the first seven months of 1998were high, the rapid downward adjustment in interestrates by BNM in the later part of 1998 saw theoverall net interest income declining by 11.7% in1998. The rapid reduction in the 3-month
intervention rate by BNM, to which the computedBLR of the commercial banks and financecompanies was pegged, from 10.5% per annum inAugust 1998 to 7% per annum in September 1998,took its toll on interest margins temporarily asbanking institutions’ average cost of funds normallylags the policy rate by 3-6 months before fallingto the new interest rate level.
The finance companies’ profitability was alsoheavily squeezed during the early part of 1998when a liquidity shortage in the system drove short-term deposit rates up on the back of fixed ratehire-purchase and term loans offered by the financecompanies, causing the interest rate margins tonarrow considerably to 1.7 percentage points. Inaddition, lack of sufficient new hire-purchase loansduring the year reduced the ability of the financecompanies to earn enough positive returns tocompensate for the negative spread incurred ontheir existing fixed rate loan portfolio. Merchantbanks, on the other hand, benefited greatly fromthe liquidity shortage in terms of interest marginsas significant increases in interbank rates in theearly part of the year were automatically translatedinto higher lending rates under their KLIBOR-plusloan pricing.
Non-interest income increased by RM1.1 billionin 1998. The favourable comparison to 1997 wasdue to an exceptional non-recurring provision fordiminution in value of regional investment securitiesby one commercial bank in 1997 of RM0.9 billionand an increase of RM461 million in net tradingincome in 1998. Staff cost was contained at RM3.9billion, while overheads rose by RM0.8 billion toRM5.1 billion in 1998.
Loan Growth
Credit extended by the banking system as awhole declined by RM7.6 billion (–1.8%) in 1998.This was due mainly to the removal of loans byDanaharta in 1998 which amounted to RM13 billion(not including loans sold by the Malaysian banks’overseas branches, which amounted to RM1.4billion). Taking into account the removal of loansby Danaharta, the banking system as a wholeregistered a marginal growth of RM5.5 billion or1.3% in 1998. Higher loan repayments, whichincreased by 5.5%, and lower turnover in loandisbursements by 26.6% also contributed to theslowdown in growth momentum. Only the
J F M A M J J A S O N D0
2
4
6
8
10
12
14
16
18
20
1998
Commercial Banks
J F M A M J J A S O N D0
2
4
6
8
10
12
14
16
18
20
1998
J F M A M J J A S O N D0
2
4
6
8
10
12
14
16
18
20
1998
Finance Companies
Merchant Banks
%
%
%
Graph 4.1Average Lending Rates and Average Cost of Funds
ALR ACOF
commercial banks as a whole managed to show apositive growth of 3.3% (7.1% if loans removed byDanaharta are taken into account), while bothfinance companies and merchant banks showednegative growth in 1998. If banks that do not havethe capacity to lend due to capital adequacyproblems are excluded, the loan growth of theremaining commercial banks was even higher at8% in 1998. The positive credit growth exhibitedby the commercial banks and the negative growthby the finance companies were partly due to theabsorption of several finance companies by theirrespective parent banks.
As the regional financial turmoil becameprolonged, banking institutions faced with economicuncertainties became cautious in extendingcredit during 1998. Tight and uneven distribution ofliquidity further heightened the problem.
Consequently, only RM38.2 billion of new loanswere approved during the first three quartersof 1998, or an average of RM4.2 billion amonth. Several measures were introduced to injectgreater liquidity, reduce interest rates and removebarriers to the supply of new financing, includingthe setting up of Danaharta to buy NPLs andthe formation of Danamodal to recapitalisebanking institutions.
The more conducive business environmentbrought about by the reduction in interestrates, greater liquidity, the removal of the twindistraction of rising NPLs and erosion of capital aswell as rising consumer confidence, resulted in asignificant rise in new loans approved during thefourth quarter of 1998. New loans approvedamounted to RM24 billion during the last quarterof 1998, or an average of RM8 billion a month,nearly two-fold increase over the preceding ninemonths. For 1998 as a whole, manufacturing andend-financing for purchase of residential propertieswere the largest recipients of new loans approved.Loans for the purchase of residential propertiescosting RM150,000 and below accounted for morethan 60% of the new loans approved to theresidential property sector.
Asset Quality
The asset quality of the banking system wasadversely affected during 1998. In an environmentwhere interest rates were high and economicactivities had contracted, the ability of borrowers toservice their debt was invariably affected. This wasevident in the sharp increase in NPLs in thebanking system in 1998.
Table 4.6Banking System: Outstanding Gross Loans
As at end
1998
1997 Excluding loans sold to Including loans sold toDanaharta Danaharta
Banking system 421,202.5 413,638.1 –1.8 426,677.3 1.3
RMmillion
RMmillion
RMmillion
1Q97 2Q97 3Q97 4Q97 1Q98 2Q98 3Q98 4Q980
20
40
60
80
100
120
0
5
10
15
20
25
RM billion
Graph 4.2Banking System : Quarterly New Loans Approved,Disbursements and Repayments
RM billion
Disbursements Repayments New loans approval
The actual NPLs of the banking system increasedby RM34.2 billion or 8.3% of total loans in 1998,whilst on the 3-month classification basis, NPLsgrew by RM48.8 billion. On a net basis, the actualNPL ratio of the banking system increased from4.1% as at end-December 1997 to 9% as at end-December 1998. As at end-December 1998, 57banking institutions have reverted to the 6-monthclassification policy for NPL and they account for54% of total loans of the banking system. Basedon the 3-month classification policy, the net NPLratio of the banking system increased from 4.7%as at end-December 1997 to 13.2% as at end-December 1998. Excluding the NPLs of threebanking institutions that were most affected, thenet NPL ratio for the industry as a whole was12.2% as at end-December 1998. For thecommercial bank industry, their net NPL ratioremained below 10% as at end-December 1998.
Although NPLs had increased during the year,the rate of increase has in fact moderated duringthe fourth quarter of 1998. The average monthlyincrease in NPLs from October to December 1998slowed down to 6.2% (after taking into accountloans sold to Danaharta), as compared with theaverage monthly increase of 11.3% in the first ninemonths of 1998. In December 1998 alone, themonthly rate of growth in NPLs moderated to 2.7%.Loan loss coverage ratio of the banking systemdeclined slightly with total provisions (interest-in-suspense, specific provisions and general provisions)set aside by the banking system amounting to55.7% of NPLs. Including the value of collateral,the total loan loss coverage of the bankingsystem amounted to 143.3% of NPLs as at end-December 1998.
In terms of NPLs by sector, as at end-December1998, loans to the broad property sector accountedfor 35.3% of total loans and gross NPLs to thebroad property sector accounted for 35.1% of totalNPLs as at end-December 1998. A major proportionof NPLs to the broad property sector came from theconstruction and real estate sectors, which accountedfor 61.6% of total broad property sector NPLs (52%as at end-1997). NPLs for the purchase of residentialproperties remained relatively low at 11%.
The sharp decline in the stock market has alsoadversely affected the quality of loans extended forthe purchase of securities. The NPL ratio for thepurchase of securities increased from 6.5% as at
New Loans Approved
Graph 4.3Banking System: New Loans Approved,Disbursements & Repayments by Sector in 1998
26%
14%
21%
6%
13%
6%5% 9%
Repayments
27%
16%
22%
4%
14%
2%6% 9%
Disbursements
17%
12%
9%
9%
8%
5%
25%
15%
Manufacturing Fin., ins. & bus. serv.
Construction Purch. of res. prop.
Purch. of transport veh. Gen. commerce
Purch. of securities Others
end-1997 to 23.2% as at 31 December 1998.However, given the relatively low exposure of thebanking system to share financing at 7.9% as atend-1998, the high levels of NPLs for sharefinancing remained manageable.
The increase in NPLs was mainly concentratedin the construction, real estate and commercialsectors and for the purchase of shares whichtogether accounted for RM15.5 billion or 45.2%of the total increase in NPLs in 1998.Recognising the vulnerabilities of these sectors,BNM has prohibited banking insti tutionsfrom extending bridging f inancing for thedevelopment of properties above RM250,000.Although the limit on loans extended for thepurchase of shares was increased from 15% to20% of total loans in September 1998, this wasaimed at providing share financing for genuinelong-term investment and not for short-termspeculative purposes.
Table 4.7Banking System: Non-performing Loans and LoanLoss Provisions
Finance, insurance& business services 3.8 12.4 13.9
Purchase of securities 6.5 23.2 34.2Consumption credit 6.9 14.1 14.1Personal use 6.0 15.4 15.6Credit card 10.1 17.4 17.4Purchase of consumer
durables 13.3 18.2 19.4Purchase of transport
vehicles 1 6.7 13.0 13.0Others 7.5 12.6 13.2
Total 5.9 14.3 16.8
1 Includes commercial vehicles.
Exposure to the East Asian Region
The Malaysian banks’ exposure to countries inthe East Asian region affected by the severeeconomic crisis was mainly confined to sevenbanking institutions through their overseas branchesand Labuan offshore units. As at 31 December1998, the loan exposure of the banking institutionsto Indonesia, Thailand, Korea and the Philippineswas US$777 million, a reduction of US$758 millionfrom December 1997. The significant reduction wasdue to the sale of some of these loans toDanaharta, particularly those originating from thePhilippines. The loan exposure represented only1.7% of the total assets of the affected Malaysianbanks. Nevertheless, banking institutions have beenencouraged to recognise potential problems earlyand to build up provisions for the regionalexposures.
Capital Strength
Corresponding with the losses made by thebanking system, total Tier-1 capital of the bankingsystem fell by RM4.3 billion (–9.2%) to RM42 billionas at end-1998. The year also saw a reduction inthe paid-up capital of finance companies due tothe absorption of five finance companies by theirparent banks and a merger of two financecompanies. Nevertheless, the decline in Tier-1capital was offset by a RM4.55 billion injection ofTier-2 capital funds by Danamodal in the form ofExchangeable Subordinated Capital Loan into ninebanking institutions. This resulted in a marginalincrease in the overall capital base of the bankingsystem by 2.2% or RM1.2 billion to RM55.6 billion.
Total risk-weighted assets of the banking systemdeclined by 8.9% or RM46.1 billion to RM470.9
billion as at end-1998, due mainly to the contractionof credit during the first three quarters of the year,and acquisition and management of loans of RM13billion by Danaharta. The risk-weighted assets in the0% and 20% risk-weight category also declinedsignificantly by RM34.2 billion and RM23.6 billionrespectively. The reduction in the riskless assetclass was mainly due to reduction in the bankingsystem’s statutory deposit with BNM of RM41.7billion following the reduction in the statutory reserverequirement from 13.5% to 4%. The bulk of thereduction was channelled towards repaying thebanking system’s money market borrowings fromBNM which amounted to RM23.7 billion. Thereduction in assets in the 20% risk category wasdue to a significant decline in NIDs held (–RM5billion), other acceptances discounted (–RM5.7 billion),claims on reverse repos (–RM3.2 billion), and claimson OECD and non-OECD banks (–RM7.9 billion).
Reflecting the injection of capital by Danamodal,the removal of NPLs by Danaharta and the decline
Table 4.9Exposures of Malaysian Banks to East Asian Region
in total loans, the risk-weighted capital ratio (RWCR)of the banking system showed an increase of 1.3percentage points to 11.8% as at end-1998 inspiteof the pre-tax loss recorded by the banking systemas a whole. By type of institution, the RWCR ofcommercial banks, finance companies and merchantbanks showed an improvement from the 1997position, to 11.7%, 11.1% and 15.2% respectively.
Foreign Currency Exposure
The banking system maintained a relatively smallforeign currency position during 1998. Throughoutthe year, the banking system was net long inforward foreign exchange transactions. This was inline with the net export position recorded during1998, where overall, there were more partiescontracting to sell forward foreign exchangeproceeds compared with forward purchases to thebanking system. Nevertheless, those positions wereessentially matched by the banking system withopposite swap contracts and foreign currencyborrowings. There were less forward foreignexchange contracts towards the fourth quarterwhen capital controls were introduced inSeptember 1998 and concerns over volatileexchange rates diminished.
Liquidity
A large number of banking institutionsexperienced tight liquidity situation in the first halfof the year. Tight liquidity during the period wasattributed to the continuous fall in total deposits ofRM7.7 billion and the decline in the net externalliability position of banking system of RM11 billion,
caused by the withdrawal of external funds fromthe domestic banking system. As a result, bankinginstitutions that had been over-reliant on short-termfunding to finance their asset growth, particularlyfrom the interbank money market, encounteredfunding difficulties. The uneven distribution of liquidityled to a rise in short-term interest rates early inthe year. The differences between the highest andthe lowest rates transacted among interbank playerswere as high as 8.8 percentage points for 1-weekmoney and 1.1 percentage points for 1-monthmoney in January. In order to distribute liquiditymore evenly among the banking institutions, thestatutory reserve requirement of banking institutionswas reduced from 13.5% to 10% in February 1998.
Liquidity conditions improved further towards thesecond half of the year following further reductionsin the statutory reserve requirement from 10% to8% in July and subsequently to 6% and 4% inSeptember. This was accompanied by gradualreductions in the BNM 3-month intervention ratefrom 10.5% per annum at the beginning of Augustto 7% per annum in November. These measurescontributed to ease the liquidity conditions in themoney market as well as to bring down the costof funds of the banking institutions. As a result,the computed BLR for commercial banks declinedfrom 12.30% per annum in June to 8.08% perannum in December 1998 and for financecompanies, from 14.76% per annum to 9.54% perannum. The improvement in the overall liquiditycondition was also reflected by the reduction inBNM’s money market lending to the banking system.
-20
-10
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-2
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Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Graph 4.5Liquidity of the Banking System
RM billion %
1998
1. Amount released from SRR reduction is calculated using December 1997 as zero reference base.2. Increase in deposit-loan gap in December is due to annual seasonal trends
net deposit loan gap net interbank moneyborrowing by BNMnet external liabilitiesamount released fromSRR reduction
average 3 month interbankrate transacted (right axis)
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Graph 4.4Net Open Foreign Currency Position of Banking System
Net asset, spot & misc positionNet forward positionNet swap position
Net Open FC PositionExchange Rate (2nd axis)
Introduction
Given the heavy dependence of thenation on information technology andautomation, there is grave concern thatbusiness operations would be severelydisrupted as we move on to the next millenniumif computer systems and automated applicationsfail to be Year 2000 (Y2K) ready. For thefinancial sector, the Y2K challenges areespecially acute, as it relies heavily onautomation in almost all aspects of operations.If automated applications fail to function properly,it will be difficult, if not impossible, to conductbusiness. In view of this, BNM and the industryhas adopted a proactive approach to confrontthe Y2K challenges.
Impact of the Y2K Challenges
In any economy, the Y2K issue posessignificant challenges as businesses and otherdaily activities are highly dependent on computertechnology and integrity of data. Failure toaddress the problem would result in manyautomated applications failing to function normallyand lead to disruptions in business activities aswell as our everyday life. The banking industryfaces the greatest challenge, due to its pivotalrole in the payment and settlement systems. Itis exposed to various risks if it fails to addressthe Y2K challenges in a proper and timelymanner. The payment system may be severelydisrupted if the Y2K challenges are notaddressed expeditiously. When this happens, thesettlement system, both domestically andinternationally, will be affected and as a result,customers will not be able to perform theirnormal banking transactions.
These disruptions could expose bankinginstitutions to a wide array of risks, whichinclude operational risks, credit risks,reputational risks, settlement risks as well aslegal risks.
Managing the Y2K Challenges in the MalaysianBanking Industry
Operational risks are the mostobvious. Failure to ensure fully operationalautomated systems can prevent even simplebusiness functions from being transacted becausemanual or other alternatives may not be feasible,in view of the sizeable volume of transactionsor integrity of data. For example, if theAutomated Teller Machine (ATM) network, whichis highly dependent on automation, fails tocomply with Y2K requirements, cardholders willnot be able to perform banking transactionsthrough the ATM.
There are other risks associated with thebreakdown in the operations as correspondentsand clients would be severely affected by thedisruption in the operating environment. In thecase where the ATM of a banking institutionfails to function, there would be a build-up ofnegative perception on that institution. This mayin turn expose the institution to reputationalrisks and consequently to legal risks.Customers would resort to legal action againstthe institution as it would not be able to conducttransactions, resulting in potential damage to theinstitution’s business.
Business customers of banking institutions mayalso suffer serious disruptions to their businessesif they fail to meet with the Y2K requirements,thus probably affecting their ability to servicetheir loans. This will in turn increase the creditrisks for the banking institutions. Furthermore,an operational breakdown resulting from the lackof preparation to deal with the Y2K challengesby any one of the financial market participantsmay affect the integrity and operation of theentire settlement system, which may even leadto the collapse of the entire payment system.For example, a Y2K-induced operationalbreakdown that results in delayed fund paymentsmay cause significant liquidity pressures for othermarket participants. These disruptions andinterruptions in the banking system could erode
Box VII
the public confidence in the integrity of thebanking system.
Bank Negara Malaysia’s Action Plan
BNM is aware and concerned about thechallenges posed by the Y2K problem andthe potentially serious implications for thefinancial market and the public at large arisingfrom the lack of readiness. BNM has adopteda proactive approach to confront the Y2Kchallenges. Amongst the measures implementedby BNM in managing the Y2K challengesinclude:-
• Establishing targets and benchmarks forinstitutions to adhere to in addressing theY2K challenges;
• Developing and communicating the necessºaryframework in implementing the Y2K projectthrough the issuance of circulars andguidelines;
• Conducting an industry-wide statusassessment through regular reporting bythe financial institutions to BNM and theperiodic examination of the financialinstitutions; and
• Placing supervisory pressure on financialinstitutions to ensure high level of compliancewith the Y2K requirements.
A Y2K monitoring system has beenimplemented to monitor the progress of eachbanking institution in achieving a fully Y2K-
compliant operation. BNM also conducts regularon-site inspections on financial institutions tocomplement the monitoring process. A specialunit, staffed with trained personnel to conductIT audits, has also been set up to specificallyaudit the progress of banking institutions incomplying with the Y2K requirements.
Y2K Steering Committee for Bankingand Insurance Industries
BNM realises that the Y2K issue, whichinitially started as a technical problem, is abusiness survival issue for the bankingcommunity as a failure by one institution wouldhave ramifications on the whole system. In thisregard, an industry-driven approach withsupervisory support and oversight from BNMwas adopted. Under this approach, the industryundertook collectively planned and co-ordinatedsteps spearheaded by an Industry Y2K SteeringCommittee. The Steering Committee, comprisingchief executive officers of financial institutions,plays a proactive role to ensure that thefinancial industry in Malaysia can moveconfidently and smoothly into the next millennium.
The terms of reference of the Y2K SteeringCommittee are as follows:-
(i) Creating awareness across the industry;
(ii) Creating support from the highest levelwithin an institution;
(iii) Planning and co-ordinating industry-wideaction plan;
Banking and Insurance IndustryY2K Steering Committee
BNM
Steering Committee
Banking Insurance
Business &Costing
Technical &Security
Implementation& Testing
Business &Costing
Technical &Security
Implementation& Testing
(iv) Planning and co-ordinating testing andinterfacing of various applications;
(v) Managing cost control;
(vi) Co-ordinating issuance of publicstatements on the state of readinessof the banking and insurance industriesin complying with the Y2K issue;and
(vii) Ensuring security and control issues areappropriately addressed.
Working Committees
The Y2K Steering Committee is supported bytwo working committees, namely the BankingSector Working Committee and the InsuranceSector Working Committee. The Banking SectorWorking Committee comprises representativesfrom the commercial banks, merchant banks andfinance companies, whilst the members of theInsurance Sector Working Committee arerepresentatives from the insurance companies.Within these two groups, three sub-workingcommittees on each sector were formed totackle specific issues. The technical andsecurity working committee would addresstechnical and security-related issues, includingidentifying and listing of inventories to berenovated, while the business and costingworking committee would address businessand cost-related issues. The responsibilityof the business and costing working committeeincludes co-ordination with vendors toobtain a reasonable cost of renovation aswell as ensuring a co-ordinated approachin communicating with the public onY2K-related issues. The implementation andtesting working committee is responsible forco-ordinating testing initiatives within theindustry. These sub-committees report to theY2K Steering Committee on a regular basisin order to keep the Steering Committeeabreast with the current progress of theindustry's Y2K readiness.
Implementation Timeframe
As compliance with the Y2K requirements iscrucial, the deadline for complying with the Y2K
requirements cannot be compromised. In thisregard, the timeframe as recommendedby the Bank for International Settlements(BIS) in handling the Y2K challenges hasbeen adopted for the Malaysian bankingand insurance industries. Under the timeframe,there are four main stages as follows:-
Assessment stage - defined as a phase thatmoves the project from “concept” to “concreteactions”. This stage involves developingdetailed inventories of what must be done,the scope of which covers centralisedand decentralised hardware, software, andnetworks, as well as equipment withembedded computer chips and logic. Theinventories should include all aspects ofbusiness line activities whether internal to thebank or external to it. The risks should bequantified and the priorities should be setbased on these risks.
Renovation stage - defined as a phase thatis primarily technical in nature. During thisphase, the necessary fixing of operatingsystems, applications, hardware and equipmenttakes place. The development of contingencyplans that identify alternative approaches ifrenovations lag or fail, is an important partof this phase.
Testing stage - defined as a phasewhere detailed test schedules must bedeveloped and co-ordinated withcorrespondents and customers. Data flows,internally and with third parties, mustbe thoroughly tested, while both thesender and receiver simulates “Year2000 conditions”.
Implementation stage - defined as a phasethat requires careful planning to make surethat inter-related applications are co-ordinatedwhen they are put into production. Theimplementation phase also requires themonitoring of progress by service providersand vendors.
In accordance with the Y2K implementationtimeframe, financial institutions should havecompleted detailing inventories and renovationwork on systems, applications and equipmentas well as carried out validation and testingby the end of 1998. This is to provide ample
lead time for banking institutions to conducttesting, including external testing to ensurethat the system has undergone rigoroustesting and validation before it is deemed asY2K ready.
Financial institutions have to adhere strictlyto this implementation timeframe and tosubmit reports on a monthly basis to BNMon the progress in complying with theY2K requirements.
Progress Made by the BankingIndustry
As at end-February 1999, 96.1% or 74out of 77 banking institutions have completedall the three stages of assessment, renovationand testing. The remaining three bankinginstitutions (one commercial bank andtwo merchant banks) have completedat least 75% of the testing stage and areexpected to complete the entire testing byend-March 1999. BNM monitors closelythe progress of these institutions andadditional supervisory actions have beentaken, including conducting regular on-siteexaminations and meeting with the managementof the institutions, to get their full commitmentto resolve problems that could impederemedial efforts.
Other Initiatives
BNM has also initiated a series of measuresas follows:-
Self-Assessment by Institutions• Banking institutions have been required to
conduct self-assessment exercises on theirY2K compliance process to ensure that theyhave taken reasonable and prudential stepsto address the Y2K challenges and thatsatisfactory progress is being made to meetthe compliance deadline. Banking institutionshave been required to report to BNM onthe self-assessment.
Assessment Renovation Testing Implementation0
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75% completed 100% completed
% of Financial Institutions
Graph VIIFinancial Institutions: Level of Readinessas at end - February 1999
stages
Implementation Timeframe
• Developing strategicapproach
• Creating organisationalawareness
• Assessing actions anddevelop detailed plans
• Renovation of systems,applications & equipment
• Validating renovationthrough testing
• Implementing tested,compliant system
J S D M J S D M J S D M J1997 1998 1999 2000
Formal Statement by Chief ExecutiveOfficers• To ensure the involvement of the highest
level of management in handling the Y2Kchallenges, the chief executive officers ofbanking institutions have been required toprovide formal statements of the Y2Kcompliance progress on a monthly basis toBNM commencing July 1998. The resultsso far indicate that the majority of the chiefexecutive officers are satisfied with theirinstitutions’ progress.
Public Disclosures• In order to provide accurate and sufficient
information on the progress of the bankingindustry in achieving the Y2K compliance,banking institutions have been required todisclose their level of compliance with theY2K requirement in their published accountsfrom the financial year ending 30 June1998. As it is crucial to instil publicconfidence, the Business and CostingWorking Committee has also been requiredto co-ordinate the disclosure of Y2Kreadiness of the Malaysian financial system.
Business Resumption Plan• Banking institutions have also been required
to develop business resumption plansand submit their plans to BNM by 30 April1999. The plan would elaborate clearly theprocess and steps to be taken byeach institution in managing the Y2Kchallenges. It should cover areas oforganisational planning, business impactanalysis, identification and documentationof the business resumption plans andits implementation modes, as well asevaluation by an independent audit of theviability and soundness of the businessresumption plans.
The National Y2K Task Force
To ensure a coherent approach in tacklingthe Y2K initiatives at the national level, BNMalso sits as a member on the National Y2KTask Force, which was set up by theGovernment to co-ordinate the Y2K preparationsnation-wide. The National Y2K Task Forceis headed by the Minister of Energy,Communications and Multimedia and it
co-ordinates the Y2K initiatives of the criticalsectors in the economy. The banking andinsurance industries have been identifiedas among the critical sectors with regard toY2K compliance.
Progress of the Payment System Y2KCompliance
The payment and settlement system is thekey element in facilitating banking transactions.As such, BNM has taken the necessary stepsto ensure that all the critical systems will beY2K compliant by June 1999. The Y2Kcompliance activities for BNM’s internal systemshave started since January 1997. As at the endof February 1999, about 50% of the criticalsystems have been tested for Y2K compliance.The other systems are scheduled to be testedin stages until June 1999. The status of theBNM internal critical systems is as follows:-
• The Bond Information DisseminationSystem (BIDS) and the Fully AutomatedSystem for Tendering (FAST) havebeen tested for Y2K compliance inDecember 1998.
• The National Imaging Cheque ClearingSystem (SPICK) was tested for Y2Kcompliance in February 1999.
• The Real Time Electronic Transfer of Fundsand Securities (RENTAS) is now at theadvanced stage of development and isscheduled to be implemented as a Y2Kready system in June 1999.
In addition, the Malaysian Electronic PaymentSystem (1997) Sdn. Bhd. (MEPS), the serviceprovider of the largest shared ATM network inMalaysia, has also taken various steps to resolvethe Y2K challenges. The focus of MEPS is toratify the Y2K problem on the existingproduction system which is the shared ATMnetwork, as well as the development of newapplication systems such as E-Purse, SETPayment Gateway and Inter Bank Giro. Thescope of MEPS Y2K programme covers allcritical systems' hardware and software, datacentre equipment, network equipment, officeequipment and tools, suppliers, service providers,as well as the legal aspect. MEPS has, to
date, completed the assessment and renovationon all critical systems, including replacement ofhardware, software and modification of systems.The testing of the main hardware and operatingsystem has been successfully conducted toensure Y2K compliance. The office equipmentand other non-critical systems are at the finalstage of testing and implementation. The sharedATM switching module is currently at the finalstage of testing with selected financial institutions.
Conclusion
With the year 2000 fast approaching, it isimportant for everyone to fully realise the
challenges and implications of the Y2K issue,and accord the highest priority to ensurecompliance with the stipulated timeframe. It isindeed one of the greatest challenges facingmankind today. As a result of a co-ordinatedand systematic approach adopted in tackling theY2K challenges, the banking system is wellahead in preparing for the new millennium. Inview of the progress made in complying withthe Y2K requirements, we should be able tomove on smoothly and confidently into the nextmillennium. Notwithstanding the measures alreadyin place to ensure readiness, BNM will intensifyits supervisory effort and put in place a soundand comprehensive business resumption plan tominimise any potential disruptions.
BNM turned from being a net lender duringthe initial part of the year to a net borrower fromthe banking system towards the last quarter ofthe year.
In terms of managing the timing of liquidityto meet obligations, the banking system as awhole maintains sufficient stock of liquefiable assetsthat can be liquidated to meet any projectedpotential shortfall that may arise. Taking intoaccount the liquefiable assets as at 31 December1998, the banking system as a whole had projecteda cumulative liquidity surplus of RM20 billion toRM40 bill ion over the next three months.Approximately 37% of the liquefiable assets heldby banking institutions were in the form ofGovernment securities and 22.5% in Danaharta andDanamodal bonds.
The liquidity position by type of institution,however, differs significantly. Finance companies, ingeneral, tend to exhibit higher potential of liquidityshortfall compared with commercial banks,as their deposit base was less stable. Thosemerchant banks, whose funding structure reliedon a small number of large corporate depositors,also faced a higher degree of risk inencountering potential shortfalls. As at 31 December1998, 77.3% of banking institutions forecastedpotential surpluses of liquidity for at leastone-month ahead.
Islamic Banking
Islamic banking continued to record moderategrowth in 1998. Total deposits mobilised registereda strong growth of 59.1% to RM16.4 billion duringthe year. The shareholders’ funds of the Islamicbank and the Islamic Banking Fund increased by23% to RM1.6 billion, while profit before taxationand zakat decreased by 3.3% to RM148 million in1998. Total assets expanded by 21% to RM21.6billion due mainly to the increase in holdings ofsecurities (162.4% or RM3.1 billion). Total financingrecorded a growth of 1.8% to RM10.9 billion.
Total deposits recorded a strong growth in 1998,particularly in the second half of the year. Theincrease was partly due to the migration of depositsfrom conventional banking to Islamic banking inview of the better investment deposit rates.Investment deposits constituted the bulk of deposits(60.5%), which recorded a growth of 108.9% toRM9.9 billion.
The expansion in total financing was smallin 1998, due mainly to a decline of 1.4%(RM149 million) in the first half-year, which offsetan increase of 3.2% (RM342 million) in the secondhalf of the year. The exposure of Islamic bankingto the broad property sector remained significant,at 41.7% of total financing. The high demand forbroad property sector financing under Islamicbanking was partly attributed to the fixed-rate natureof Islamic financing i.e. Bai’ Bithaman Ajil. Duringthe period of rising interest rates in early 1998,
up to 1 wk >1wk-1 mth >1mth-3 mths >3-6 mths >6 mths-1 yr
Tenor Buckets
Potential cumulative net maturity mismatch
Potential cumulative net maturity mismatch after includingstock of liquefiable assets
Graph 4.6Aggregate Projected Potential Cumulative LiquiditySurplus/(Shortfall) of Banking Institutionsas at 31 December 1998
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Graph 4.7Profile of Individual Institution's Potential LiquiditySurplus/(Shortfall) Up to One Month Aheadas at 31 December 1998
As a percentage of deposit
borrowers took the opportunity to refinance theirloans under Bai’ Bithaman Ajil to lock in their costof financing.
The contraction in economic activity in 1998 wasalso reflected in lower financing activities of theIslamic banking sector. The financing-deposit ratiodeclined from 104.1% as at end-1997 to 64.9% asat end-1998. The excess deposits were mostlyinvested in the Islamic money market.
During the year, the Bank introduced thefollowing measures as part of the on-goingexercise to strengthen the development ofIslamic banking.
• With effect from 1 December 1998, the term“Perbankan Tanpa Faedah (Interest-freeBanking)” was replaced by “Perbankan Islam
(Islamic Banking)”. Banking institutions coulduse the new term in all their Islamic bankingoperations, dealings and correspondence.
• With effect from 2 January 1999, bankinginstitutions participating in Skim Perbankan Islamwere required to upgrade their Islamic BankingUnit (IBU) into an Islamic Banking Division(IBD). The IBD was required to carry out all
aspects of Islamic banking such as bankingservices (formulation of policy, processing ofapplications and full-fledged Islamic bankingbranch supervision) and administration (productdevelopment, training etc.). The IBD should beheaded by a senior management officer of thebank, preferably at the level of the AssistantGeneral Manager (AGM).
• With effect from 2 January 1999, the minimumIslamic Banking Fund (IBF) initially set at RM1million, was revised upwards as follows:-
(i) Commercial banks - RM5 million, to begradually increased to RM20 million by31 December 2000;
(ii) Finance companies - RM5 million, to begradually increased to RM10 million by31 December 2000;
(iii) Merchant banks - RM3 million, to begradually increased to RM6 million by31 December 2000.
• With effect from 12 November 1998, bankinginstitutions participating in Skim PerbankanIslam were allowed to accept funds of lessthan one-month maturity from non-interbankcustomers. However, the funds receivedthrough the repos were to be util isedsolely for Islamic banking purposes.Previously, only principal dealers were grantedthe privilege to accept funds from repos ofless than one-month maturity from non-interbank customers.
• On 8 December 1998, the Bank introducedthe Guidelines on Islamic NegotiableInstruments for two new deposit-taking productsbased on Islamic principles, namely NegotiableIslamic Debt Certificate (NIDC) based on theconcept of Bai’ Bithaman Ajil and IslamicNegotiable Instruments of Deposit (INID)based on the concept of Al-Mudharabah. Theproducts provided an additional avenue for theIslamic bank and banking institutionsparticipating in Skim Perbankan Islam tomobilise domestic savings from the public, andat the same time, promote the development ofthe Islamic money market with marketable andliquid instruments.
• With effect from 4 January 1999, discounthouses were allowed to participate in theSkim Perbankan Islam. As at end-February
1999, three discount houses had participatedin the scheme.
Other Financial Institutions
Discount Houses
The operations of the discount houses sloweddown markedly in 1998. The tight l iquidityenvironment and the high short-term interest ratesin late 1997 and the first half of 1998 raised theiroperational costs and consequently reducedprofitability. The situation improved in the secondhalf of 1998 when the liquidity situation easedsignificantly following the relaxation of monetarypolicy. Total resources of the industry declined byRM970 million or 4.6% in 1998, compared with anincrease of RM3.8 billion or 22% in 1997. The bulkof the decline was due to lower deposits placed bycommercial banks with discount houses.
In 1998, total deposits mobilised by discounthouses declined by RM1.3 billion or 6.5%. In termsof type of deposits, call money placed with discounthouses fell by RM4.8 billion or 63.2% (an increaseof RM2 billion or 36.6% in 1997). In the first halfof 1998, there was a large withdrawal of callmoney as financial institutions began to withdrawfunds due to the tight liquidity conditions. Meanwhile,
Table 4.14Discount Houses: Sources and Uses of Funds
Loans to licensed institutions 1,395 –1,354 832Others –70 199 502
interbank borrowings by discount houses increasedby RM3 billion, most of which was in borrowingsfrom commercial banks. Fixed deposits recorded asmaller increase of RM660 million in 1998 (RM1.2billion in 1997).
Despite the decrease in total resources, totalinvestments by the discount houses continued toincrease, albeit at a very moderate level. Totalinvestment increased by RM185 million (an increaseof RM2.4 bil l ion in 1997). The bulk of theinvestments were in Malaysian GovernmentSecurities (MGS) as well as negotiable instrumentsof deposit. Investments in MGS by discount housespicked up due to the large issuance of MGS in1998 as well as the shift into the New LiquidityFramework. These developments have reduced theliquid asset premium and increased the effective yieldplaced on these papers.
During the year, the fee-based activitiesof the discount houses slowed down significantly.The industry arranged, lead-managed andco-managed RM360 million (RM434 million in1997) of Private Debt Securities, while the totalamount underwritten by the discount housesfell to RM510 million (RM1.5 billion in 1997).As in the previous year, there were onlythree discount houses appointed as principaldealers in 1998.
National Savings Bank
Total resources of the National Savings Bank(NSB) increased more moderately in 1998 by RM463million or 6.1% to RM8 billion (RM616 million or8.9% in 1997). The increase was due mainly tohigher deposits, in tandem with the increase in thenumber of active account holders which rose to 8.7million at the end of 1998 from 8.5 million at theend of 1997. Fixed deposits rose by 38.1% anddeposits in Sistem Perbankan Islam (SPI) productsrose significantly by 147.9%, while other types ofdeposits declined. The higher fixed deposits mobilisedduring the year was due to extensive savingspromotions by NSB for their corporate clients.Although deposits mobilised through the GIROscheme declined by 3.6%, it continued to be themost popular deposit scheme, accounting for 38.5%of total deposits. The number of PremiumSavings Certificates sold during the year declinedby 11.9% to 515,003 certificates amounting toRM536 million.
During the year, NSB invested about 49.2% ofits total resources in various types of investmentcertificates. As in previous years, in line with thestatutory requirement, the bulk of the resourceswas invested in MGS, which accounted for 29.9%of the total investment as at end-1998. Otherinvestments were in the form of trustee stocks(RM1 billion), unquoted shares (RM487 million),Government guaranteed bonds (RM333 million),non-trustee stocks (RM312 million) and Governmentpromissory notes (RM307 million).
Reflecting the contraction in economic activities,lending operations of NSB slowed down in 1998.Total loans outstanding increased by 10.1% (36%in 1997) to RM2.2 billion as at end-1998. The bulkof the outstanding loans continued to be extendedto individuals, accounting for RM1.9 billion or 87.6%of total loans outstanding. Of the total loansoutstanding, RM1 billion or 45.4% was grantedfor the purchase of houses and RM0.7 billion or33.2% was utilised for hire-purchase financing.While corporate loans declined by RM6.5 million or6% (+RM0.8 million or 0.8% in 1997), subordinateloans increased by RM125 million. During the year,NSB allocated about 4.2% of its total loansoutstanding for doubtful debts. At the end of 1998,non-performing loans accounted for 9.4% ofits gross loans.
1 Includes interest credited.2 Includes mini-branches and sub-branches.p Preliminary
As atend
1998p
In 1998, several branches of NSB weremerged, reducing the total number of branchesand sub-branches to 448 from 468 at the endof 1997. In addition, savings account facilitieswere also provided in 624 permanent and 21mobile post offices. During the year, 13 automatedteller machines (ATMs) were closed, bringingthe total number of ATMs to 583 by the endof 1998.
Provident and Pension Funds
The provident and pension funds (PPFs), thelargest source of long-term finance among the non-bank financial intermediaries, continued to expandtheir activities during the year. Total resources mobilisedby the 14 provident and pension funds surveyed byBNM increased by 12.2% to RM172.8 billion at theend of 1998, against a growth of 13.5% to RM154.1billion at the end of 1997. Most of the resourceswere derived from accumulated contributions incontributors’ accounts (89.7% or RM155 billion), withthe balance held in the form of reserves and otherliabilities. Contributions placed with the EmployeesProvident Fund (EPF) have traditionally dominated,representing 94.1% of accumulated contributions. Onan annual basis, accumulated contributions of thePPFs grew at a slower pace, at 11.4% (14.4% in1997), due mainly to lower net contributions as wellas the moderation in the growth of the number ofmembers. Total membership rose by 2.4% to 17.2million persons at the end of 1998 compared withan expansion of 5.4% in 1997.
Net contributions of the PPFs were lower in1998, for the second consecutive year, amountingto RM7.7 billion (RM10.1 billion in 1997). Thelower amount of net contributions was dueto the marginally higher gross contributions(RM16.7 bill ion; RM16.5 bil l ion in 1997),while withdrawals were higher, at RM9 billion(RM6.4 billion in 1997). Nine of the PPFssurveyed, in fact, experienced net withdrawalsduring the year, with the largest net withdrawalregistered by the Armed Forces Fundconsequent to the lower increase in new recruitscompared with the number of retirees. Meanwhile,net contributions were also smaller for therest of the PPFs except for the Pension TrustFund. Similarly, net contributions as a percentageof gross national savings was lower at 7.1%(9.9% in 1997).
In the case of the EPF, gross contributionswere only slightly higher (RM14.8 billion; RM14.6billion in 1997). This was attributed to the slowergrowth in average wages as a result of thereduction in salaries, although the number of activecontributors expanded by 2.8% (3% in 1997). Incontrast, withdrawals were higher, at RM8.4 billion(RM5.7 billion in 1997), reflecting the cumulativeeffects of the liberalisation of the EPF’s withdrawalschemes. Of the total, RM3.5 billion (or 42.3%)was withdrawn under the Age 55 WithdrawalsScheme, and RM2.4 billion (or 28.1%) for thepurchase of houses. Since the introduction ofthe Member’s Savings Investment Schemein November 1996, which allowed withdrawals toinvest in approved fund management institutions,such withdrawals doubled to RM1.2 billion, toaccount for 14.4% of total withdrawals from theEPF in 1998.
In terms of investments, total new investmentsby PPFs continued to expand by 12.2% orRM18.7 billion (13.5% or RM18.4 billion in1997). However, there was a significant shiftin the investment strategy of PPFs in 1998.Contrary to the trend which had emerged since1995, whereby the focus of investment wason private financial instruments, investmentin Government papers absorbed the bulk (35.9%)of new investments in 1998. Investmentsin Government papers expanded by 16.8%or RM6.7 billion (decline of 2.3% or RM931.1 millionin 1997) to RM46.8 billion, representing 27.1% ofthe total assets of PPFs. This was made possibleby new issues of Malaysian Government Securities
Table 4.16Provident and Pension Funds: Selected Indicators
1996 1997 1998p
RM million
As at endNumber of Contributors (’000) 15,931 16,788 17,196Accumulated Contributions 121,668 139,246 155,067Assets 135,724 154,080 172,819Of which: Investments in
Malaysian Government Securities 40,952 40,021 46,756
During the yearContributions 14,515 16,524 16,707Withdrawals 4,107 6,392 9,042Net Contributions 10,408 10,133 7,665Dividends Credited 8,196 8,163 9,043Income 9,637 10,233 11,510
p Preliminary
Source: Employees Provident Fund, Pensions Trust Fund, Social SecurityOrganisation, Armed Forces Fund, Malaysian Estates Staff ProvidentFund, Teachers Provident Fund and eight other private providentand pension funds.
(MGS) in line with the deficit in the Government’sfiscal position.
Investments of the PPFs in fixed depositsand money market papers were also higher,encouraged by the high interest rate environmentduring the first half of the year and hence,higher returns. These investments constituted18.4% of total new investments. Investmentsin these instruments rose by RM3.4 billionor 9.2% (–RM722.5 million or –1.9% in 1997), toreach RM40.8 billion or 23.6% of total investmentsat end-1998.
The economic downturn and the fall in the equitymarket during most of the year had directly affectedthe investment of the PPFs in equities. As a result,the growth in the holdings of equities slowedmarkedly to 6.1% or RM2.2 billion, against anincrease of 27.3% or RM7.7 billion in 1997. Inaddition, investments in equities accounted for asmaller share (11.7%) of the total new investments(42.2% in 1997), although the share of total assetsof the PPFs at end-1998 remained relativelyunchanged (22.1%).
Similarly, investments in corporate bonds by PPFswere also lower (10.1% or RM1.4 billion; 38.5% orRM3.7 billion in 1997), due to the fewer new issuesof private debt securities in the capital market. Ofthe total new investments of PPFs, 7.2% wasinvested in corporate bonds, compared with a higher
share of 20.4% in the previous year. Loansextended by the PPFs slowed to grow at an annualrate of 19.5% (or RM4.3 billion) from 50.2% (orRM7.3 billion) in 1997.
A similar trend was observed in the assetstructure of the EPF given its dominanceamong the PPFs. Holdings of Government papersby EPF increased by RM6.9 billion or by 18.1%to RM45 billion. Investments in Governmentpapers accounted for 44.2% of total newinvestments of EPF, with the investment effectedthrough private placement, tender and purchases inthe secondary market. In addition, EPF continuedto extend Government or bank guaranteed loans tofinance Government projects although these loansincreased at a slower pace of 20.1% (48.3% in1997), contributing to 27.1% of total newinvestments of EPF. Meanwhile, investment inequities increased by RM781.4 million or 3.1%(RM6.4 billion or 33.9% in 1997), while investmentsin deposits and money market instruments roseby RM1.5 billion or 4.7% (–RM1.9 billion or–5.6% in 1997).
Pilgrims Fund Board
The activities of the Pilgrims Fund Boardcontinued to expand, albeit at a slower pace in1998. Total resources mobilised by the Boardamounted to RM7.3 billion at the end of 1998,representing an increase of RM1.1 billion or 18.7%(RM1.4 billion or 30.4% in 1997). The increase in
MGS26.0% Deposits & money
market24.3%
Foreigninvestment
0.3%
Others2.7%
Corporatebonds8.7%
Loans14.2%
Equity23.4%
Deposits & moneymarket23.6%
MGS27.1%
Fixed assets0.4%
Others2.7%
Corporatebonds8.6%
Loans15.2%
Equity22.1%
Provident and Pension Funds: Composition of Assets
1997 1998
Graph 4.8
Fixed assets0.4%
Foreigninvestment
0.3%
resources reflected mainly an expansion of itsoperations which included the number of depositorsincreasing by 8.5% to 3,477,562 at the end of1998 compared with 3,205,885 in the previous year.At the same time, the number of Muslims registeredwith the Board to perform the pilgrimage was higherat 27,341 (23,886 in 1997).
Total balances held by depositors, includingbonuses credited, rose by RM1 billion or 18.3%(RM1.4 billion or 33.4% in 1997), accountingfor 92.7% of the total resources mobilisedat the end of 1998 (93% at the end of 1997).During the year, deposits placed with the Boardincreased by 36.7% to RM2.9 billion. Withwithdrawals of deposits rising by 103.1% to RM2.4billion in the same period (1997: RM1.2 billion),there was a net increase in deposits of RM580million. Although the bonus rate was lower at 8%per annum in 1998 (9.5% per annum in 1997),the amount of bonuses credited to depositors’accounts was higher at RM461 million (1997:RM440 million).
The Board invested the bulk of its investiblefunds in corporate securities. Investments incorporate securities rose by RM518 million or17.4% (RM1 billion or 54.2% in 1997) to RM3.5billion, accounting for 48.1% of total assets in 1998.Of these investments, 71.5% was in quotedshares, mainly in the industrial and property sectors,and 28.5% in unquoted shares. Investments inshort-term instruments continued to decline byRM193 million or 9.6% (–RM174 million or –8% in1997) to RM1.8 billion in 1998. Consequently, theirshare of total assets was also lower at 25.1%. Asa result of higher investments in corporate
securities, gross dividends received by the Boardincreased by 37.6% to RM245 million in 1998.Income earned from other investments alsoincreased to RM508 million in 1998 (RM482 millionin 1997).
Industrial Finance Institutions
The industrial finance institutions recorded astrong increase in their assets of 43% in 1998(22.3% in 1997). The increase in assets wasattributed mainly to the higher investments in termsof deposits with financial institutions and loanswhich accounted for 40.9% and 34.5% respectivelyof the increase. The increase was funded mainlyby borrowing.
As the industrial finance institutions are notlicensed to conduct deposit-taking activities fromthe public, they have traditionally relied heavily onborrowing to fund their asset growth. Establishedprimarily to promote development programmes inthe agricultural, industrial and international tradeand export sectors, they are able to access cheapresources from the Government and internationaldevelopment funds, l ike the ASEAN-JapanDevelopment Fund and the Overseas EconomicCo-operation Fund of Japan.
Borrowings by the industrial finance institutionsincreased significantly from RM6,655.4million (25.5%) in 1997 to RM10,463.8 million(57.2%) in 1998, to account for 83.9% of theincrease in the total liabilities. The increase inborrowings was mainly by Export-Import Bank ofMalaysia Berhad (RM1,782.9 million) and Bank
Table 4.17Industrial Finance Institutions: Changes in Direction of Lending
Total 1,102.20 100.00 1,102.17 100.00 1,564.43 100.00
Industri Malaysia Berhad (RM1,577.2 million).The increase in total borrowings of Export-Import Bank of Malaysia Berhad, was to financethe Export Credit Refinancing Scheme, aportfolio which was transferred from BankNegara Malaysia since January 1998. BankIndustri Malaysia Berhad sourced its funds mainlythrough deposits placed by the Governmentagencies following the Government’s approval forthe bank to accept such deposits to ease itsliquidity position.
The other major source of funding for theindustrial finance institut ions in 1998 wascapital funds. However, capital funds declined in1998 by RM47.6 million due mainly to the lossesamounting to RM193.4 million incurred by theindustrial finance institutions (in 1997, thecapital funds accounted for 28.7% of the totalincrease in the liabilities of the industrial financeinstitutions). In 1998, two institutions, namely theExport-Import Bank of Malaysia Berhad andthe Malaysian Industrial Estates Berhad (MIEL)had increased their paid-up capital, by RM100million each.
Loans extended by the industrial financeinstitutions increased by 25.7% in 1998 (22.1% in1997). The increase reflected the active participationof these institutions in utilising the various fundsestablished by the Government for lending topriority sectors. Loans to the manufacturing sectoraccounted for the largest share (85.3%) of theincrease in loans, amounting to RM1.3 billioncompared with RM214.3 million (19.4%) in theprevious year. Loans to the transport and storagesector increased by RM125.8 mill ion, afterregistering a decrease of RM26 million in 1997.However, loans to the real estate and constructionsector declined by RM507 million to RM61.8 millionin 1998.
The sharp increase in loans to the manufacturingsector resulted in the exposure to this sectorto increase to 44.7% of the total loans outstandingat the end of 1998 (1997: 34.2%). Despite thedecline in loans to the real estate and constructionsector, the exposure to this sector continued toremain high at 28.9%. Notwithstanding the sharpincrease in loans to the transport and storagesector, the industrial finance institutions’ exposureto this sector was only 4.5% of the total loansoutstanding.
Financial Markets
Reflecting external developments andprevailing domestic economic conditions, activity inthe financial markets was generally slower in1998. A turnaround in the capital and foreignexchange markets was, however, observedconsequent to the imposition of the selectiveexchange controls in September. While the pricesand trading volume of stocks improved significantly,offshore trading in the ringgit ceased afterSeptember. Market development efforts, nevertheless,continued unhindered.
Recourse to the capital market wasinfluenced by the slowdown in corporate activity,contraction in private sector investmentand economic activity, the higher interestrate environment in the first half-year as well asthe weak sentiment in the equity market formost of the year. As a result, net fundsraised were significantly lower at RM17.3 billion,amounting to half of the peak level of RM33.5billion in 1997, attributed to the substantially loweramount of net funds sourced by the privatesector. The public sector, meanwhile, was moreactive in tapping funds, for the first time since1988, as it undertook the lead role in promotingeconomic recovery.
In the equity market, the benchmark KualaLumpur Composite Index (KLCI) ended the year1.4% lower than the level at the end of 1997,while the total trading volume on the Kuala LumpurStock Exchange (KLSE) was lower by 19.9% at58.3 billion units. After commencing the year on apessimistic note, the KLCI rose significantlybetween mid-January and end-February. This was,however, followed by consecutive price declines untilthe KLCI reached 262.70 points on 1 September,the lowest level in ten years. Improved investorsentiment following the more stable conditionswith the introduction of the selective exchangecontrol measures resulted in a turnaround inSeptember, as reflected by the KLCI whichincreased strongly by 123% to 586.13 points byyear-end. Given the lower stock prices for most ofthe year and the lower trading volume, the valueof transactions fell by 71.8% to RM115.2 billion forthe year. The market capitalisation of the KLSEwhich declined marginally to RM374.5 billion at theend of 1998, maintained its seventh rank in theAsia-Pacific region and second rank in theASEAN region.
As in the equity market, the Kuala Lumpur foreignexchange market also experienced a decline intransactions during the year. In the first eightmonths of the year, ringgit trading activity wasintensive, with the monthly volume averagingRM73.8 billion. The volatility of the marketconditions, however, moderated consequent to theintroduction of the selective exchange controlmeasures and fixing of the ringgit exchange rateagainst the United States dollar in September. Asa result, the monthly average volume oftransactions fell to RM28.4 billion, less than halfof that transacted during January-August. For theyear as a whole, the average daily volume,therefore, decreased by 32.1% to RM3.7 billionin 1998.
The volume of funds traded in the money market,similarly, declined by 2% to RM1,822.6 billion.Trading in interbank deposits declined, reflectingreduced dependence on the money market as asource of funding and improved liquidity flows inthe system. Transactions were focused on theshorter tenures in an environment of uncertaintyover the future direction of interest rates. As withinterbank deposits, money market papers weretraded on a smaller scale. The tight liquiditysituation limited the primary issuance andsecondary trading of negotiable instruments ofdeposit and bankers acceptances, while there wasno issuance of Bank Negara Bills, although therewas a larger volume of trading in MalaysianGovernment Securities.
Efforts continued to be focused on developingthe financial markets. Measures in the moneymarket were intended to enhance the efficiency ofliquidity management. Among the measures werethe introduction of a new money market operationsprocedure, widening of the daily variation band forcompliance with the statutory reserve requirement,the introduction of a new liquidity framework, andchanges to the privileges granted to the principaldealers in the money market. In the capital market,measures were directed towards strengthening theregulatory framework. Towards this end, disclosureand transparency, investor protection andenforcement capabilities of the regulatory authoritieswere enhanced, corporate governance practicesimproved, and financial standing of domesticstockbroking companies strengthened. Equallysignificant was the move towards consolidating theexchanges in the capital market, in line with globaltrends. Such consolidation would lead to economies
of scale by enhancing the efficient utilisation ofresources, improving operational efficiency andenhancing the availability of financial productsoffered. This in turn would contribute to enhanceinvestor confidence in the Malaysian financialmarkets. Meanwhile, enhancement of the financialinfrastructure, product development and educationof members, companies and investors were thepriorities of the Malaysian Exchange of SecuritiesDealing and Automated Quotation.
Money Market
Following a robust expansion of 61% in 1997,the volume of funds traded in the money marketfell marginally by 2.1% to RM1,822.3 billion in1998, reflecting a contraction in both the volumeof trading in interbank deposits (–1.4%) as wellas money market papers (–8.2%). The decline inthe volume of interbank deposits reflected theimprovement of liquidity flows in the system andreduced reliance on the money market to meetfunding requirements given the slowdown in loangrowth. Transactions also became moreconcentrated at the shorter-end of the market.Transactions in tenures of one month and abovedeclined while shorter tenures registered increases.A similar trend was evident in 1997, although theshift in 1998 was less pronounced. The highernumber of transactions in the shorter tenuredeposits in 1997 and 1998 was associated withthe volatility of interest rates. Given the uncertaintyabout the future direction of interest rates, market
Table 4.18Money Market
1997 1998
Volume Annual Volume Annual(RM change (RM change
billion) (%) billion) (%)
Total Money MarketTransactions 1,860.6 +61.0 1,822.3 –2.1
players avoided being locked-in as lenders orborrowers of longer-term funds. The volatility ininterest rates since 1997 was primarily associatedwith the speculative pressure on the ringgit; theoutflows of short-term speculative funds and theconsequent tightening of domestic liquidity;inefficiencies in the financial intermediationprocess; as well as shifts in the stance ofmonetary policy. Meanwhile, the decline in thevolume of money market papers tradedreflected reduced trading of Negotiable Instrumentsof Deposit (NIDs), which more than offset theincreased trading of Malaysian GovernmentSecurities (MGS). The decline in the tradingvolume of NIDs and Bankers Acceptances(BAs) was due to the tight liquidity situation,especially in the first half of 1998, which limitedthe primary issuance and secondary trading ofthese papers. There was also no trading of BankNegara Bills in 1998, in the absence of newissues by Bank Negara Malaysia (BNM) sinceOctober 1997 when the last outstanding BankNegara Bills matured. Meanwhile, Cagamas Bondsalso recorded lower trading volumes due to a netredemption of the paper in 1998 (–RM1.7 billion;net issue of RM3.5 billion in 1997). In contrast,the increase in the trading of MGS was attributedto the larger primary issues of the paper to meetthe funding needs of the government in the secondhalf of 1998.
Similarly, the total volume of transactions in theIslamic interbank money market (IIMM) declined
by RM18.7 billion (-13.9%) to RM115.4 billion,compared with a significant increase of RM85.4billion in 1997. The contraction in volume reflecteddeclines in all types of transactions, namelyMudharabah interbank investment (MII), the Islamicinterbank cheque clearing system (IICCS) andinterbank trading of Islamic papers. As a result,the relative size of the IIMM compared to theconventional money market was smaller. Thetrading volume of the IIMM fell to 6.3% of theconventional money market volume in 1998 (7.2%in 1997).
A number of measures to improve theefficiency of liquidity management in the bankingsystem were introduced in 1998. Firstly, a newmoney market operations procedure was introducedon 30 April. The new system enabled marketparticipants to better assess the liquidity surplus ordeficit in the system via BNM’s forecasted cashflow of the financial system provided at regularintervals during the day. In addition, transparencywas enhanced with all BNM operations beingconducted via tender under the new procedure,with the exception of overnight lending/borrowingand the small liquidity support operations forinstitutions facing exceptionally tight liquidity. Asecond measure to improve liquidity managementwas the widening of the daily variation band forthe statutory reserve requirement (SRR) compliance.Effective 1 May 1998, this band for the permissibledaily variation in the average balances that arerequired to meet the SRR was widened to ±2%of the prescribed SRR rate from the previousband of ±0.5%. This accorded financial institutionsgreater flexibility in managing their daily liquidityoperations. Thirdly, a new liquidity frameworkwas introduced in July 1998, featuring activemonitoring and forecasting of the liquidity positionof financial institutions based on the maturity profileof assets and liabilities, as well as diversity offunding sources.
Several measures were also taken during theyear to further promote a more active moneymarket. These included increasing the number ofprincipal dealers (PDs) to 16 in 1999, with theappointment of another PD on 1 January 1999.To promote trading in the money market, changeswere also introduced to the privileges given toPDs. For the purpose of the calculation of theSRR, PDs were previously allowed to net off fromtheir eligible liabilities (EL) base an amountequivalent to 15% of the higher of either sales or
purchases of specified liquid asset instruments inthe secondary market, subject to the amountdeducted being less than 1% of EL. Effective1 January 1999, the amount deductible was raisedfrom 15% to 50% of the volume of liquid assetstraded. In addition, the deduction limit (1% of EL)was abolished.
Foreign Exchange Market
The average daily volume of interbank foreignexchange transactions (spot and swap transactions)effected through the eight foreign exchange brokersin the Kuala Lumpur foreign exchange marketdeclined by 32.1% during the year, from RM5.4billion in 1997 to RM3.7 billion in 1998. The declinewas largely attributable to the moderation in thevolatility of the currency market conditions, followingthe imposition of the selective exchange controlmeasures and the fixing of the ringgit exchange rateagainst the United States dollar in September. Thevolatility of the ringgit as measured by the standarddeviation moderated to 0.22 in 1998 compared witha standard deviation of 0.44 in 1997. The highervolume of transactions in 1997 was on account ofthe increased number of transactions as well ashigher value for each transaction in the wake of thecurrency turbulence in the region. The activities inthe foreign exchange market in 1998 continued tobe dominated by the transactions of the UnitedStates dollar against the ringgit. These transactions,however, declined to RM703 billion (1997: RM1,215billion) to account for 77.9% of total transactions(1997: 92.1%). The continued dominance oftransactions of the United States dollar against theringgit was in view of the “safe-haven” status of thecurrency during the period of economic crisis.Demand for the United States dollar also reflected
outflows of foreign funds from the domestic stockmarket. Transactions in the United States dollar forthe Deutsche Mark and Japanese yen accountedfor 17.1% and 3.3% respectively.
Activity in the foreign exchange market peaked inJanuary 1998 as speculative activity intensifiedfollowing adverse market reaction to developmentsin Indonesia. The monthly volume of totaltransactions (spot and swap) of the United Statesdollar against the ringgit averaged RM73.8 billionduring the period January-August, which was wellabove the monthly average of RM58.6 billion forthe whole of 1998. However, ringgit trading activitydeclined significantly in the last four months of 1998following the imposition of the selective exchangecontrol measures in September. During this period,the monthly average volume of foreign exchangetransactions amounted to only RM28.4 billion(RM115.8 billion in the same period in 1997). Theexchange control measures effectively restricted thetrading activity of ringgit in non-trade transactions.Hence, during this period, the foreign exchangetransactions originated mainly from trade-relatedtransactions.
As in the previous year, the offshore financialinstitutions were the major buyers of the UnitedStates dollar for the ringgit, both in the spot andswap markets. Transactions by offshore financialinstitutions were attributed mainly to speculativeactivities on expectations of ringgit depreciation aswell as outflows of short-term portfolio investmentsof non-residents. Swap market transactionsaccounted for 66% of total transactions in the KualaLumpur interbank foreign exchange market in 1998(1997: 75.5%), with a large proportion beingtransacted during the period January-August. Themonthly volume of swap transactions of the UnitedStates dollar against the ringgit during this periodaveraged RM47.8 billion compared with an averageof RM38.7 billion for 1998 as a whole. As aconsequence of the reduced volatility in the foreignexchange market, the monthly volume of swaptransactions declined markedly to an average ofRM20.7 billion in the last four months of the year.
Funds Raised in the Capital Market
Funds raised in 1998 were significantlylower, amounting to RM17.8 billion compared withthe peak recorded in 1997 (RM33.5 billion). Duringthe year, net funds raised on a monthly basis
1993 1994 1995 1996 1997 19980
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Graph 4.9Volume of Interbank Transaction in the Kuala LumpurForeign Exchange Market
RM billion
Spot Swap Total
were generally moderate, except in October. In themonths of January, March, July, August, Septemberand November, there were in fact net redemptions.This situation last occurred in April 1995. Despitethe lower net funds raised, the capital market was amore important source of financing in 1998 comparedwith the banking system. The ratio of net fundsraised in the capital market to loans extended bythe banking system rose to 3.17 in 1998 (0.41 in1997). This reflected caution on the part of banks intheir lending activities, the slowdown in the demandfor loans as well as the increase in the volume ofdebt securities issued by the Federal Governmentand Danamodal Nasional Berhad (Danamodal).
The lower net funds raised during the year wasdue solely to the significantly smaller amount of netfunds raised by the private sector of RM8 billion(RM34.9 billion in 1997) from both the equityand debt markets. Danamodal and SyarikatPerumahan Negara accounted for more than half(61.5%) of the new funds tapped through debt issues.However, higher net funds were raised by the publicsector in 1998. This was a significant development,reflecting the lead role by the Government in reviving
economic activities, for the first time since 1988. Thepublic sector raised RM9.8 billion in 1998 (a netredemption of RM1.4 billion in the previous year),accounting for 55% of the net funds raised duringthe year.
Recourse to the capital market was affected byinvestor concerns over the financial health ofcorporations, the weak sentiment in the stock andbond markets as well as uncertainties over the impactof the global financial market turmoil. Issuers werealso affected by the contraction in private sectorinvestment and economic activity, the higher interestrate environment and the freeze on new submissionsfor capital-raising exercises in the first half-year.
In terms of debt instruments issued by the publicsector, Malaysian Government Securities (MGS)accounted for the bulk (84.5%) of the gross issuancein 1998. There were six new issues of MGS in 1998totalling RM14.95 billion (1997: two issues totallingRM3 billion), with yields and maturities rangingbetween 7.005%-9.03% and 3-20 years respectively.The MGS were issued to offset the redemptions ofMGS (RM6.2 billion) and Government InvestmentIssues (RM750 million) in order to meet marketdemand as well as to finance the Budget deficit.As a result of the higher number of new issues,total outstanding MGS rose by 13.2% (1997: –1%)to RM75 billion at the end of 1998. Meanwhile,Khazanah Nasional Berhad (KNB), the investmentarm of the Ministry of Finance, continued with itsprogramme to issue a series of bonds aimed atproviding a benchmark yield curve for the ringgitbond market. KNB made four new issues of
Table 4.20Funds Raised in the Capital Market
1997 1998 p
RM million
By Public SectorGovernment Securities (gross) 3,000 14,950Less Redemptions 3,648 6,200Less Government Holdings –1 0
Equals Net Federal Receipts –647 8,750Khazanah Bonds 794 2,732Govt. Investment Issues (net) –1,400 –750Malaysia Savings Bond (net) –155 –928
Net Funds Raised –1,408 9,804
By Private SectorShares 18,359 1,788Debt Securities1 19,597 14,152
Less Redemptions 3,009 7,916Equals Net Issues 16,588 6,235
Net Funds Raised 34,947 8,023
Total Net Funds Raised 33,540 17,827
Short-term Papers and Notes (net)2 4,946 –155
Total 38,486 17,672
1 Excludes debt securities issued by banking institutions.2 Refers to commercial papers and Cagamas Notes only.p Preliminary
-5
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8RM billion
Graph 4.10Net Funds Raised in the Capital MarketBy the Public and Private Sectors
Public sector Private sector Net funds raised/Bank loans extended
1994 1995 1996 1997 1998
Ratio
Khazanah Murabahah zero-coupon government-guaranteed bonds in 1998, with nominal values ofRM3.85 billion (1997: one issue with nominal valueof RM1 billion), raising RM2.7 billion (1997: RM794million). The yields on the bonds ranged between6.797%-11.23%. The new issues increased theoutstanding KNB bonds to RM4.85 billion at the endof 1998. The year also saw the maturity of thediscounted 5-year Malaysia Savings Bonds that wasissued by BNM in February 1993 as part of themeasures to promote savings.
Developments in the equity market reflected theslowdown in corporate activity and private sectorinvestment as well as the weak sentiment on theKLSE in the first three quarters of the year. As aresult, funds raised from new equity issues weresubstantially lower, by 90.3% (1997: +15.3%) andamounted to only RM1.8 billion. The bulk of thefunds were raised through rights issues (40.4%)and initial public offers (38.3%). A large portion ofthe funds raised from the equity market (72.8% oftotal) was raised in the first half-year, from issuessubmitted before the general freeze on submissionsfor capital- raising exercises that was imposed on5 December 1997 and subsequently lifted on30 June 1998. The heightened risk aversion ofinvestors and the bearish investor sentiment thatprevailed throughout most of 1998 was reflected inthe higher percentage of initial public offers (IPOs)that closed at a discount to their offer prices aswell as the higher percentage of IPOs that wereundersubscribed. Of the 28 IPOs in 1998, 10 IPOs
or 35.7% (1997: 17%) closed at a discount to theiroffer prices on their listing date. In addition, 13were oversubscribed while the balance of 15 wasundersubscribed.
In the longer-term corporate debt securitiesmarket, the smaller amount of gross funds sourcedthrough the new issuance of bonds, amounting toRM14.2 billion compared with RM19.6 billion in1997, and increased redemptions of RM7.9 billioncompared with RM3 billion caused net funds tappedfrom the market to be sharply lower, by 62.4% atRM6.2 billion (1997: RM16.6 billion). SyarikatPerumahan Negara Berhad and Danamodal playeda key role, accounting for more than half (61.5%)of the new funds raised, while the higherredemptions were due in part to four earlyredemptions totalling RM745 million. On a monthlybasis, there were net repayments every month,except for four months (i.e. February, April, Mayand October), with no new debt securities beingissued in the month of November.
The lower amount of funds raised reflected mainlyinvestors’ aversion to investments in corporate bondsand the lower demand for funds by bond issuers.The cautious attitude of the investors can beattributed to several factors, among others, the tightliquidity environment in the first seven months ofthe year and the high number of rating downgradesthat reflected the weakening credit standing ofissuers and the increased risk of corporate defaults.Apart from the weak investor sentiment, the lowissuing activity in the primary market for privatebonds was on account of the relatively higher costof borrowing and the lower demand for funds forinvestments by issuers.
In terms of utilisation, 84.4% of the funds raisedwas channelled to the finance, insurance, andbusiness services sector and 5.5% to the transport,storage and communication sector. By instrument,straight bonds accounted for 72.3% of the grossissuance of debt securities (21.5% in 1997) whilethe share of asset-backed bonds declined from26.4% in 1997 to 23.5%. Of the funds raisedthrough the issuance of straight bonds, three-quarters (RM7.7 billion) were in the form of 5-yearzero-coupon bonds with a nominal value of RM11billion, issued by Danamodal for the recapitalisationand strengthening of the banking institutions. In thecase of long-term asset-backed bonds issued byCagamas Berhad, there was a net redemption of
Table 4.21New Issue of Private Debt Securitiesby Sector
Construction 177.1 –Purchase of residential property – 1,000Purchase of non-residential property 7.8 –Real estate 302.9 370.0Transport, storage and communications 3,438.4 1,103.3Finance, insurance & business services 8,362.5 16,921.4Purchase of securities 837.5 –Others 24.0 –
Total 19,781.4 20,048.7
p Preliminary
RM million
RM1.7 billion (1997: +RM3.5 billion) resulting fromthe smaller amount of bonds issued (RM3.3 billion)and the higher amount of redemptions (RM5 billion).A significant development in the private bond marketin 1998 was the issuance of two Government-guaranteed zero coupon bonds by PengurusanDanaharta Nasional Berhad (Danaharta), with a totalnominal value of RM2.6 billion. These bonds wereunique in that they did not raise any funds fromthe market but were instead issued to the bankinginstitutions as consideration for non-performing loanspurchased by Danaharta. This, together with theincrease in the net issues of bonds, contributed tothe growth of 19.1% in the total outstanding long-term private debt securities (1997: 35.5%) toRM75.5 billion at the end of 1998.
Equity Market
The performance of the Kuala Lumpur StockExchange (KLSE) during 1998 was mixed,influenced by a combination of domestic andexternal factors. The benchmark Kuala LumpurComposite Index (KLCI) experienced threediscernible phases, namely the mini-rally phase,
downward trend phase and a recovery phase. Theyear began on a pessimistic note, continuing thedownward trend that had prevailed since April 1997.This trend was short-lived as the KLCI increasedsignificantly between mid-January and end-February.During January-February, the KLCI rose by 56%from 477.57 points on 12 January to peak at 745.36points at the end of February. This was, however,followed by a period of six months of continuousprice declines. Between March and early September,the index declined by 64.8% to its lowest level in10 years of 262.70 points on 1 September. TheKLCI subsequently made a significant turnaround,from September to the end of the year, risingstrongly by 123% to end the year at 586.13points. Despite the strong recovery, the KLCIwas still 1.4% lower than the level at the end of1997, reflecting mainly the contraction incorporate activity, private investment and economicactivity in general.
The performance of the other indices on theKLSE generally followed the movements in theKLCI. In the first two months of the year, all theindices were on an uptrend, with the best
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Graph 4.11Performance of the KLCI in 1998
Strengtheningregionalcurrencies
Announcement ofSRR reduction to10% from 13.5%and 1997 tradesurplus
Stabil isationmeasuresby theGovernment
Concerns over health ofstockbroking industry &riots in Indonesia Yen depreciated to
its lowest level in 8years & speculativepressures on theHong Kong dollar
Liberalisationof foreignparticipation intelecommunicationscompanies to 49%
Concernsover healthof corporatesector
Establishmentof Danaharta &resignation ofSuharto
Russian rubledevalued
Extension of exerciseperiod for warrants & BNMintervention rate loweredto 7%
BNM interventionrate lowered to7.5% from 8%
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 1998
KLSE transparency measures,selective exchange controlmeasures & fixing of the ringgitexchange rate
KLSEintroducedprudentialmeasures
,
performing indices being the Mining (+68.6%) andFinance (+39.3%) Indices. During the bearish phasefrom the end of February to end-August, the declinewas led by the Mining, Construction, Finance andSecond Board Indices, which declined by 70.4%,69.1%, 62.8% and 61.8% respectively. Thesignificant decrease in the Mining Index reflected acorrection following a rise of 68.6% in the indexduring the mini-rally in the first two months of theyear, while the decline in the Construction Indexreflected the considerable contraction in constructionactivities (decline of 24.5% in 1998). Investorconcerns over the health of the banking institutionsand stockbroking companies contributed to thedecline in the Finance Index. The fall in the SecondBoard Index reflected concerns over the health ofSecond Board companies, following the move by anumber of Second Board companies for courtprotection under Section 176 of the Companies Act1965. The index that registered the lowest declinewas the Plantation Index, since plantation stockswere viewed by investors to have benefited mostfrom the exchange rate depreciation. The Mining,Finance, Construction and Second Board Indicesrebounded strongly by 186.6%, 116.4%, 116.3% and106.1% respectively, as investor sentiment improvedfollowing the introduction of the selective exchangecontrol measures on 1 September, and the moreaccommodative monetary conditions with ampleliquidity and declining interest rates.
The KLSE started off weaker in 1998, as theregional currency crisis continued. Sentiment,however, reversed in mid-January, with the KLCIbolstered by the strengthening ringgit, a preliminary
announcement of a trade surplus for 1997,the reduction in the statutory reserve requirement(SRR) of the banking institutions from 13.5% to10% in February and announcements to allow anincrease in foreign equity participation intelecommunications companies. These developmentswere reflected in the 30.9% increase in share pricesand 214.4% increase in turnover in February, thehighest monthly increase for the entire year, pushingthe KLCI to 745.36 points and the turnover to 12billion units.
The brief rally was abruptly interrupted inearly March as concerns over the health of thefinancial sector emerged for the first time sincethe early 1990s, amidst rising non-performing loansand financial problems of the corporatesector. Announcements of companies seekingcourt protection under Section 176 of theCompanies Act 1965 and companies beingplaced under receivership dampened theincentive to invest in equities. In May, news of thecessation of trading of a domestic stockbrokingcompany and the escalation of widespread socialunrest in Indonesia as well as the fall in regionalstock markets further dampened sentiment. Thebearish sentiment, particularly on the financialsector and Second Board companies, werereflected in the decrease in the Finance andSecond Board Indices.
The downtrend, however, reversed on 21 May,prompted by the announcement of the establishmentof Pengurusan Danaharta Nasional Berhad toacquire and manage the non-performing loans ofthe financial institutions. The political succession inIndonesia also restored some regional confidencethat contributed positively to the KLSE. Thisoptimism was, however, not sustained. From earlyJune, investors became concerned over theperformance of the domestic economy following theannouncement of a contraction in the first quarterGDP. Market sentiment continued to deteriorate insubsequent months due to the interaction of bothdomestic and external factors. Domestic factorsincluded uncertainty over the outlook for theeconomy for 1998, downgrades of Malaysia’s creditrating by two international credit rating agenciesand poor corporate earnings. The most significantexternal factors were the weakening Japanese yenand speculative pressures on the Hong Kong dollarand the Chinese renminbi which dampened regionalstock markets. By the end of August, the KLCIhad declined sharply by 43.7% from the level at
0
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30
40
50
60
70
0
50
100
150
200
250
Index (Jan 1994=100) Volume (RM billion)
Graph 4.12Kuala Lumpur Composite Index, Second Board Indexand KLSE Trading Volume
2nd Board IndexKLSE Volume KLCI
Source: Kuala Lumpur Stock Exchange
94 94 95 95 96 96 97 97 98 98Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec
the end of May, while the Mining and ConstructionIndices fell the most, by 54.8% and 50.2%respectively.
The KLCI staged a turnaround in September onthe introduction of selective exchange controlmeasures, although the initial reaction was a 13.3%drop in the KLCI to 262.70 points on 1 September,its lowest level in 1998. This decline also reflectedthe response to the huge 512-point collapse of theDow Jones Industrial Average on 31 August. Prices,however, recovered in heavy trading volume as theKLCI surged for four consecutive trading days from2 September to record a gain of 69% to 445.06points on 7 September. During this period, on4 September, the Stock Exchange of Singaporeannounced the discontinuation of trading inMalaysian shares on CLOB International. Measuresto support the economic recovery process such asthe fixing of the ringgit exchange rate, easierliquidity conditions and reductions in interest ratescontributed to the improved investor sentiment.Within one month, the KLCI had increased by23.3% to 373.52 points, while turnover was notablyhigher by 128.6% at six billion units. The bestperforming index in September was the ConstructionIndex, which rose by 60.1%.
Buying interest continued to be sustained in thefourth quarter of the year, supported by expectationsof an expansionary Budget announcement,considerable progress achieved in bank restructuringand recapitalisation, the introduction of a schemeto resolve the problems of troubled stockbroking
companies and the extension of the exercise periodfor some listed warrants, in an environment ofample liquidity and lower interest rates. Gainsexperienced in regional markets further reinforcedthe positive sentiment. With some stocks continuingto be involved in window-dressing, theKLCI continued to climb to end the year at586.13 points. This, however, represented aloss of 8.31 points or 1.4% from the level at theend of 1997.
Compared with the performance of the otherstock markets in the region, the fall in the KLCIwas smaller than the declines in the TaiwanWeighted Index (–21.6%), the Tokyo Nikkei-225Index (–9.3%), Singapore ST Index (–9%), theHong Kong Hang Seng Index (–6.3%) and theThailand SET Index (–4.5%). However, theperformance of the KLCI was poorer whencompared against the Korea Composite Index, whichrecorded a 49.5% gain, and the PhilippinesComposite Index (5.3%).
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Graph 4.13Performance of Selected Regional & Emerging StockMarket Indices (% change from 1997 to 1998)
-33.5
-25.0 -24.5-21.6
-12.8-6.3
-9.0
-1.4
49.5
-4.5-0.9
%
Table 4.22Kuala Lumpur Stock Exchange: Selected Indicators
Total No. of Companies Listed 708 736Main Board 444 454Second Board 264 282
Market Liquidity:Turnover Value/Market
Capitalisation (%) 108.7 30.8Turnover Volume/Number of
Listed Securities (%) 47.4 37.1
Market Concentration:10 Most Highly Capitalised Stocks/
Market Capitalisation (%) 35.9 35.5
Average Paid-Up Capital ofStockbroking Firms (RM million) 72.0 86.1
Source: Kuala Lumpur Stock Exchange
Reflecting the marginally lower share pricesand slower corporate activity, the marketvaluation of the securities listed on the KLSEdecreased marginally by 0.35% to RM374.5 billionat the end of 1998 (end-1997: RM375.8 billion),equivalent to 134.4% of the nation’s GDP (1997:136.5% of GDP). At its highest point, thecapitalisation was 323.6% of GDP on 25 February1997. The KLSE maintained its 1997 ranking ofseventh in the Asia-Pacific region and second inthe ASEAN region.
Trading volume on the KLSE was lowerby 19.9% in 1998, amounting to 58.3 billion unitsor an average daily volume of 237 million units(72.8 billion and 293.5 million units respectively in1997). Reflecting the lower stock prices for thegreater part of 1998 and the lower tradingvolume, the total transacted value was markedlylower by 71.8% at RM115.2 billion. The bulk ofthe trading volume was concentrated in thefirst and fourth quarters of the year (accounting for68% of total trading volume) when shareprices were generally rising. In terms of sectors,greater interest continued to be centered on thetrading/services (23.3%), finance (16.7%) andproperty (11.5%) sectors on the Main Board,while the share of the Second Board wasreduced to 10.6% (1997: 14.4%). Reflecting thelower trading volume, market liquidity (measured bythe ratio of trading volume to number of securitieslisted) fell to 37.1% in 1998 from 47.4% in 1997.Similarly, the ratio of trading value to marketcapitalisation, declined to 30.8% in 1998 from108.7% in 1997.
Economic and financial conditions during theyear similarly affected developments on theMalaysian Exchange of Securities Dealing andAutomated Quotation (MESDAQ). In October 1997,the Government set up MESDAQ as an over-the-counter market where high-technology and smallcompanies with good growth potential could raisecapital. In 1998, three companies, of which twowere in software development and one in theelectronics and information technology hardwarebusiness, had applied for listing. Another twocompanies delayed the submission of theirapplications due to the significant changes in thebusiness environment during the year. As atthe end of 1998, the exchange had 18members, of which eight were market makers.Trading on the exchange is expected to commencein 1999.
In the meantime, MESDAQ focused efforts onenhancing the infrastructure and undertaking productdevelopment, as well as educating members,companies and investors. During the year, theMESDAQ Quotation System (MQS) was developedfor the trading of MESDAQ stocks. The MQS isan electronic, quote-driven system that supportscompetitive market-making through the use ofBloomberg software and hardware and representsthe first step towards the full deployment ofMESDAQ’s open architecture. In addition, MESDAQorganised various roadshows and presentations topotential issuers, investors, MESDAQ members,analysts, media and the general public. MESDAQis also planning to launch the Malaysian EnterpriseNetwork soon. The network represents one of thefirst electronic networks within the Asian region thatutilises the Internet as a medium to showcasecompanies, thereby enabling them to reach out toinvestors and strategic partners.
Bond Market
Trading activity on the secondary market forbonds was mixed in 1998. Trading continued to befocused on the unlisted segment of the market(98.9%), particularly on MGS. Trading of MGS wassignificantly higher at RM27.3 billion, more thandouble the amount traded in 1997 (RM12.4 billion),while the trading volume of Cagamas bonds andnotes was 6.9% lower, at RM15.2 billion (1997:RM16.3 billion). Trading of Khazanah bonds (RM5billion), Government Investment Issues (RM3 million)and the other unlisted bonds (RM2.4 billion) wereon a smaller scale (data for these bonds were
Graph 4.14Trading of Domestic Debt Securities in 1998
Cagamas Bondsand Notes
30.1%
Gll0.01%
Other Unlisted Bonds4.7% Listed Corp. Bonds
1.1%
MGS54.2%
Khazanah Bonds9.9%
Source: BNM page on Reuters, Bond Information & Dissemination System (BIDS) & Kuala Lumpur Stock Exchange (KLSE)
only available since the launch of the BondInformation and Dissemination System (BIDS) inOctober 1997). In contrast, trading of listedcorporate bonds on the KLSE was considerablylower, amounting to RM536 million or 79.5% lowerthan the volume traded in 1997. The high tradingvolume of MGS and the low turnover of corporatebonds can be attributed to increased issues ofMGS in 1998. There were six new issues totallingRM14.95 billion in 1998, of which two issuesamounting to RM6 billion were privately placed withthe EPF. At the same time, due to uncertaintiesin the economic and financial environment, investorshad a preference for the risk-free MGS. Investorswere also concerned over the weakening credit riskprofiles of corporates, resulting, to some extent, ina “flight to quality”.
In terms of composition, MGS accounted for morethan half (54.2%) of the total volume of bondstraded in 1998, while Cagamas bonds and notesand Khazanah bonds accounted for 30.1% and9.9% respectively. The dominance of MGS emergedin the second half of the year, with trading ofother bonds being more active in the first half-year. In January, February, March and May,Cagamas bonds and notes accounted for most ofthe trades, while trading in June was concentratedon Khazanah bonds.
Trading was more active in the second half ofthe year, with 81.9% of the total trades beingtransacted during this period. The increase in bondprices on the back of declining interest rates led
investors to accumulate debt securities in anticipationof the continued softening of interest rates. Anothercontributory factor was the increase in liquidityarising from the three reductions in the SRR (onein July and two in September). The large numberof MGS issued also contributed to the higher tradingvolume during this period. Three out of thefour non-privately placed MGS involving RM6.95billion issued in 1998 were in the second halfof the year.
In 1998, the number of new issue ratings(including commercial papers) conducted byRating Agency Malaysia Berhad (RAM) and MalaysiaRating Corporation Berhad (MARC) was sharplylower. This reflected the reduced issuance ofprivate debt securities in an environment of aslowdown in economic activities and high interestrates during the first half-year. During the year,RAM completed seven rating exercises valued atRM1.4 billion (51 exercises totalling RM13.5billion in 1997). The bonds issued were bycorporations in the financial services, property andconsumer products industries. Similarly for MARC,new issue ratings numbered seven compared with22 issues in the preceding year, while the totalvalue of debt rated was RM2.5 billion (RM11.2billion in 1997). The bonds rated were from theproperty, industrial products, transportation, utility andinfrastructure sectors. In terms of the maturity profileof the bonds rated, there was a preference forshort- and medium-term papers (nine short- andmedium-term papers compared with five long-termpapers), as the market anticipated an easing ininterest rates.
Government Private Funds Total Government Private Funds TotalSponsored Sponsored
Funds Funds
No. of Unit Trust Mgt. Cos. 10 21 31 10 22 32No. of Unit Trust Funds * 27 53 80 28 61 89Units in Circulation (billion) 35.9 9.3 45.2 35.5 11.0 46.5No. of Accounts (million) 7.5 0.8 8.3 7.7 0.8 8.6Net Asset Value (NAV) (RM billion) 28.6 5.0 33.6 32.3 6.4 38.7% of NAV to KLSE Market Capitalisation 7.6 1.3 8.9 8.6 1.7 10.3
* Refers to funds already launched.
Source: Securities Commission Malaysia
Capital market measures implemented in 1998were aimed mainly at strengthening the regulatoryframework. Among others, the measures wereintended to enhance disclosure and transparency,investor protection and the enforcementcapabilities of the regulatory authorities as wellas improve corporate governance practices,ensure an orderly and fair market in the tradingof securities and futures contracts on theMalaysian exchanges and strengthen the financialstanding of domestic stockbroking companies.The key measures were as follows:
Rules on Gearing Ratio, Exposures toSingle Client and Single Security andMargin Financing
With effect from 19 January 1998, the KualaLumpur Stock Exchange (KLSE) announced newrules on gearing, and improvements to existingrules on margin financing and exposure to singleclient and single security to instill a greatersense of financial discipline and to enhance thefinancial standing of stockbroking companies(SBCs).
Gearing ratio on borrowing exposures● Under this new rule, SBCs were required
to maintain a gearing ratio on the approvedlimit of not more than three times theadjusted capital and on the utilised levelof not more than two and a half times theadjusted capital of the SBCs, by 31December 1998. Prior to this, there wereno prudential rules on the SBCs’ borrowingexposures.
Exposures to a single client and a singlesecurity● In these new rules, there was a clear
distinction between the exposure for marginfinancing clients and trading clients.
– For exposure to a single clientThe limits on margin financing exposurewere 30% of the SBC’s adjusted capital,and for trading exposure, 100%.(Previously, the total combined limit on
Key Capital Market Measures in 1998
margin financing and trading exposurewas 300% of the SBC’s last auditedshareholders’ funds, provided that theexposure for margin financing did notexceed 30%).
– For exposure to a single securityThe limit on margin-financing exposurewas 20% of the SBC’s adjusted capital.The limit on trading exposure for SBCswith adjusted capital of less than RM200million was 100% of the adjusted capitaland the limit for SBCs with adjustedcapital exceeding RM200 million was200% of its adjusted capital. (Previously,the total combined limit on marginfinancing and trading exposure was500% of the SBC’s last auditedshareholders’ funds).
Margin financing● The maximum exposure to a margin client
was limited to 30% of the SBC’s adjustedcapital (30% of the SBC’s shareholders’funds in the old rule), and the totalexposure to all margin clients was 100%(12.5 times the shareholders’ fundspreviously).
Rules on the Placement of Clients’Funds in Trust Accounts
The KLSE announced a new rule provisioningfor the placement of clients’ funds in trustaccounts to enhance investor protection, effective4 March 1998.
Practice Notes to Enhance Disclosure
On 29 May 1998, the KLSE in its effortstowards enhancing corporate disclosure andtransparency amongst public listed companies,embarked on the issuance of Practice Notes.With effect from 1 June 1998, two PracticeNotes were issued on disclosure of informationon the Year 2000 (Y2K) Compliance andon Default in Payment. The Practice Notes
served to promote better disclosure bypublic listed companies regarding their Y2Kcompliance/readiness and their defaultsin payments of interest and/or principal inrespect of loan stocks, bonds, debentures orcredit facilities.
Removal of Restrictions on CorporateExercises
On 30 June 1998, the Securities Commission(SC) announced the lifting of most of therestrictions on submissions for new listings,capital raising exercises and restructuringschemes that were announced on 5 December1997, to provide companies with the neededavenues to raise funds to support their corebusinesses. Nonetheless, the SC would continueto exercise close scrutiny over all applications,especially with regard to listing on the SecondBoard of the KLSE. This was to consolidate andstrengthen listed companies in those sectorswhere there were already a significant numberof companies.
Changes to Rules on Related-Party andInterested-Party Transactions
With effect from 2 July 1998, the rules onrelated-party and interested-party transactionswere revised by the SC to enhance the overallframework for corporate governance in listedcompanies. The new rules, inter alia:
– widened the scope of the application of therules beyond directors and substantialshareholders to include persons connectedwith them;
– required details of such transactions to beannounced and included in circulars toshareholders;
– required shareholder approval for thetransaction while preventing personsinterested in the transaction from voting onthe resolution approving the transaction;
– required the appointment of corporateadvisers to ensure that the transaction wascarried out on fair and reasonable terms;and
– required the board of directors to state thatthe transaction was in the best interests ofthe company.
Measures to Enhance Transparency inthe Stock Market
On 31 August 1998, the KLSE as part ofits efforts to further enhance transparency in thestock market, announed new measures effective1 September 1998, to ensure an orderly and fairmarket in the trading of Malaysian securities andto improve overall market transparency in theMalaysian capital market. Among the manybenefits that the measures sought to bring aboutwere enhanced transparency in share trading,enhanced investor protection, cost efficiency andoverall greater efficiency in the trading system.Key features of the measures were:-
Trading of listed securities● All dealings in securities listed on the KLSE
were to be effected only through the KLSEor through a stock exchange recognised bythe KLSE.
● Except as otherwise permitted, all dealingsin KLSE securities were to be effected onlythrough the KLSE trading system.
● SBCs should not deal in securities on behalfof a client if they had reason to believethat the transaction was intended to facilitatethe dealing in securities on a stockexchange not recognised by the KLSE.
New disclosure requirements● A client, in dealing in securities listed on
the KLSE on another person’s behalf, wouldhave to disclose the identity of that personto the SBCs.
● For all new and existing nominee accounts,the name and other particulars of thebeneficiary would have to be stated in full.
● Each Central Depository System (CDS)account operated by a nominee could haveonly one beneficiary. For nominee accountswhich were presently shared by more thanone beneficiary, new accounts would haveto be opened to comply with the newrequirements.
Off-market business and its clearing andsettlement
● SBCs were permitted to engage inoff-market dealing only in the form ofdirect business ( i.e. crossings andmarried deals).
● All direct business was to be cleared andsettled through the Securities ClearingAutomated Network Services Sdn. Bhd.
New issues of securities● Public l isted companies were not
permitted to issue certificates to thesecurities holders in respect of any newissues of securities as all new issues wereto be made by way of crediting thesecurities into the CDS accounts of thesecurities holders.
Mandatory deposit● Shareholders of companies which had been
approved for listing or were currently listedon the KLSE would have to deposit theirshare certificates with Malaysian CentralDepository Sdn. Bhd. (MCD).
Withdrawal● All withdrawals of securities would be
prohibited, except for the circumstancesallowed in the notice issued by the KLSE(for example, to facilitate share buyback;conversion of debt securities; the processof company restructuring).
Amendments to Securities Laws
The Securities Industry Act 1983 (SIA)and Securities Industry (Central Depositories)Act 1991 (SICDA) were amended twice. The firstset of amendments was passed during theOctober 1997 session of Parliament andcame into force on 1 April 1998. The secondset of amendments was made during anemergency Parliamentary sitting held from 28-30September 1998 and came into force on 1November 1998. At the same time, amendmentswere also made to the Securities CommissionAct 1993 (SCA) and to the Futures Industry Act1993 (FIA).
April 1998 AmendmentsThe SIA amendments broadened the definition
of insider trading; increased the range ofsanctions, including civil sanctions, todeter insider trading and market manipulation;required additional disclosure fromdirectors and chief executive officers (CEOs);and increased the power of the SC overdirectors and CEOs. Amendments to theSICDA included the amendment to thedefinition of “securities” to include “unit trustschemes”.
November 1998 AmendmentsKey amendments to the Acts were as follows:
SICDA● It was mandatory for securities to be
deposited into the CDS within one monthof the coming into force of the AmendmentAct. Failure to do so would result in thesecurities being transferred to the accountmaintained under the name of the Ministerof Finance.
● Every securi t ies account with theMCD was to be in the name of thebenef icial owner of the depositedsecurities or in the name of the authorisednominees.
● Off-market deals that were not transactedthrough a recognised stock exchange andcleared through a recognised clearinghouse were prohibited.
SIA● The enforcement powers of the
exchange and clearing house inrelation to any person failing to complywith their rules or the exchange’s listingrequirements were enhanced. Amongothers, the power relat ing to thecompliance with the rules and listingrequirements of the exchange andclearing house have been extended toapply to a person to whom the rules orlisting requirements are directed andadvisers.
SCA● The powers of investigations of an
Investigating Officer (IO) of the SC toenforce securities laws were extensivelyincreased. For example, an IO may arrestwithout warrant, any person he reasonably
suspects to have committed an offenceunder the securities laws.
● The Amendment Act empowered the SC toconduct an examination without prior noticeon licensed persons.
FIA● The Amendment Act prohibits the setting
up of a futures market for the trading infutures contracts unless such futures marketswere recognised.
● The provisions that protect the money andproperty of a client of a futures fundmanager were tightened.
New Capital Adequacy Requirementsfor the Stockbroking Industry
On 31 December 1998, the SC approvedthe Capital Adequacy Requirements forSBCs to refine the prudential benchmarkfor maintaining market integrity. The newrequirements would replace the existingMinimum Liquid Fund rules once they wereimplemented through the KLSE’s businessrules in 1999. The new risk-based capitaladequacy framework would enable boththe KLSE and SBCs to identify more clearlythe capital available to cover the risks ofrunning a securities business and wouldencourage market intermediaries to adopt amore relevant approach to risk management.
Unit Trust Industry
The unit trust industry expanded in 1998, withthe launching of nine unit trust funds comparedwith six in the preceding year and the establishmentof one unit trust management company, the samenumber as in 1997 (see Table 4.23). Units incirculation rose marginally by 1.3 billion units to46.5 billion units, compared with an increase of6.2 billion units in 1997. As at the end of 1998,there were 32 management companies and 89 unittrust funds. The increase in the number of fundslaunched and units in circulation as well as thestrong performance of the KLSE in the last fourmonths of the year contributed to a 15.3% growth(1997: –44%) in the net asset value (NAV) of theunit trust industry. The NAV of the industryamounted to RM38.7 billion at the end of 1998(1997: RM33.6 billion). Consequently, the ratio ofthe industry’s NAV to the total market capitalisationof the KLSE improved from 8.9% in 1997 to10.3% in 1998.
Futures Market
The Kuala Lumpur Stock Exchange CompositeIndex Futures (FKLI), remained the only productoffered by the Kuala Lumpur Options and FinancialFutures Exchange (KLOFFE) since it was firstlaunched in December 1995. The FKLI contractperformed remarkably well for the larger part ofthe year, continuing the trend from the previousyear. This reflected the increased maturity of themarket as well as greater investor awareness of
the efficacy of the product, leading to increasedutilisation for both income enhancement as wellas for hedging investors’ portfolio exposure inthe underlying stock market. Nevertheless,following the implementation of the selectiveexchange control measures in September, the lackof depth in the market and the withdrawal offoreign participants caused a substantial drop inactivities. Activities, however, stabilised towards theend of the year.
During the first eight months of the year, theFKLI recorded a marked improvement inperformance. The average daily turnover climbedprogressively, from 2,869 contracts in January 1998to peak at 4,646 contracts in August 1998. Theaverage daily open interest also rose from 8,787contracts to reach a record high of 18,442 contractsat the end of June and 14,293 contracts at theend of August. The improvement was equallyevident when compared with the same period in1997. In this regard, the average daily turnover forthe first eight months expanded by 289% to 3,888contracts, while the average daily open interestwas significantly higher by 514% to 18,965contracts. The total turnover during the periodincreased by 284% to 625,919 contracts. TheDerivative Liquidity Ratio (DLR), which measuresthe value of futures contracts traded against thetotal value of the 100 underlying component stocks,rose from 55.1% in January to exceed 100% inApril and in subsequent months, indicating thatinvestor exposure in the underlying market wasfully covered by similar investments in the futures
market. This development indicates signs of growingmaturity in the futures market.
The trend, however, reversed subsequentlyfollowing the imposition of the selective exchangecontrol measures in September. The withdrawal offoreign participation, coupled with the lack ofdomestic participation, contributed to significantlylower trading activities. As foreign players beganto close their open positions, the share of foreigninstitutions decreased, from 54% of total turnoverin August to 28% in September. Consequent tothese developments, the average daily volume fellfrom 4,646 contracts in August to 3,588 contractsin September, accompanied by a more drasticdecline in the average daily open interest from14,293 contracts to only 681 contracts. The DLRalso declined from 104% to 48%. To ensure thattrading activities were not hindered by the rulesrestricting the transfer of funds held in externalaccounts by foreign participants, on 14 September,non-resident clearing members of the MalaysianDerivatives Clearing House (MDCH) were allowedto open designated external accounts for tradingpurposes in KLOFFE, Malaysia Monetary Exchangeand Kuala Lumpur Commodity Exchange. With this,the restrictions on external accounts were relaxedfor funds maintained in these accounts for purposesof derivatives trading.
Trading activities stabilised somewhat towardsthe last two months of the year. Nevertheless, forthe period September-December, activities slowedwhen compared with the corresponding period in1997, as total turnover declined to 145,325contracts (1997: 220,082 contracts), while theaverage daily turnover and average daily openinterest also decreased to 1,710 contracts and4,353 contracts respectively (1997: 2,589contracts and 9,446 contracts). In comparison withthe period January-August, both the averagemonthly turnover and average daily turnover fellby 56% and 77% respectively. This situationreflected the lack of foreign participation in themarket. The dominance of foreign participantsdeclined significantly to account for only 5% to 9%of total turnover in the last three months of 1998.Despite this downturn, for the year as a whole,the considerable improvement over the largerpart of the year saw total turnover andaverage daily open interest improve to 771,244contracts and 13,916 contracts respectively, from382,974 contracts and 5,267 contracts respectivelyin 1997.
Recognising the need to ensure greater domesticparticipation, the Futures Industry Act 1993 wasamended during the year to allow the participationof asset managers and unit trusts in the futuresindustry. Parallel to this, the Securities Commissionalso issued guidelines for the licensing of futuresfund managers and futures fund managers’representatives. In addition, unit trust companies,as provided in the Securities Commission’sGuidelines on Unit Trust Funds, have since beenexempted from the licensing requirement under theAct to trade in futures contracts.
Another important development that took placein January 1999 was the acquisition of KLOFFECapital Sdn. Bhd., the holding company of KLOFFEBhd. by the KLSE. The merger would pave theway for greater consolidation between the twoexchanges particularly in the areas of businessdevelopment and system requirements. Suchconsolidation, which is in line with global trends,would further enhance investor confidence inMalaysian financial markets. At the end of1998, KLOFFE had 40 trading members, 49local members and 563 futures brokerrepresentatives.
In 1998, the 3-month Kuala Lumpur InterbankOffered Rate (KLIBOR) futures contract continuedto be the only product traded in the MalaysiaMonetary Exchange (MME), which was laterrenamed Commodity and Monetary Exchange ofMalaysia (COMMEX) after the merger betweenMME and the Kuala Lumpur Commodity Exchange
0
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Turnover (No. of Contracts) Open interest (No. of Contracts)
Graph 4.15FKLI & KLIBOR Futures: Turnover and Open Interest
Source: KLOFFE and COMMEX
FKLI - turnoverKLIBOR Futures - turnover
FKLI - open interestKLIBOR Futures -open interest
1997 1998J F M A M J J A S O N D J F M A M J J A S O N D
(KLCE). Trading of the product declined significantlyin 1998 compared with 1997 as trading activitiesslowed although the year-end open position added1,896 contracts to 3,092 contracts.
As the total volume for the year decreased by67.6% to 24,738 contracts, the average dailyvolume also fell by 67.3% to 101 contracts. Thelower trading volume was attributable to severalfactors. First, there was a divergence between the3-month KLIBOR and the rates of related moneymarket instruments, notably the 3-month negotiableinstruments of deposit and bankers acceptances.The divergence was particularly noticeable in early1998 when the shorter-term interbank rates wereaggressively bidded up by some smaller bankinginstitutions. To rationalise the term structure ofinterest rates as well as to improve liquidity flowsin the system, in February 1998, BNM officiallyannounced the 3-month intervention rate as itspolicy rate and reduced the SRR. Second, thepreoccupation of the banking institutions withmanaging their non-performing loans as well asloan recovery reduced their participation in theKLIBOR futures market. This was significant asthe domestic banking institutions were major playersin the market, accounting for 72.8% of totalturnover during July-December 1998. Third, theintroduction of selective exchange control measuresin September also reduced the activities of theforeign players. During the period August toSeptember, their share of total turnover averaged23%, but declined to an average of 4.3% in theremaining months of the year.
The low trading volume contributed to reducedtrading by market-makers, worsening the lack ofliquidity in the market. This was reflected in thewide bid-ask spread averaging 40 ticks (1 tick =0.01%) in 1998 (average of 3.5 ticks from theperiod May 1996-June 1997, when the product wasfirst launched to just before the crisis). In fact, thebid-ask spread widened to 200 ticks in the firstweek of September following the introduction ofthe selective exchange control measures, indicatingthe severe lack of liquidity in the market. As theenvironment remained unconducive, the market-making scheme was terminated on 7 July.
An encouraging development, however, was therelatively stable open-interest position at the endof the year which stood at 3,092 contracts (1,196contracts in 1997), attributed to the increased use
of strip trading among participants. The strip order,introduced in April, essentially involved using threeor more consecutive quarterly KLIBOR futurescontracts at one single price. The trade wasinitiated when it was determined that the tradercould lock in a higher return or a lower borrowingcost for the spectrum of the 3-year yield curvethan was otherwise available in the cash-onlymoney market transaction. In terms of type oftrades, outright trades remained most popular,representing 70.3% (93.2% in 1997) of totalturnover followed by cross trades (13.8%, 5.3% in1997), strip trades (12.5%, none in 1997), spreadtrades (2.4%, 1.2% in 1997) and All-or-None trades(1%, 0.3% in 1997).
The term structure of the 3-month KLIBORfutures implied yield during the year generallyreflected that of the underlying interest rates.Hence, movements in the futures implied yieldcurve during the year could be divided into threedistinct periods, similar to the developments in thecash rates. In January and February 1998, impliedyields were high, as indicated by the spot monthyield of 10.95% on 16 February, depicting theprevailing high interest rates associated with theprogressive tightening of liquidity conditions thathad commenced in September 1997. Marketexpectations during this period were for interestrates to increase further in the near term.Subsequently, the implied yield curve shifted slightlydownward on 1 July with the spot month yield of10.70%, while cash rates were stable amidst thetight liquidity in the system due to continuedpressure on the ringgit. The flatness of the impliedyield curve indicated that the interest rates were
to remain high in the near future. In the thirdperiod from August to December, the implied yieldcurve shifted significantly downward on 9 Novemberwhen the spot monthly yield declined further to7% following successive reductions of theintervention rate and SRR of the bankinginstitutions as part of the measures to support theeconomic recovery process. However, the impliedyield curve became inverted, implying marketexpectation for further reductions in interest ratesin the future.
An important development during the year wasthe merger between MME and KLCE to establishCOMMEX on 7 December. The merger wouldbenefit the industry through economies of scale inenhancing the efficient utilisation of resources aswell as improving operational efficiency. In addition,it would enable the exchange to offer multi-financialand commodity derivative products to their clients.At the end of the year, there were 28 companies(18 Broker Members and 10 Non-Broker Members)and 49 individuals (Locals) who had been awardedmembership in COMMEX.
In 1998, trading of crude palm oil (CPO) futurescontracts on the Kuala Lumpur CommodityExchange (KLCE) declined by 27% to 353,539 lotsor equivalent to 8.8 million tonnes of CPO (1997:-2.8% or 484,323 lots or equivalent to 12.3 milliontonnes). However, prices have recorded acontinuous upward trend since mid-1997. Prices roseabove the psychological support level of RM2,000per tonne at the beginning of 1998 and remainedabove this level throughout the year. The higherprices reflected primarily the sustained demand forpalm oil and its products worldwide as well aslower supplies. Crude palm oil production declinedin Malaysia, and supplies were also lower fromIndonesia, the world’s second largest producer. TheIndonesian Government, for most of 1998, hadimposed very high export duties (up to 60%) onpalm oil exports in its efforts to contain rising pricesin Indonesia. During 1998, the price range for CPOfutures was, however, slightly narrower at RM500compared with RM800 in 1997. The highest price
0
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Lots Open position Ave. 3-month prices
Lots (thousand tonnes) Price (RM/tonne)
Graph 4.17Futures Trading on the KLCE
Palm oil
1997 1998M J S D M J S D
recorded was for the third month contract atRM2,562 per tonne.
The price volatility resulted in several sessionsof limit-up and limit-down in the KLCE, therebyimpeding market participation. Consequently, theKLCE expanded the daily price limits, effective 9February 1998, allowing the palm oil industry tocontinue to undertake hedging activity. Meanwhile,the average daily turnover for the first nine monthswas 1,615 lots before falling to 928 lots per dayin the last quarter. The decline in trading volumeduring the final quarter reflected mainly subduedforeign interest following the imposition of selectiveexchange control measures on 1 September 1998as well as market uncertainties regarding the priceprospect for crude palm oil, in view of its highpremium over competing oils and expectations ofchanges to export duties on palm oil in someproducing countries. For the year as a whole, theaverage daily volume was lower at 1,443 lots,compared with the daily average of 1,961 lotsin 1997, while the total open positions declinedfrom 6,899 lots in January to 4,597 lots inDecember. Overall, the decline in activity on theCPO futures market was due primarily to the lowerproduction of crude palm oil in Malaysia and thehigh price volatility.
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