C01 Letter of Transmittal EN - Bank Negara Malaysia...which are incorporated into this Financial Stability and Payment Systems Report 2007. Respectfully submitted, Zeti Akhtar Aziz

Letter of Transmittal

Yang Amat Berhormat Dato’ Seri Abdullah bin Hj. Ahmad Badawi,Prime Minister/Minister of Finance,Malaysia.

YAB Dato’ Seri,

In accordance with section 56 of the Takaful Act 1984 and section 192 of the Insurance Act 1996,I have the honour to submit for presentation to Parliament, reports on the administration of the TakafulAct 1984 and Insurance Act 1996, and other related matters for the year ended 31 December 2007which are incorporated into this Financial Stability and Payment Systems Report 2007.

Respectfully submitted,

Zeti Akhtar Aziz26 March 2008 Governor

Contents

Governor’s Statement

Executive Summary

Financial Stability Report

Risk Assessment of the Financial System11 Overview11 Global Macroeconomic and Financial Developments15 Malaysian Macroeconomic and Financial Developments24 Financial Sector Risk Assessment35 Risk Assessment Going Forward39 White Box: Enhancing the Surveillance Framework – Forward Looking Indicator

of Banking System Vulnerability43 White Box: Malaysia’s Anti-Money Laundering / Counter Financing of Terrorism

(AML/CFT) Programme

Development of the Financial Sector51 Institutional Development52 Positioning Malaysia as an International Islamic Financial Centre53 White Box: Sukuk: Efficient Diversification Mechanism and New Asset Class59 Enhancing Operational Efficiency and Effectiveness61 Enhancing Financial Market Infrastructure62 Strengthening Inter-Agency Cooperation62 Human Capital Development66 Broadening Access to Financial Services68 Challenges and Outlook70 White Box: The Landscape of the Malaysian Financial System Today

Prudential Regulation and Supervisory Framework81 Implementation of Principle-Based Regulation83 White Box: Prudential Standards Issued in 200786 Risk-Based Supervision88 Ensuring a Cohesive Prudential and Supervisory Framework90 Implementation of Revised Capital Adequacy Frameworks91 Priorities in 200894 White Box: Distinct Features of Islamic Financial Transactions: Perspective

on Musharakah Mutanaqisah (Diminishing Partnership)

Market Conduct and Enhancing Financial Capability 101 Promoting Fair and Equitable Market Practices 103 Enhancing Financial Capability of Consumers 104 Strengthening Avenues for Consumer Redress 105 Market Conduct Supervision and Enforcement 105 Regulation of Insurance and Takaful Intermediaries 106 Moving Forward

Payment Systems Report

Payment and Settlement Systems 109 Managing Payment System Safety and Stability 114 Promoting Greater Efficiency in the Payment System

Annex

Financial stability issues were dramatically brought to the forefront in 2007. The resilience of the globalfinancial system has come under significant pressure following problems in the US subprime mortgagemarket which has rapidly broadened into large-scale liquidity strains. As events surrounding the turmoilcontinue to unfold with heightened concerns over global growth prospects, central banks and regulatorsare maintaining a close watch on the direction of risks to the financial system. Of importance, is the needto contain the implications of these developments on financial stability, and ensuring the ability toexercise firm and coordinated actions, including facilitating orderly resolutions, to avert a full-fledgedcrisis of global proportions.

The Malaysian financial system has so far been relatively insulated from the global financial turmoil,with negligible direct exposures of Malaysian banks to US subprime investments and ample liquidity inthe system, in addition to an insignificant reliance by Malaysian banks on funding in offshore wholesaledebt markets. The effects of widespread financial market volatility, however, were felt in the domesticfinancial markets. Increased two-way portfolio flows led to heightened volatility in the prices of financialassets during the year. Despite the increased volatility, banking institutions on the whole turned in a solidperformance for the year, supported by strong loan growth, higher income from treasury and fee-basedactivities and continued improvements in the quality of credit exposures. Non-performing loans havedeclined to their lowest level since the Asian financial crisis. The capital and solvency positions of thebanking and insurance industries remained strong during the year, while the payment systems hascontinued to perform well with no disruptions being experienced.

Malaysia’s financial sector has continued, during the year, to transform and mature. Thetransformation combines market-based incentives, changes in the institutional configuration and theexpansion of the depth and breadth of the financial markets. All of Malaysia’s domestic banking groupshave evolved into financial conglomerates, providing the comprehensive suite of financial solutions thatcater to the broader range of consumers and businesses. Financial services are now provided throughmultiple and more convenient channels. This has significantly expanded the scope and reach of financialservices. There has also been a more pervasive infusion of best business practices into domesticinstitutions with financial services taking on an increasingly international dimension. This has beenreinforced by the liberalisation that has increased the diversity of the players and foreign participation inour financial system.

The continued strengthening of the financial sector has enabled Malaysia to pursue a progressivederegulation and liberalisation agenda. Deregulation and liberalisation measures have been carefullysequenced to promote improved performance, while avoiding destabilising implications arising frompremature liberalisation. Important preconditions are strengthened domestic institutional capacity,efficient financial markets, a robust financial infrastructure, an inclusive financial system and acomprehensive financial safety net. As these have strengthened over the years, the Bank hasprogressively liberalised the financial sector to strengthen further our linkages with the global economyand promote new business activities. While this liberalisation has been accelerated, it has not only beenaccompanied by increased economic and financial resilience, but also the enhanced capacity of the Bankin surveillance and management of the risks associated with the liberalisation.

With the significant deepening of our financial markets, Malaysia’s bond market in particular is nowamong the more developed in the region. This has bolstered business efficiency and growth by providingan alternative avenue for financing, while dispersing the concentration of credit risk from the banking

Governor’s Statement

sector. An exciting development has been being at the frontier in the development of Islamic finance.Islamic finance has flourished with its international dimension gaining greater significance. The Islamicfinancial system in Malaysia has become among the most comprehensive and active in the world.Accompanying this development has been the strengthening of the regulatory framework and theShariah governance practices. The advanced stage of development of the Islamic financial system hasenabled Malaysia to play a significant role in shaping the global Islamic financial landscape. In theseefforts, Malaysia has considered it vital for greater engagement across jurisdictions to drive harmonisationand convergence on prudential practices and mutual recognition of Shariah interpretations. This greaterinternational engagement and interface that has taken place thus far contributed to significantconvergence. The establishment of the International Shariah Research Academy for Islamic Finance (ISRA)by Malaysia to be an academy within the International Centre for Education in Islamic Finance (INCEIF)aims to provide a formal institutional structure to facilitate this process. All of these developments havecontributed to the efficient functioning of the financial system, its resilience and thus, to financial stability.

The Bank will remain vigilant to the new emerging trends and challenges to the Malaysian financialsystem which could result in risks to financial stability. In the domestic environment, competition in thebanking sector has continued to intensify, with growing pressures on interest margins. The shift towardsmarket-based credit intermediation through securitisation activities is also gaining momentum. This willadd to the complexity and opacity of credit risk distributions in the system and the linkages between thecredit markets and financial institutions. This raises the need for financial institutions to address thevaluation challenges with the adoption of fair value measurement, and to have in place robust processesfor valuations of complex instruments.

During the year, the Bank’s surveillance capabilities were significantly strengthened. The external anddomestic developments are being closely monitored for early signs of systemic implications on thefinancial system. Attention is also being focused on any deterioration in credit evaluations, any significantchanges in the liquidity profiles of banking institutions or any impairment in the ability of institutions toeffectively monitor and measure risk concentrations on a continuing basis. Such signs have notmaterialised. More rigorous supervisory assessments and the deployment of enhanced surveillance toolshave been adopted to capture the more complex linkages between the different components of thefinancial system. The prudential regulatory framework has also been strengthened in a number of keyareas – including capital adequacy standards, stress testing, risk management practices and corporategovernance. The risk management processes within financial institutions have now become more robust,reflecting improved techniques for measuring and managing risk. The realignment of the regulatory andsupervisory functions has also facilitated a more integrated approach to regulatory reforms andsurveillance, and has enabled the more efficient allocation of supervisory resources within the Bank.

The institutional infrastructure to support greater financial inclusion is now well entrenched. Anextensive support network has been established for small and medium (SME) and micro enterprises. Thisincludes the newly transformed Credit Guarantee Corporation Malaysia Berhad, the SME BusinessAdvisers Network, the Small Debt Resolution Scheme, the SMEinfo Portal, the SME Credit Bureau andmore recently, the establishment of the Cooperative Societies Commission. Preparations are on track toestablish the SME Central Coordinating Agency which will be responsible for coordinating SME policiesand Government programmes across all sectors. In addition to strengthening the institutional structure,there has also been a proliferation of new financial products tailored to meet the specific needs of SMEs,while microfinancing strategies by financial institutions have gained significant momentum. Thesedevelopments have significantly improved access to financing for this segment that has traditionally beenunderserved by the financial system, contributing to greater financial inclusion and increased participationof the sector in the economic mainstream.

The Bank continued to act proactively to contain consumer indebtedness within prudent levels.Consumer education remains a central piece of the Bank’s efforts in equipping consumers to make well-informed financial decisions, to protect themselves from predatory lending practices, and to effectively

manage their debts. Outreach efforts by the Bank expanded further during the year, through providingbasic financial education to the younger population at earlier stages of the formal education process. Thelaunch of BNMTELELINK further complements existing channels for the public to obtain information andassistance relating to financial services. The Credit Counselling and Debt Management Agency hasexpanded its presence in key regions in the country. In less than two years since its establishment,assistance has been provided to almost 50,000 consumers, including specific debt counselling andmanagement assistance to more than 5,000 individuals with combined debts totalling RM478 million.

The institutional arrangements put in place by the Bank to strengthen the consumer protectionframework has also had a significant and positive impact on the financial system. In particular, theMalaysia Deposit Insurance Corporation (MDIC) has established a strong domestic and internationalreputation as a model of best practice for deposit insurance systems, and is the first in the world toprovide coverage on both conventional and Islamic deposits within one system under a Shariah-compatible model. The MDIC will enter its third assessment year in 2008 with the implementation of adifferential premium system for premium contributions from member institutions, thereby reinforcingincentives for sound risk management within the institutions.

The Malaysian economy has continued to reap significant dividends from the efforts to develop andstrengthen the resilience of the financial sector. The financial sector has now become a major source ofeconomic growth, while broader access to financing and financial services has improved prospects formore Malaysians and businesses to benefit from economic progress. It has also contributed towardssustaining domestic-led growth, thus reducing Malaysia’s vulnerability to external market conditions.There is a high level of confidence in Malaysia’s financial system and the regulatory and supervisoryregime. At the same time, improvements in the level of financial capability among Malaysian householdsand small businesses have promoted more prudent financial management, and encouraged innovationand a more competitive financial system.

Against a backdrop of an increasingly uncertain external environment, the Malaysian financial systemis therefore well positioned, both financially and structurally, to weather the more challenging outlook for2008. In the coming year, the focus will be on effective surveillance, institutional development, financialmarket and infrastructure development, as well as to ensure a state of readiness to cope with anypotential shocks to the system, and thus sustain overall stability and confidence in the financial system.This will be achieved by further accelerating the development of a more diversified financial sector – thatincludes the Islamic financial system and the foreign exchange market so as to complement the othercomponents of the financial system, strengthening the resilience of financial institutions to market-basedshocks, and finally, enhancing the Bank’s crisis management framework and surveillance capabilities.Significant attention is being devoted to intensively develop and secure skilled human capital resourcesneeded to support the continued growth and development of the financial sector as well as the Bank’saccountabilities in a far more challenging environment. Key pieces of financial sector legislation will alsobe strengthened and updated to reinforce a sound legislative framework for financial stability. The Bank iscommitted to achieving these results.

Zeti Akhtar AzizGovernor

26 March 2008

Executive Summary

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The Financial Stability and Payment SystemsReport aims to promote increased understandingof issues and developments that affect financialsystem stability. The Report covers Bank NegaraMalaysia’s assessment of key risks and trends inthe financial system, and potential implications forthe effective functioning of the system. The Reportalso reviews developments surrounding thetransformation of the financial sector andpayment systems, as well as key regulatory andsupervisory initiatives to promote financial stability.

Risk Assessment and Performance of FinancialInstitutionsThe Malaysian financial system remained resilientthroughout 2007 despite challenging externalconditions marked by a slowing United States (US)economy, rising global inflationary pressures,increased risk aversion by market participants andmore volatile financial markets. During the year,global financial markets experienced unstable andincreased uncertainties after a prolonged period ofexuberance.

On the whole, financial institutions in Malaysiaremained well capitalised throughout the year. Inaddition, the foundations for long-term stabilityhave continued to strengthen with ongoingimprovements in risk management capabilities,governance and operating efficiencies. Interbankand money markets remained amply liquid, withinterbank rates holding steady throughout theyear and banking institutions maintainingadequate liquidity buffers. These conditionsenabled the Malaysian financial system tocontinue functioning effectively without majordisruptions, in spite of the bouts of elevatedvolatility experienced in domestic financialmarkets.

Total financing extended to businessesthrough both the banking system and capitalmarket expanded by 14.1% in 2007. Withimproved operating and financial performance,private investments by businesses remainedrobust. Demand for financing by householdsmeanwhile also remained strong, with outstandinghousing loans and securities financing facilitiesgrowing by 5.9% and 11.1% respectively. Overall,outstanding loans from the banking system grewat a stronger pace of 8.6%, while outstanding

private debt securities (PDS) expanded by 15.2%.In the insurance sector, life insurers registered a6.1% growth in new premiums while new familytakaful business grew 15.8%, driven mainly by thegrowing demand for investment-linked products.Despite sluggish motor vehicle sales and continuedpressure from higher claims exerted onunderwriting margins, the general insurancesector maintained its positive, albeit more modest,growth momentum, increasing by 4.3% in termsof gross direct premiums.

Despite more intense competition weighingdown on margins, credit discipline has beenmaintained. The net non-performing loan (NPL)ratio improved to 3.2%, its lowest level in adecade. The structural characteristics ofMalaysian housing finance, including the deposit-based funding structure and more prevalent"originate-and-hold" business models adopted,provide sufficient incentives for bankinginstitutions to control and monitor the quality ofthe loan portfolio on a continuing basis. This hasbeen borne out by an improvement in assetquality observed in the housing finance segmentwhich saw the NPL ratio decline to 7% in 2007(2006: 8.7%).

With limited direct exposures to marketsaffected by the US subprime crisis and supportivedomestic economic conditions, the profitability ofbanking institutions in Malaysia improved further.Preliminary unaudited pre-tax profits amounted toRM17.7 billion (2006: RM12.9 billion), mainlyattributed to efficiency and productivity gainsresulting from ongoing rationalisation efforts andinvestments in technology, as well as higherincome from treasury and other fee-basedactivities. Improved returns were also harnessedfrom more efficient capital managementprogrammes while continuous product innovationsenabled banks to retain and grow their marketshares.

Development of the Financial SectorA more diversified financial system continued toevolve in 2007. The role of the capital market as asource of funds and avenue for risk diversificationgained increasing importance. Debt securityissuances during the year increased to RM302billion (of which RM66.5 billion were PDS),

Executive Summary

Financial Stability and Payment Systems Report 2007

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representing a significant increase of 65.3% fromissuances in 2006. Of significance, some newissues were also of longer maturities, shiftingabove 10 years. This has further lengthened thematurity structure of fixed income securities,thereby providing opportunities for insurancecompanies and pension funds to match andnarrow the maturity gap between assets andliabilities. The more liberal foreign exchangeadministration policies that have been introducedin recent years also saw the turnover of foreignexchange transactions by non-residents more thandouble over the previous year, therebycontributing to the development of a more activeforeign exchange market. This, in turn, will enablebusinesses and banks to manage their foreignexchange exposures more effectively, whilereducing the cost of doing business.

The development of Islamic finance gainedfurther momentum. Malaysia solidified its lead inglobal sukuk issuances, adding further to thebreadth and depth of the domestic capital market.As at end-2007, sukuk originated in Malaysiaaccounted for 68.9% of global outstanding sukuk.Existing institutional structures supporting Islamicfinancial business were substantially strengthenedas the remaining domestic banking institutionsand two locally-incorporated foreign banks (LIFBs)with window operations took steps to transformthese operations into full-fledged Islamic bankingsubsidiaries, thus providing a stronger anddedicated platform to expand the business.

A greater diversity of players in the marketwas also achieved with the introduction of Islamicbanking operations by two more existing LIFBs,while 16 new approvals for the conduct ofinternational currency business were grantedunder the Malaysia as an International IslamicFinancial Centre (MIFC) initiative. Productinnovations thrived during the year, supported bythe pragmatic approach taken by the ShariahAdvisory Council to ensure that new Islamicfinance products offered are Shariah-compatiblewhile encouraging innovation.

Going forward, the Shariah Advisory Councilwill be further supported by the InternationalShariah Research Academy for Islamic Finance(ISRA) which has been established under theInternational Centre for Education in IslamicFinance (INCEIF) to spearhead research in currentShariah issues. Additional flexibilities in the areas

of tax, foreign exchange administration,immigration and foreign ownership rules as wellas simplified regulatory processes were alsointroduced under the MIFC. These incentivestogether with the comprehensive infrastructureand diversity of players in Malaysia continued toattract significant foreign interest in Malaysia as apreferred centre for sukuk issuances. Totalapprovals for the issuance of foreigncurrency-denominated debt securities in 2007increased by 58% in value to USD12.3 billion, ofwhich 68% was foreign currency-denominatedsukuk.

With the robust growth and rapid evolution ofthe financial sector, competition for highly-skilledfinancial professionals has remained intense. Atthe same time, the global dimension of suchcompetition has become more pronounced asfast-growing financial markets in the regionincreasingly look to the same limited pool of talentto meet their needs. Competition for talent hasbeen particularly intense in the fields of Islamicfinance and investment banking, while specificexpertise in the areas around Basel II, riskmanagement and financial reporting continued tobe in short supply.

The development of a strong talent pipelinefor the financial sector was therefore identified asa key priority of the Bank in 2007. Significantresources have been invested by the Bank indriving and supporting initiatives in this area,paving the way for a more coordinated andeffective approach to address the critical talentdemand and supply gaps. While the needs remainsignificant, important progress was achievedduring the year both in meeting the immediateshort-term needs of the industry, and laying thefoundation for longer-term collaboration betweeninstitutions of higher learning, the industrytraining institutes, the financial services industry aswell as the Government and other regulatoryagencies to identify and develop future talent. InNovember, the Financial Sector Talent EnrichmentProgramme (FSTEP), developed by the financialservices industry in collaboration with the Bank,was launched to equip new graduates with theessential practical knowledge and skill sets to fillmore than 2,000 existing entry-level vacantpositions in the industry. Various initiatives werealso taken forward to complement thedevelopment of relevant teaching and learningresources in line with the demands of the market

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and to enhance existing complementaritiesbetween the various training providers. INCEIF andthe International Centre for Leadership in Finance(ICLIF) also continued to enhance their roles inproviding a solid educational foundation in thefield of Islamic finance, and harnessing theeffectiveness of current and future leadership inthe financial services industry respectively.

Prudential Regulation and SupervisionThe development of a sound, effective andefficient prudential framework remained animportant priority in 2007. The standardisedapproaches under the revised capital frameworkfor conventional banks (Basel II) and the CapitalAdequacy Framework for Islamic Banks, came intoeffect on 1 January 2008, while the Risk-BasedCapital Framework for insurers entered a secondyear of parallel run. The Bank continued to workclosely with financial institutions to ensure thesmooth implementation of these revisedframeworks, and more importantly, to integratethe frameworks with more robust riskmanagement processes and systems within theinstitutions. On the whole, the net increase incapital requirements as a result of the revisedcapital frameworks is not expected to be materialfor most institutions.

The Bank’s risk-based supervisory framework(RBSF) has been further enhanced to facilitatemore granular and holistic risk assessments offinancial institutions. During the year, the Bankalso strengthened the supporting structure,processes and core capabilities required toeffectively implement RBSF. This included puttingin place a rigorous quality assurance framework,strengthening the specialised risk units andenhancing the Bank’s supervisory informationsystems and infrastructure. The closer integrationand coordination between the Bank’s macro- andmicro-surveillance functions have also served toreinforce sound supervisory assessments offinancial institutions taking into accountdevelopments in the broader macroeconomy,while providing early signals of potentialvulnerabilities at the macro level fromdevelopments observed at the institutional level.As at end-2007, the Bank’s supervisoryassessments affirmed that the vast majority offinancial institutions remained in healthy positionswith the capacity to manage the increased risksassociated with the more volatile externalenvironment.

A more principle-based regulatory regimecontinued to evolve, while preserving anappropriate balance between principle-based andrule-based regulations. This process has facilitateda more proportionate approach to regulationaccording to the size, complexity and risk profilesof different institutions. Financial institutions arealso better positioned as a result to respondquickly to changing market conditions from bothrisk and competitiveness perspectives, withoutbeing unduly constrained by detailed rules. Insupporting the transition from a rule- to principle-based regime, the Bank continued to directsignificant attention at strengthening thenecessary preconditions for sound riskmanagement under the more flexible regime. Inthis regard, marked improvements in theeffectiveness of board oversight and seniormanagement continued to be observed, reinforcedby firm supervisory actions taken by the Bank toaddress material deficiencies in financial andbusiness practices within individual institutions.These developments have continued to supportthe growing momentum towards principle-basedregulations in more recent periods. More than 50prudential standards have been developed orreviewed under a more principle-based regulatoryapproach since 2001.

Financial InclusionBank Negara Malaysia also continued to promotebroad-based and balanced growth throughfinancial inclusion, with a particular focus as inprevious years on the small and mediumenterprises (SMEs) and micro enterprises. SMEloans approved by banking institutions anddevelopment financial institutions (DFIs) grewstrongly by 34.3% to RM63.2 billion in 2007. Themicrofinance initiative, introduced in 2006, saw afurther RM224.7 million in outstanding financingextended by nine financial institutions to morethan 22,000 microfinance customer accounts.During the year, financial capacities andinstitutional arrangements of DFIs were alsostrengthened to complement access to specialfunds and financing facilities that are aimedprimarily at supporting the agricultural sector andMalaysian companies venturing overseas.

New credit enhancement products introducedby the Credit Guarantee Corporation MalaysiaBerhad and the launch of a securitisationprogramme by Cagamas Berhad for SME loansfurther enhanced the capacity of banking


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institutions to lend to SMEs. A morecomprehensive advisory and support network hasalso been put in place for small borrowers over theyears to assist in business expansions and effectivemanagement of debts. In 2007, this network wasfurther expanded to include a one-stop web-baseddirectory that allows SME business advisers toshare expertise, while the Small Debt ResolutionScheme, which is aimed at assisting financiallydistressed SMEs, saw the participation of anadditional three DFIs in the scheme.

Financial Capability and Fair Market ConductA more challenging environment continued toconfront financial consumers. Specifically,consumers have to contend with the increasingchoice and complexity of financial productsoffered in the market, while coping with easieraccess to credit and substantially reduced directcontact between financial institutions andconsumers as a result of outsourcing trends andgreater use of automated delivery channels forfinancial services. Extended life expectancies havealso increased the need for consumers to takegreater individual responsibility for sound financialplanning.

Equipping consumers to manage thesechallenges remained an important part of theBank’s efforts to maintain confidence in thefinancial system, contain household indebtednesswithin prudent levels, and minimise the erosion ofinvestments and savings as a result of unethicalsales, servicing or advisory practices. For thispurpose, product disclosure and transparencystandards were further enhanced during the year,while best practices were introduced to improvethe professionalism of insurance and takafulintermediaries and outsourcing service providersthat interface with consumers. Heightened marketconduct surveillance and enforcement activitiesundertaken by the Bank have led to improvementsin the industry’s overall observance of fair marketconduct practices as evidenced by the Bank’sfollow up assessments, and corrective actionstaken by institutions to address the marketconduct deficiencies identified by the Bank.

The consumer redress and protectionframework was enhanced further with the launchof the BNMTELELINK in July 2007 to complementexisting channels for the general public to obtaininformation and seek assistance in relation tofinancial services. Public response to this new

channel has been overwhelming, with more than25,000 enquiries received in the first five monthsof its operations. The Credit Counselling and DebtManagement Agency also continued to play animportant role in helping individuals in managingdebts, providing assistance to more than 5,000individuals with aggregate debts of RM478 millionunder its debt management programme since itsestablishment in 2006.

During the year, the Bank led a more targetedapproach to raise the level of financial capabilityamong Malaysian financial consumers. Consumereducation programmes and activities in 2007focused in particular on women, school children,college and university students, rural communitiesand retirees. The Bank and the financial industrywere also able to leverage more effectively oncollaborative arrangements with schools, traininginstitutes, regulatory agencies and interest groupsto expand the reach of the Bank and industry’sfinancial capability initiatives.

Payment System Safety and StabilityBoth the large value and retail payment systemsfunctioned efficiently and did not encounter majordisruptions during the year. The value of non-cashpayments handled by the Real-time ElectronicTransfer of Funds and Securities (RENTAS) systemin 2007 increased by 23.6% to RM124.5 billion inpayment transactions daily. A self-assessment ofRENTAS carried out during the year against theBank for International Settlements Core Principlesfor Systemically Important Payment Systemsaffirmed a high level of robustness of the RENTASsystem which came close to achieving fullobservance of the Core Principles. Fraud in theretail payment systems remained insignificant,with sustained initiatives by the Bank, paymentsystems operators and other regulatory authoritiesto combat this risk. Settlement risk has also beenreduced following the establishment of Paymentversus Payment (PvP) and Delivery versus Payment(DvP) links with Hong Kong which facilitate thesimultaneous settlement of ringgit and US dollarpayments and securities.

Payment System EfficiencyTo promote efficiency in payment systems,initiatives were undertaken to enhance thepayment infrastructure, foster the adoption of newtechnologies and provide support to stakeholdersfor the migration to electronic payments. Theadoption of a fully image-based cheque clearing

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process in 2008 will expedite the receipt of fundswhile also providing cost savings through theelimination of physical handling and transportationof cheques. The year also saw the functionalitiesand availability of automated teller machine (ATM)services provided by banking institutions enhancedwith the introduction of 24-hour ATM facilities onthe shared network and expanded services offeringmobile phone top-up facilities and interbank fundstransfer services. Such services have also beenexpanded across borders through strategicpartnerships signed between Malaysian ElectronicPayment System (1997) Sdn. Bhd. and overseasATM network operators in Indonesia, Thailand,Singapore and China.

Facilitative regulatory policies and supportfrom the Government have continued to fosterpayment innovations and the adoption of

various electronic payment applications. In thisregard, several innovations were introducedduring the year, including the world’s firstinternational mobile-to-mobile money transferservice and mobile remittance services usingshort messaging services, mobile operatoroutlets and prepaid cards. On a broader scale,the adoption of various electronic paymentapplications by the Government has contributedtowards accelerating the pace of migration toelectronic payments in the economy. This moveby the Government has been strategicallyimportant in encouraging the wider use andacceptance of electronic payments as observedfrom the significant increase in value ofGovernment payments made through electronicchannels which has increased by almost threetimes from RM16.7 billion in 2004 to RM64.9billion in 2007.

Risk Assessment of the Financial System

Financial Stability Report

OverviewGlobal Macroeconomic and Financial DevelopmentsMalaysian Macroeconomic and Financial DevelopmentsFinancial Sector Risk AssessmentRisk Assessment Going Forward White Box: Enhancing the Surveillance Framework - Forward Looking Indicator of Banking System Vulnerability White Box: Malaysia’s Anti-Money Laundering / Counter Financing of Terrorism (AML/CFT) Programme

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OVERVIEW

Financial stability was preserved throughout theyear although the financial markets experiencedbouts of increased volatility, influenced primarilyby developments in the external environment,particularly in the global financial and creditmarkets. The growing risk aversion and thecontinuous repricing of risks, which led to thetightening of liquidity and credit conditions inthe global markets, however, had no majorimpact on the Malaysian financial system.

The financial system remained resilient withfinancial institutions recording sound financialperformance supported by stronger lending andtreasury activities. This was further supported bycontinuous enhancements to the riskmanagement infrastructure, practices andcapability, financial infrastructure development,and strengthened governance and oversight atthe institutional level. Financial intermediationremained robust throughout the year andsupportive of economic activity, whiledevelopments in the capital market continued toremain favourable for fund raising by theprivate sector.


The financial systemremained resilient withfinancial institutionsexhibiting sound financialperformance and strongerfundamentals, supported bycontinuous enhancements torisk management, financialinfrastructure developmentas well as strengthenedgovernance and oversight atthe institutional level. Non-performing loans improvedto a 10-year low of 3.2%,while return on equity ofbanking institutions rose to19.7% in 2007.

The risk-bearing capacity of the financialsector strengthened further, supported by thecontinuous accumulation of financial buffers. Thelevel of capitalisation of banking institutions,measured in terms of the risk-weighted capitalratio (RWCR), remained at a level of at least 13%throughout the year while the quality of the loanportfolio improved significantly, with non-performing loans (NPLs) recording a 10-year low of3.2% as at end-2007. Capital in excess of theminimum regulatory requirement of 8% RWCRstood at RM38.5 billion as at end-2007. Withminimal exposures to the United States (US)subprime mortgage segment and associatedderivatives, financial institutions in Malaysiagenerally benefited from the more vibrantdomestic business environment, registering strongprofitability despite greater volatility in thedomestic financial markets. Preliminary unauditedpre-tax profit for the banking sector rose toRM17.7 billion resulting in a substantially higheraverage return on equity of 19.7%. The highdegree of resilience of the banking institutions wasalso supported by the stress test results whichdemonstrated the strengthened risk absorptioncapacity and tolerance against adverse shocks.

Financial stability surveillance for the yearwas largely concentrated on monitoring andassessing the implications for asset marketsarising from inflows of portfolio funds thatpersisted during the first half of the year, and theincreased volatility in the financial marketsfollowing adverse developments anduncertainties in the external environment.Surveillance was also focused on the impact ofrising prices on the debt servicing capacity andcash flow position of households and businesses.

GLOBAL MACROECONOMIC AND FINANCIALDEVELOPMENTS

The year 2007 was highly challenging to policymakers and financial market participants globally.The prolonged period of excessive risk-takingactivity in an environment of low risk premia andincreasing sophistication of financial instrumentshas masked the excessive build-up of risk whichexperienced a major turning point in 2007. Thiswas triggered by the rapid rise in mortgagedelinquencies by subprime borrowers in the US.


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Such mortgages formed the underlying for asubstantial portion of structured investments andrisk transfer instruments. Beginning with thefinancial institutions and their structuredinvestment vehicles and conduits, it has extendedinto a more widespread problem that has affectedother financial markets. While global growth wasgenerally sustained in 2007, the year ended on apessimistic note. In addition, greater inflationarypressures from higher food, oil and commodityprices have increased the uncertainty on theoutlook of the US economy and stability in theinternational financial system.

Global growth was sustained while the Asianregion continued to expand amidst increasinginflationary pressures following rising oil andfood pricesGlobal growth was sustained in 2007 in anenvironment of a slowing US economy, risingconcerns on inflationary pressures and persistentfinancial market turbulence. The downturn in theUS housing sector after decades of robust growthled to increased incidences of delinquencyemanating from the subprime segment of themortgage market that eventually led to broaderdisruptions in the credit markets and volatility inglobal financial markets. In the Asian region, whileexports of electronic products and equipment haveslowed, overall growth remained resilient,supported by strong domestic demand and robustexpansion in the major economies (Chart 2.1).

The prolonged period of favourable globalgrowth for four consecutive years has createdprice pressures on resource utilisation and resultedin the high commodity prices. Oil prices havesurged to record highs which has consequentlycontributed to higher food prices due to the

increasing demand for conventional fuelsubstitutes, including renewable energy such asbiodiesel and ethanol. More frequent incidences ofadverse weather conditions as well as risingtransportation costs, have also contributed tohigher food prices. Recent trends seem to suggestthat underlying demand conditions forcommodities remain firm, especially in the fast-growing regions. Hence, in comparison to theprevious year, there has been a pick-up in overallglobal inflation. The US economy has experiencedincreases in headline inflation, while the Euro areacontinued to record rapid money and creditgrowth amidst increasing pressures for higherwages. Meanwhile, in the Asian region, severalcountries faced price pressures from tighter labourmarket conditions in addition to the increase infood and energy prices (Charts 2.2 and 2.3).

Mixed monetary policy actions by majorcentral banksWhile global inflationary pressures heightened in2007, disparate growth performance and

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Jul Oct Jan2005

Apr Jul Oct Jan2006

Apr Jul Oct Jan2007

Apr Jul Oct Jan2008

Annual change (%)


02468

101214161820

Indonesia

Thailand

MalaysiaPhilippines


13

domestic issues between the industrialised andAsian countries resulted in mixed monetary policyactions by the respective central banks. In the US,the Federal Reserve Board reduced the policy rateby 100 basis points during the year to supportgrowth as domestic demand weakened due to themajor downturn in its housing market and thedeepening financial and credit market crisis thatled to credit tightening by financial institutions. InEurope, however, rising inflation prompted theEuropean Central Bank to raise interest rates tocurb inflationary pressures. The Bank of Englandraised interest rates during the early part of 2007but subsequently eased monetary policy inDecember to support growth as the impact of thefinancial market turbulence intensified. In theAsian region, China raised interest rates to slowcredit and investment growth while other regionaleconomies, including South Korea and India, alsotightened monetary policy to contain inflation.Meanwhile, the Philippines, Thailand andIndonesia reduced interest rates in 2007 tostimulate domestic demand as inflationarypressures eased (Charts 2.4 and 2.5).

Heightened risk aversion led to repricing ofrisks and increased volatilities across globalfinancial markets in the second half of theyearGlobal and regional equity markets were largelybullish in the first half of 2007 despite emergingconcerns of declining house prices in the UShousing market and inflationary pressuresfollowing rising commodity prices. Capital flowsinto emerging economies and Asia weresubstantial in view of the strong prospects forgrowth in the region. Despite some signs ofrepricing of risk during the February-March 2007sell-off in the global equity markets, the continuedsearch for better returns by investors contributedto a quick rebound in equity prices and asustained low bond yield environment.

Deterioration in house prices in the US in thesecond half of the year led to higher arrears anddelinquencies in residential mortgages,particularly those in the subprime segment. Thiseventually precipitated a downward spiral inprices of residential mortgage-backed securities(RMBS) backed by subprime mortgages whichsubsequently spilled over into a wider class ofstructured credit products. Heighteneduncertainties and increased risk aversion caused awidespread repricing of risks (Chart 2.6) andincreased volatilities. Liquidity tightened in theasset-backed commercial paper (ABCP) andmoney markets as financial institutions retainedliquidity in anticipation of potential losses fromexposures to the subprime market and relatedsecurities. Flight to quality was evident asinvestors switched from corporate commercialpapers into treasury bonds. While the flight toquality also affected the demand for sovereignbonds of emerging market economies, liquidityconditions remained favourable on account of

Source: Bloomberg

Chart 2.6Spreads on CDX Crossover and iTraxx Crossover

J F M A M J J A S O N D

2007

Basis points

0

100

200

300

400

500 iTraxx EuropeCrossover

CDX Crossover

Asia(excl Japan)


Chart 2.4Interest Rate Movements in Major IndustrialisedCountries

Jan2005

Rate (%)

Apr Jul Oct Jan2006

Apr Jul Oct Jan2007

Apr Jul Oct01

23

4

5

67 United States

(Fed funds rate)

United Kingdom(base lending rate)

Euro area(repo rate)Japan

(overnight rate)

Jan2005

Apr Jul Oct Jan2006

Apr Jul Oct Jan2007

Apr Jul Oct

Chart 2.5Interest Rate Movements in Regional Countries

Rate (%)


Indonesia

Thailand

Korea

PR China

2468

101214


14

improved economic fundamentals, strong externalbalances and more developed financial markets(Charts 2.7 to 2.9).

Tightened liquidity conditions and theincreasing incidence of losses reported by majorfinancial institutions in the US, Europe and someparts of Asia triggered periods of heightenedvolatilities and large declines in major

international equity indices. This was furtherexacerbated by the unwinding of carry tradeactivities. Although regional equity marketsexperienced some adjustments, the magnitudewas relatively less and equity markets in theregion rebounded fairly quickly on account ofsigns of sustained strong economic growth(Charts 2.10 and 2.11).

Meanwhile, global equity markets reboundedfollowing central bank liquidity injections and thelowering of the policy rate in the US. Volatilitiesremained high across global and regional equity aswell as bond markets (Charts 2.12 to 2.15), whilethe longer-term funding market in the majoreconomies remained relatively less liquid givenfurther write-downs and losses reported byfinancial institutions. In early 2008, confidencesuffered yet another setback following thedowngrades of several monoline insurers whichsparked another round of sell-offs and furtherwrite-downs of securities by financial institutions.

Rate (%) Rate (%)


2007

Chart 2.7Money Market Rates in Major IndustrialisedEconomies

Source: Bloomberg

US, 4.73

UK, 6.02

Aus, 7.12

Japan (RHS),0.90

4

5

7

6

8

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1 Against US Libor of corresponding maturity

Source: Bloomberg

Chart 2.8US Asset-Backed Commercial Paper (30-day) Spreads1

-20

0

20

40

60

80

100

120

140


2007

Spread

0

50

100

150

200

250

300

350

Source: Bloomberg

Chart 2.9Emerging Market Bond Spread

Spread


2007

Chart 2.10Major International Equity Indices

Source: Bloomberg

Index (2 Jan 2007=100)

Dow Jones S & P 500S & P Euro 500FTSE 100AS 51Nikkei


2007

8590

95

100

105

110

115

120

Chart 2.11Regional Equity Indices

Index (2 Jan 2007=100)

Source: Bloomberg

KLCI STI SET JCI SHCOMP SENSEX

J F M A M J J A S O N D80

100

120140160180200220240

2007


15

The ensuing widening of spreads in the creditdefault swap market and tightness of liquidity inthe auction-rate securities market raised new setsof concerns regarding the capability ofmunicipalities and public entities in the US to fundsocial and infrastructure development commitmentswhich could have undesirable spillover implicationsfor the already weakened US economy.

MALAYSIAN MACROECONOMIC ANDFINANCIAL DEVELOPMENTS

Continued expansion in the Malaysianeconomy driven by strong domestic demanddespite weaker external environmentThe Malaysian economy strengthened further by6.3% in 2007, driven mainly by strong domesticdemand (Chart 2.16). Growth was led by thestrong performance in the services sector andsupported by the construction and miningsectors. Private consumption expenditure wasrobust, recording the highest growth of 11.7%since 2000. Consumers benefited fromcontinued growth in disposable incomesupported by high commodity prices, salaryincrements in the public and private sectors, andfavourable labour market conditions.Promotions in conjunction with the VisitMalaysia Year 2007 also encouraged higherconsumer spending. Gross fixed capitalformation expanded by 10.2%. Stronginvestment activity in the manufacturing,services, construction and oil and gas industries,combined with positive business sentiments,supported the higher growth in privateinvestment by 12.3% compared to 7% in the


2007

Chart 2.12Volatilities of Equity Indices in Major Economies

Source: Bloomberg

%

0

5

10

15

20

25

30

Dow Jones S & P 500S & P Euro 500FTSE 100AS 51Nikkei

Source: Bloomberg

Chart 2.13Volatilities of Equity Indices in Regional Economies

90-day volatility (%)


0

10

20

30

40

50


2007

J J

2007

Source: Bloomberg

Chart 2.14Volatilities of Benchmark Yields (10-Year)in Major Economies

J F M A M A S O N D


US Euro area UK Japan

0

5

10

15

20

25

30

35

Indonesia Phillipines Thailand Singapore

Malaysia PR China India

50

101520253035

Source: Bloomberg


2007

Chart 2.15Volatilities of Benchmark Yields (10-Year)in Regional Economies



16

preceding year. This was further reinforced bythe large inflows of foreign direct investmentin 2007.

Growth was also supported by greaterpublic sector activity. Public consumptionincreased by 6.4% supported by higherexpenditure on emoluments as well as suppliesand services. In addition, public investmentexpanded further at a sustained rate of 8% in2007. Large development expenditure waschannelled into projects to further improve theeconomic and social services sectors, particularlyin enhancing the transportation and publicutilities infrastructure, as well as upgrading andproviding essential services such as healthcareand education.

Ringgit DevelopmentsThe broadly orderly performance of the ringgitagainst major and regional currencies during theyear was driven by strong two-way trade andinvestment flows. While the ringgit benefitedfrom a positive net trade balance, sustainedinward direct investment and substantialrepatriation of profits and dividends byMalaysian companies with investments abroad,there were significant outflows attributed toforeign direct investment by Malaysiancorporations, the repatriation of profits anddividends of foreign multinationals operating inMalaysia, and the repayment and prepayment offoreign debt. Ringgit demand was further

augmented by significant portfolio inflows,especially into the equity market, asexpectations of further currency appreciationand the strong domestic economic growthperformance enhanced investor sentiment. Thiswas further reinforced by the generallyoptimistic investor sentiment towards the regionand the broad weakness of the US dollar.

Inflation and Monetary Policy DevelopmentsHeadline inflation rate, as measured by the annualchange in the Consumer Price Index (CPI),increased at a slower pace of 2% in 2007(2006: 3.6%), attributed to the absence of majoradjustments to price-administered items duringthe year. Nevertheless, the combined effect ofrising global prices of primary commodities andfood as well as strong private consumption ledboth headline and core inflation rates to edgeslightly higher in the final quarter of the year. TheProducer Price Index (PPI) increased by an annualrate of 6.7% in 2007 (2006: 5.1%), followinghigher global prices of commodities such asrubber, crude palm oil and crude oil. Against thesedevelopments, monetary policy took intoconsideration the downside risks to domesticgrowth following the weaker global growthperformance, and the upside risks to domesticprices. The Overnight Policy Rate was thus keptunchanged at 3.5% with the monetary policystance remaining still supportive of the domesticeconomy.

Financial Market DevelopmentsDomestic financial markets remainedresilient despite increased volatilitiesreflecting global developmentsThe Malaysian equity and bond markets exhibitedstrong rallies in the first half of the year, drivenmainly by positive domestic macroeconomicconditions, expectations of a stronger ringgit,anticipation of changes in monetary policy andcontinued portfolio inflows into the region.Nonetheless, with the developments in globalfinancial markets in the second half of the year,heightened volatilities in the domestic financialmarkets persisted.

The Kuala Lumpur Composite Index (KLCI)remained resilient throughout 2007, supported bystrong domestic conditions (Chart 2.17). Positivebusiness sentiment was sustained with continuedincrease in capacity expansion and strongerrecovery in the property sector. In addition, the

p Preliminaryf Forecast

Chart 2.16Contribution to Real Gross Domestic Product(GDP) Growth

Percentage point Annual change (%)

Change in stocks Net exports

Gross fixed capital formation Private consumption

Public consumption Real GDP growth (RHS)

-5

0

5

10

-5

0

5

10

2001 2002 2003 2004 2005 2006 2007p 2008f


17

relatively lower price-earnings (P/E) ratio of theKLCI compared to regional indices andexpectations of a stronger ringgit continued toattract higher foreign participation in the equitymarket (Chart 2.18). Against this backdrop, theKLCI concluded the year with an annual growth of31.8% to reach 1,445.03 points, recording an all-year high of 1,447.04 points on 28 December.Following developments in the global financialmarkets, the domestic equity market experiencedtwo major setbacks during the year, first in lateFebruary to early March attributed mainly tocontagion effects from the weaker USmacroeconomic performance and developments inthe Chinese financial markets, and second, in theperiod July to August following concerns triggeredby the US subprime market. There were also someprofit-taking activities during the year. Totalturnover in Bursa Malaysia was the highest since1996, amounting to RM540.2 billion(2006: RM250.6 billion), with market capitalisation

growing by 30.3% to RM1,106.2 billion or172.4% of GDP as at end-2007. While the impactof the retracement in early 2007 was onlytemporary, the ensuing correction at the onset ofthe US subprime mortgage crisis that causedportfolio outflows from the region in the periodJune to August 2007 almost wiped out the earliergains as the KLCI dipped to 1,191.55 points on17 August. Nevertheless, the KLCI reboundedquickly to 1,273.52 points on 24 August asportfolio funds returned to the region.

The domestic bond market also grewsignificantly following the stronger new issuancesof debt papers and sukuk during the year. As atend-2007, total outstanding public and privatedebt securities expanded by 22.8% to accountfor 86.8% of nominal GDP. With increasedinterest in the domestic bond market, theturnover in the bond market rose by 45.8% toRM777 billion.

Malaysian Government Securities (MGS)yields were more volatile in 2007 withmovements generally reflective of domestic andglobal developments. Yields on MGS declined inthe first quarter of 2007 following sustainedinvestors’ interest and expectations of a strongerringgit. In the second half of 2007, amidst netportfolio outflows, portfolio rebalancingfollowing greater uncertainties and increased riskaversion arising from the subprime and creditcrisis, and a higher inflationary outlook, MGSyields readjusted upwards (Chart 2.19). Thespread between the 10-year MGS and theshorter- and medium-term MGS widened and

Volume (billion)

J J

2007

Source: Bloomberg

Chart 2.17KLCI Performance

1,500

Index

900

1,000

1,100

1,200

1,300

1,400

800 0

1

2

3

4

5

J F M A M A S O N D

Bursa Malaysia trading volume (RHS) KLCI Index

Source: Bloomberg

Chart 2.18Price-Earnings Ratio of Regional Equity IndicesRatio


0

10

20

30

40

50

60


Dec '06 Mar '07 Jun '07

Sept '07 Dec '07

Source: Bloomberg

Chart 2.19Movements in MGS Yield Curve

Yield (%)

1 2 3 4 5 6 7 8 9 10 15 20

Year

3.0

3.5

4.0

4.5

5.0


18

While volatility levels in the MGS market havegenerally subsided and stabilised, the domesticequity market remained susceptible to globalmarket developments. The 90-day volatility inthe KLCI remained at an elevated average levelof 16.3% for the year.

Yields on corporate sukuk were on averagethree basis points below similarly ratedconventional asset-backed bonds, reflecting thelower cost of issuing these papers and strongdemand for sukuk. The trend in sukuk yieldmovements mirrored the pricing of conventionalbonds, suggesting that the sukuk market isalready well-established and reflective ofbehaviours in a mature market. The distinctivefeatures of Islamic financing require that anyfinancial transactions must be supported byunderlying trade- or business-related activities.These unique characteristics added to theattractiveness of sukuk as an investmentinstrument. Many investors thus adopted a

Chart 2.20Implied Volatility Index

Source: Bloomberg

0

5

10

15

20

25

30

35%


2007

Chart 2.21Volatility in MGS Yields

Source: Bloomberg

5

0

10

15

20

25

30


10-year 5-year 3-year


2007

J J

2007

Chart 2.22Volatility in KLCI

Source: Bloomberg


10

5

15

20

J F M A M A S O N D

Chart 2.23Yields on Malaysian Sukuk and Conventional Asset-Backed Securities (5-year) (A1 Rated)

Source: Bondweb Malaysia

Islamic Conventional

5.0

5.5

6.0

6.5

Jan2007


Mar

%

eventually led to the steepening of the MGSbenchmark yield curve in December 2007. In thecorporate bond market, yields generally moved intandem with the movement of MGS yields,especially for the higher rated credits. However,during periods of uncertainty, a higher degree ofrisk aversion was observed particularly in thelower rated issues, as reflected in the slightwidening in the spread between corporate bondsand MGS yields.

Given the openness of the domesticeconomy, the domestic financial markets are notinsulated from uncertainties in the globalenvironment. Volatility in the domestic equityand bond markets increased as global riskaversion became more pronounced in thesecond half of 2007 (Charts 2.20 to 2.22).


19

"buy-and-keep" attitude in view of its scarcityand high market demand. During the periodwhen the general level of uncertainty rose in thewake of problems in the US subprime mortgagemarket where all asset classes were treatedindiscriminately, the sukuk market was alsoaffected. Yields on corporate sukuk convergedwith conventional yields during the period Julyto mid-September 2007 before trending to itsnormal level thereafter following the reductionin the US Federal Reserve Board federal fundstarget rate (Charts 2.23 and 2.24).

Non Financial Sector DevelopmentsCorporate sector performance benefitedfrom strong domestic growth despite risingcost pressuresBusinesses experienced improved financialperformance during the year in tandem withthe favourable domestic economic conditions.Against the backdrop of robust domesticdemand, higher tourism receipts andconstruction-related activities, business revenue

Chart 2.24Yields on Malaysian Sukuk and Conventional Asset-Backed Securities (5-year) (AAA Rated)

Source: Bondweb Malaysia

Islamic Conventional

3.5

4.0

4.5

5.0

Jan2007


Mar

%

Businesses registered improvedoperating and financialperformance supported byfavourable domestic economicconditions despite weakerexport performance faced byexport-oriented industries andescalating costs of productionin an environment of highcommodity and energy prices.

A sample of 100 listed corporations whichrepresents approximately 60% of BursaMalaysia’s total market capitalisation showedthat profits were higher since the third quarterof 2006 (Chart 2.25). In 2007, these listedcompanies recorded further improvementshaving achieved the highest returns on assetsand equity since 2000 of 7% and 13.9%respectively. Meanwhile, the debt-to-equity ratiowas sustained at 59.2% despite higherfinancing obtained. The debt servicing capacityof these corporations remained unchanged withthe interest coverage ratio (measured as theratio of earnings before interest and taxes tototal financing cost) of 5.7 times (Chart 2.26).On aggregate, despite rising costs, the strongerbusiness sector performance and resilience ledto further improvements in the delinquencyrates on bank loans (Chart 2.27).

While businesses operating in some of theexport-oriented industries were affected by theweaker external demand, the corporate sector

Chart 2.25Profitability for Selected Companies

p PreliminarySource: Bloomberg

RM billion %

1Q2005

0

2

4

6

8

10

12

1Q2004

2Q 3Q 4Q 2Q 3Q 4Q 1Q2006

2Q 3Q 4Q 1Q2007

2Q 3Q 4Qp0

5

10

15

20

Net income Operating margin (RHS)Return on assets (RHS)

and profitability strengthened despiteincreasing costs of production in anenvironment of high commodity and energyprices. Private investment by businessesremained encouraging, supported by continuedaccess to financing at competitive costs. Duringthe year, a total of RM405.5 billion wasdisbursed by the banking system for variousactivities and to a broad range of businesses,while new financing via the bond marketamounted to RM66.5 billion. As at end-2007,total financing extended to businesses throughthe banking system and the capital marketexpanded at a rate of 14.1% to account for79.3% of GDP.


20

generally benefited from strong domestic andregional demand as well as higher commodityprices (Charts 2.28 and 2.29). During the year,businesses in the plantation industries continuedto strengthen on account of the strong rally inthe prices of crude oil, crude palm oil and rubber.Similarly, businesses in the construction sector,especially those in the civil engineering segmentand commercial and residential propertydevelopment, also posted stronger performancefollowing increased activity in the propertymarket. Within the services sector, theperformance of tourism and related industries,particularly leisure and hospitality and the retailand wholesale sectors, were boosted by therecord level of tourist arrivals and higher hoteloccupancy rates during the year.

Growth in the manufacturing sectormoderated in 2007 attributable mainly to aslowdown in exports of electrical and electronics(E&E) goods, in particular computers and parts,

amidst slower demand from the US. Financialindicators of selected companies in the E&Esegment (Charts 2.30 and 2.31), however,exhibited sustained profitability, debt servicecapacity and cash flow position, despite lowerprices of E&E exports.

Having registered negative growth since thesecond quarter of 2004, the construction sectorturned around with a marginal expansion of0.6% in the final quarter of 2006. It hassustained its momentum, expanding by 4.6%during 2007. In the property developmentsegment, vacancy rates for offices and retailproperties remained stable at 19.8% and 20.5%respectively. The level of overhang and unsoldproperties improved amidst a slightly lowernumber of new housing units launched. Theaverage sales performance of new housing unitslaunched during the year also improved to

Chart 2.26Debt Servicing Capacity and Leverage Position for Selected Companies


Interest coverage ratio Debt-to-equity ratio (RHS)

0

12345678

1Q2004

2Q 3Q 4Q 1Q2005

2Q 3Q 4Q 1Q2006

2Q 3Q 4Q 1Q2007

2Q 3Q 4Qp

Times

40

50

60

70%

Chart 2.27Spreads and Delinquency Rate

0.0

0.5

1.0

1.5

2.0

2.5

Mar2006

Jun Sept Dec Mar2007

Jun Sept Dec

Percentage point

0

2

4

6

8

10

12%

Spread between MGS and AA- of 10-year maturity

Business NPL Ratio (RHS)

Chart 2.28Return on Assets for Selected Sectors


0

2

4

6

8

10

12

1Q2004

2Q 3Q 4Q 1Q2005

2Q 3Q 4Q 1Q2006

2Q 3Q 4Q 1Q2007

2Q 3Q 4Qp

%

ManufacturingOverall corporate sector

Primary commodity Broad property

Services

Chart 2.29Interest Coverage Ratio for Selected Sectors


ManufacturingOverall corporate sector

Primary commodity Broad property

Services

02468

1012141618

1Q2004

2Q 3Q 4Q 1Q2005

2Q 3Q 4Q 1Q2006

2Q 3Q 4Q 1Q2007

2Q 3Q 4Qp

%


21

19.7% (1Q-3Q 2006: 11.3%), while residentialproperty transactions registered an increase inboth units and value of transactions (Table 2.1).The increased activity in the primary andsecondary residential property market wasstimulated by a series of measures by theGovernment to boost activity in the propertymarket. These include the liberalisation of theForeign Investment Committee rules to facilitateeasier access to the domestic property marketby foreign investors, the exemption of the RealProperty Gains Tax, and the greater flexibility onthe use of funds maintained with the EmployeesProvident Fund for property purchases. Whilethe above developments contributed to easingconcerns on the profitability and debt servicingcapacity of property developers (Charts 2.32and 2.33), rising prices of raw materials maypose risks to the growth of the property and

Chart 2.30Profitability of Selected Companies in the E&E Segment

Source: Bloomberg

RM million %

50

0

100

150

200

0

2

4

6

8

10

1Q2004

2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q2005 2006 2007

Return on assets (RHS)Net income

Source: Bloomberg

Chart 2.31Cash Flow Position of Selected Companies in theE&E Segment

3Q 4Q 1Q2005

2Q 3Q 4Q 1Q2006

2Q 3Q 4Q 1Q2007

2Q 3Q 4Q1Q2004

2Q

Interest coverage ratio (RHS)

%

0

8

2

4

6

0

500

Cash flow from operations

100

200

300

400

RM million

50

0

100

150

200

250%

Return on assets (RHS)Net income

3Q 4Q 1Q2005

2Q 3Q 4Q 1Q2006

2Q 3Q 4Q 1Q2007

2Q 3Q 4Q

Chart 2.32Profitability of Selected Companies in the PropertyDevelopment Segment

Source: Bloomberg

1Q2004

2Q

RM million

0

2

4

6

Chart 2.33Debt Servicing Capacity of Selected Companies inthe Property Development Segment

Source: Bloomberg

3Q 4Q 1Q2006

2

0

4

6

8

10

%

Debt-to-equity ratio (RHS)Interest coverage ratio

3Q 4Q 1Q2005

2Q 2Q 3Q 4Q 1Q2007

2Q 3Q 4Q1Q2004

2Q

Times

30

35

40

45

50

Table 2.1Residential Property Transactions and SalesPerformance

1Q-3Q 2006 1Q-3Q 2007 Growth

Residential property transactionsUnits 135,322 149,004 10.1%Value (RM billion) 21.5 26.7 24.3%

Sales performance 11.3% 19.7% 8.4 pptsUnit launched 34,670 33,617 -3.0%Unit sold 3,912 6,611 69.0%

Source: National Property Information Centre (NAPIC), Valuation and PropertyServices Department

construction sector as a whole going forward.Since early 2007, the cost of building materialshas risen steadily as reflected by the BuildingMaterials Cost Index (Chart 2.34) whichincreased to 136.7 as at end-2007 (130.5 atend-September 2007).


22

investments. This led to an increase in the ratio ofhousehold financial assets-to-debts to 217.8%,from 204.2% as at the end of the preceding year.In terms of liquidity, liquid assets grew strongly by18.6% (2006: 12.8%) to account for nearly 60%of total financial assets. The ratio of householdliquid assets1-to-debts consequently expandedfurther to 119.6% as at end-2007 (Charts 2.35and 2.36).

The level of indebtedness moderated slightlywith the ratio of household debts to nominal GDPdeclining to 66.7% (2006: 69.3%) on account of

Households demonstrated strongeradaptability and capacity to adjust to therising cost of livingThe balance sheet position of the householdsector strengthened in 2007, supported by thecontinued rise in disposable income, especiallyamong those employed in the commodity sectorfollowing a sustained period of high outputprices. The higher income level was also achievedon account of wage increments in both thepublic and private sectors. The stronger wealthposition of households was further supported bythe strong performance of the equity market.

Source: CEIC

Chart 2.34Building Materials Cost Index (for Kuala Lumpur,Selangor, Melaka & Negeri Sembilan)

100

110

120

130

140

Mar2006


Jun Sept Dec

Index

%%

60

0

10

20

30

40

50

60

2003 2004 2005 2006 200740

45

50

55

Liquid financial assets (RHS) Banking system deposits

Development financialinstitutions deposits

Unit trust funds

Life insurance policies

Source: Treasury Housing Loans Division, Employees Provident Fund and internal estimates

Chart 2.36Composition of Household Financial Assets (expressed as % of total household financial assets)

Household financial assets

Household debt

Household financial assets to household debt ratio (RHS)

0

200

400

600

800

1,000

Source: Treasury Housing Loans Division, Employees Provident Fund, SecuritiesCommission Malaysia and internal estimates

RM billion Times

Chart 2.35Household Financial Assets to HouseholdDebt Ratio

2003 2004 2005 2006 20071.9

2.0

2.1

2.2

1 Household liquid assets comprise deposits with banking institutionsand two development financial institutions as well as investments inunit trust funds. Meanwhile, household financial assets also includefunds in the Employees Provident Fund and insurance policies akin todeposits.

The household sector hasdemonstrated greaterresilience to rising prices giventhe stronger financial positionand improved indebtedness inan environment of favourablelabour market conditions andwage levels.In addition, a moderation in the pace of growthin indebtedness and the stronger liquidityposition of households also strengthened theirdebt repayment capacity, thus resulting in thecontinued improvement in the quality ofhousehold borrowings throughout the year. Thishas placed households on a better position toadjust to the higher cost of living.

Aggregate household financial assetsexpanded strongly by 15.1% as at end-2007,mainly attributed to the higher growth in savingsand deposits with financial institutions andincreased net asset value of unit trust


23

loans, the bulk of household debts comprisedloans obtained to finance the acquisition of assets(Charts 2.39 and 2.40). Demand for housing loanswas sustained at a high level, particularly tofinance the purchase of high-end properties. Thestrong demand and higher volume of transactionsin the residential property market were partly inresponse to attractive property units withdistinctive characteristics and innovativedevelopment concepts offered by developers.Demand was further supported by more flexiblerepayment and financing packages offered,particularly by banking institutions. As at the endof the year, outstanding housing loans grew by5.9% to RM207.1 billion. Outstanding personalfinancing recorded a strong growth of 23.9% toamount to RM46.8 billion or 10.9% of total

Chart 2.39Composition of Household Debt by Purpose

1 Includes residential and non-residential propertiesSource: Treasury Housing Loans Division and internal estimates

Personal Use,10.9%

Other purpose,6.1%Credit card,

5.5%

Purchase of properties1,

54.5%

Purchase oftransportvehicles, 22.9%

%RM billion

Household debt to GDP ratio (RHS)

Debt service ratio (RHS)

Household debt

Nominal GDP

80

200

300

400

500

600

700

2003 2004 2005 2006 200730

40

50

60

70

Source: Treasury Housing Loans Division and internal estimates

Chart 2.37Household Indebtedness and Debt Service Ratio

0

100

Chart 2.38Employment and Consumer Sentiment Indices

Source: Malaysian Institute of Economic Research

200

406080

100120140

Index

Employment Index Consumer Sentiment Index

1Q2003

2Q 3Q 4Q 1Q2004

2Q 3Q 4Q 1Q2005

2Q 3Q 4Q 1Q2006

2Q 3Q 4Q 1Q2007

2Q 3Q 4Q

Chart 2.40Composition of Credit Providers to HouseholdSector

Source: Treasury Housing Loans Division and internal estimates

Banking system,84%

Treasury HousingLoans Division,

6%

Development financial institutions,

7%

Insurance companies, 3%

stronger GDP growth which outpaced theaccumulation of household debts during the year(Chart 2.37). Household debts expanded byRM31.3 billion during the year to RM427.9 billion.The expansion in household debts in 2007 wasmore moderate at 7.9% compared to an annualaverage growth of 13.9% for the period 2001 to2006. This, in part, was reflective of increasedattention to spending in an environment of risingprices of food and other essentials. The ConsumerSentiment Index however only moderated from124.1 to 110.7 as at end-2007 (Chart 2.38).

In 2007, almost 40% of the increase inhousehold debts was to finance house purchases,while personal loans accounted for another28.8% of the aggregate increase in householddebts. In terms of the composition of outstanding


24

household debts (2006: 9.5%). After a weakerfirst half performance in car sales that recorded adecline of 12.2%, demand for hire purchasefinancing rebounded in the second half of the yearwith the introduction of new domestic and foreigncar models at affordable prices. This resulted in asmall increase of 2% in outstanding car hirepurchase. The bullish equity market performanceled to a growth of 11.1% in householdborrowings for the purchase of quoted securitiesand unit trusts. Nevertheless, these borrowingsaccounted for only a small proportion of 3.4% ofhousehold debts.

The improved level of disposable incomealso strengthened the debt servicing capacity ofhouseholds. Total loan repayments during theyear surged by 16.2% resulting in animprovement in the ratio of repayments todisposable income to 41.1% and larger declinesin the level of delinquencies. As at end-2007,the amount of non-performing household loansin the banking system reduced further by 19.3%to RM19.1 billion. Coupled with the moderategrowth in household debts, the banking systemNPL ratio of household loans improved to 5.3%at the end of the year (Chart 2.41). In addition,the number of personal bankruptcies alsodeclined slightly by 0.6% during the year. Thiswas also attributed to some restructuring ofhousehold debts both by the lending institutionsas well as under the debt managementprogramme of the Credit Counseling and DebtManagement Agency (CCDMA) that hasenabled borrowers to meet the scheduledinstalment payments. Up to 2007, more than5,000 borrowers with aggregate debts totallingRM478 million benefited from the debtmanagement programme of CCDMA.

While growth in unsecured loans continued tobe high, particularly credit card and personal loanswhich expanded by 17.7% and 23.9% respectivelyduring the year, potential vulnerabilities from theseexposures remained fairly limited. On aggregate,these debts accounted for 16.4% of totalhousehold debts with delinquency rates of 2.5%for credit cards and 6.3% for personal loans.Despite the increase in credit card balances, growthin revolving balances moderated while the amountof cash advances remained small, collectivelyindicating manageable liquidity conditions ofhouseholds. The number of cardholders withrevolving balances accounted for 54.7% of totalcredit cards in circulation, of which 34% ofcardholders settled at least half of the cardbalances. Cash advances accounted for only 5.8%of total credit card transactions during the year.

Efforts to enhance data collection at a moregranular level on the household financial positionremained an area of emphasis during the year.This is a necessary step towards enhancing theassessment of household sector issues,particularly in identifying potential stress indifferent segments of the population, henceenabling more pre-emptive policy responses to beimplemented if and where necessary. Availabledata seemed to indicate that while employmentconditions and income levels are favourable,increasing food prices, transportation costs andother costs of living might have some impact oncertain segments of the household sector goingforward, although the risk remains manageableat present. Learning from the experience of thelate 90s, banking institutions are moreforthcoming in formulating debt rehabilitationand management programmes to support thecontinued capacity of borrowers to meet theirdebt obligations, hence preventing prematuredelinquencies. In addition, households can alsoavail themselves of the advisory and debtmanagement services provided by the CCDMA.

FINANCIAL SECTOR RISK ASSESSMENT

Financial system stability and soundnesspreserved amidst mounting challenges on theexternal environmentKey risks to the Malaysian financial system in 2007emanated mainly from developments on theexternal front which translated into higherexposures of financial institutions to market andcredit risks. The strong performance of the bond

Chart 2.41Banking System: NPL Ratio of Household Sector

Total Purchase of transport vehicles

Purchase of residentialproperty

Purchase of non-residentialproperty

Purchase of residentialproperty

Credit card

0

5

10

15

20

2003 2004 2005 2006 2007

%


25

and equity markets during the year alsoencouraged increased investments and activity infinancial assets and instruments, whilecompetition in the lending market and growth instructured products and investments intensifiedfurther. Downside risks emanating from the USsubprime and credit market events were felt onlyin terms of the increased volatility in the equityand bond markets given the small exposures ofthe financial institutions to subprime-relatedinstruments. On aggregate, the financial systemdemonstrated stronger financial resilience. Thecontinued accumulation of financial buffers hasalso led to an increased capacity of the financialsector to withstand higher risk levels from greatermarket volatility and financial shocks. This wasaffirmed by the series of stress tests performedduring the year.

RM77,519 (2006: RM74,786). However,productivity improved for the year as evidencedby the PBT generated per employee ofRM168,094 (2006: RM131,785).

The highly competitive and surplus liquidityenvironment continued to pose downwardpressures on interest margins of bankinginstitutions. NPLs improved to the lowest level ina decade, underpinned by higher recoveries andthe reclassification of NPLs to performing status.This was also driven by intensified efforts tostrengthen balance sheets through write-offs andthe disposal of loans via securitisation andoutright sales. As a result, net NPLs registered asignificant decline of 26.6% to RM20.1 billion, or3.2% of total net loans as at end-2007. Loans inarrears of between two to three months werealso lower for the year, registering a decline of7.2% to account for 1.5% of gross loans. Thesedevelopments contributed to the sustained highlevel of capitalisation of banking institutions. Therisk-weighted capital ratio (RWCR) was sustainedat a level of at least 13% throughout the year,with excess capital above the minimumregulatory capital requirement of RM38.5 billion,providing a sizeable buffer against unexpectedlosses and shocks. Efforts to diversify andenhance the cost efficiency of capital continuedduring the year, as banking institutions benefitedfrom greater innovation in capital managementactivities which contributed to a slight decline inthe composition of Tier-1 capital to 70.8% oftotal capital (2006: 72.7%). On aggregate, thestronger financial resilience enabled the bankingsector to continue to play an effective andefficient intermediary role in the economy and asan enabler of economic growth.

As at end-2007, total deposits mobilised bythe banking sector amounted to RM869.9 billionor 135.6% of GDP, while loan and financingactivities by the banking sector expanded at astrong pace of 8.6% to RM644.2 billion inoutstanding loans and financing, or 100.4% ofGDP. As large businesses continued to tap thecapital market as an alternative source offinancing, the financing portfolio of bankinginstitutions continued to be concentrated in theretail-based sectors. Loans and financing extendedto the household sector and the small andmedium enterprises (SME) accounted for 55.9%and 17.7% of total financing outstandingrespectively.

Assessment of financial sectorrisks during the year waslargely concentrated on theimplications of capital inflowsfor asset markets and lendingbehaviours of bankinginstitutions, increased financialmarket volatility and risingfood and raw material priceson the debt servicing capacityof households and businesses.

The banking system, both conventional andIslamic, posted stronger preliminary unauditedprofit before tax (PBT) of RM17.7 billion for theyear, resulting in a return on average equity of19.7%. The increase of 36.4% in profits wasachieved on account of more diversified incomesources driven mainly by sustained growth inrevenue from financing and related advisoryactivities, the provision of remittance andsettlement services, portfolio and wealthmanagement, as well as trading and investmentactivities. Meanwhile, higher overhead expensesrelating to new establishments and rebrandingstrategies increased by 15.9%. The highlycompetitive labour market in the financial sectorhas also led to higher staff-related expenditureswhich posted a growth of 13.2%. This resulted inan increase in staff cost per employee to


26

Meanwhile, the insurance and takaful sectorrecorded combined premiums and contributionstotalling RM29.4 billion, representing a growthof 11.4% during the year. Driven primarily bystronger demand for savings and investment-related products, new business premiums andcontributions in the life insurance and familytakaful sector grew by 7.6% to amount toRM9.1 billion. Despite lower sales of motor

Table 2.2:Key Financial Soundness Indicators

As at end

2003 2004 2005 2006 2007p

% (or otherwise stated)

Banking SystemRisk Weighted Capital Ratio 13.8 14.4 13.7 13.5 13.2Core Capital Ratio 11.1 11.4 10.7 10.7 10.1Return on Assets 1.3 1.4 1.4 1.3 1.5Return on Equity 15.6 16.7 16.7 16.2 19.7Liquid Assets to Total Assets 8.2 8.0 8.0 8.7 18.6Liquid Assets to Short-term Liabilities 10.7 10.6 10.2 11.1 23.6Net Non-performing Loans Ratio - 3 months 8.9 7.5 5.8 4.8 3.2

Impact of a 1% increase of interest rates (in % of capital) 4.8 5.0 8.3 7.5 4.5 Net Open Positions in FX to Capital Base 3.8 3.9 1.1 4.7 4.5 Net Open Positions in Equities to Capital Base 2.9 2.3 2.1 2.6 2.5

Insurance Companies (RM million)Solvency Surplus1 6,073.6 7,369.5 7,939.0 9,485.1 18,351.2Solvency Margin Ratio1 108.8 109.9 109.7 110.8 120.6Capital Adequacy Ratio n.a. n.a. n.a. 139.6 157.9

Life Insurance & Family Takaful (RM million)Excess of Income over Outgo 9,132.1 11,427.2 10,596.4 12,532.9 15,308.0New Business Premiums / Contributions 5,363.0 7,264.9 7,426.9 8,428.2 9,066.3Solvency Margin Ratio (conventional only) 107.9 108.8 108.7 109.9 121.8

General Insurance & General Takaful (RM million)Underwriting Profit 583.6 577.6 1,126.6 536.3 13.8Operating Profit 1,422.6 1,294.2 1,714.9 1,517.9 1,371.5Gross Direct Premiums / Contributions 8,587.8 9,049.4 9,939.6 10,352.9 10,800.5Claims Ratio 59.0 60.2 54.9 60.5 66.1Solvency Margin Ratio (conventional only) 112.4 114.2 114.4 115.2 120.7

Household (HH) SectorHH Financial Assets to Debt Ratio 216.4 212.4 201.2 204.2 217.8HH Debt to GDP Ratio 65.7 66.0 69.3 69.3 66.7HH Liquid Financial Assets to Total HH Debt Ratio 115.1 113.8 106.3 108.8 119.6Debt Service Ratio 44.7 42.4 41.3 39.8 41.1NPL Ratio of Household Sector 8.7 8.0 7.7 7.1 5.3

Corporate SectorReturn on Assets 5.0 5.9 5.1 5.9 7.0Return on Equity 11.6 11.0 10.8 12.5 13.9Debt-to-Equity Ratio 66.6 65.2 60.1 57.2 59.2Interest Coverage Ratio 5.5 6.1 5.1 5.8 5.7Operating Margin 16.2 16.7 14.0 15.8 19.0NPL Ratio of Business Sector 14.1 13.3 11.1 10.2 7.9

Development Financial Institutions2

Lending to targeted sectors (% growth) 11.4 19.2 29.6 17.5 18.6Deposits mobilised (% growth) 9.0 22.4 12.4 11.1 12.4Non-performing Loans Ratio - 6 months 14.1 13.2 10.4 10.0 8.8Return on Assets 1.4 1.3 3.0 1.5 1.9

1 As at financial year end, except for 2007 position2 Refers to development financial institutions regulated under the Development Financial Institutions Act 2002p Preliminaryn.a. Not availableNote: Insurance figures are based on unaudited calendar year, unless indicated otherwise

vehicles in the first half of the year, the generalinsurance and takaful sector recorded moderategrowth in the level of premiums andcontributions of 4.3%. Operating profits werehigher on account of larger income fromtreasury activities, albeit with weakerunderwriting performance recorded due mainlyto higher claims which also prompted higherreserving provisions. The solvency position of


27

market, which has been concentrated in the paston the funding of housing loans on a recoursebasis, is now becoming increasingly significant forfunding of other types of activities. As at end-2007,banking system deposits accounted for 60% oftotal funding, while total loans securitised by thebanking system through Cagamas Berhad, thenational mortgage corporation, was RM16.6 billion.

Continued inflow of portfolio funds duringthe year amidst an environment of prevalentample liquidity exerted downward pressureson interest ratesWhile liquidity in some major markets tightened,the persistent inflow of portfolio funds intoMalaysia continued to pose liquidity managementchallenges to the banking institutions throughout2007 (Chart 2.43). Up until the onset of thefinancial market turbulence period in the US andEurope, deposits mobilised by the banking systemgrew strongly by approximately 20% compared tothe previous year, attributed partly to the highergrowth in ringgit deposits by non-residents. Thecumulative liquidity surplus of the banking systembased on the estimated liquidity demands andunexpected withdrawals remained high. As at end-2007, the projected surplus was at RM104.5 billionfor the maturity bucket of up to one-week andRM145.6 billion for the maturity bucket of up toone-month (Table 2.3). Given the ample liquidityconditions, the overnight and one-week money

the insurance industry strengthened further withan aggregate solvency surplus of RM18.4 billion(on an unaudited basis) as at end-2007 to bufferagainst potential challenges.

Limited implications of the US subprime crisison the Malaysian financial systemThe subprime crisis has had a minimal impact onthe operations, profitability and solvency of theMalaysian financial institutions, as well as onliquidity in the system. Both direct and indirectexposures of financial institutions in terms ofholdings of securities linked to US subprimemortgages and lending to entities associated withthe subprime mortgage business were minimal,accounting for about 0.3% of the banking systemcapital base. These exposures were limited to theoverseas operations of a few domestic banks. Onaggregate, banking system exposures to foreignsecurities holdings only accounted for less than0.5% of total banking system assets. In the caseof the insurance industry, investments in subprimerelated securities accounted for not more than 1%of total foreign assets in the investment-linked funds.

During the two-week period of heightened riskaversion and volatility in the financial markets inAugust 2007, Malaysia, like other regionaleconomies experienced some net capital outflowsas the unwinding of positions took place.Nevertheless, liquidity in the Malaysian financialsystem continued to remain ample and moneymarket rates were stable with no bankinginstitutions experiencing difficulty in sourcing fundsfor their liquidity needs (Chart 2.42). The Malaysianbanking system lending is predominantly funded bydeposit-based instruments. The securitisation

Chart 2.42Banking System: Liquidity Buffer

As % of total deposits

8

10

12

14

16

18

20

22

Jan2006


Mar May Jul Sept Nov

<1 week in maturity

>1 week to 1 month in maturityOther liabilities

Other assets Other debt securities issued

Securities held andsold under repo

Other borrowings andsub debt capital

Loans Interbank borrowings

Interbank placements Deposits accepted

Deposits placed & reverse repos Capital

0

20

40

60

80

100%

Chart 2.43Composition of Assets and Liabilities of theBanking System

Assets Capital and Liabilities


28

market rates remained almost unchanged at 3.49%per annum and 3.52% per annum at the close of2007. The rapid growth in banking system depositswhich outstripped the expansion in financingactivities in the first half of the year led to downwardadjustments in deposit rates offered by some

Table 2.3Banking System: Liquidity Projection as at 31 December 2007

Cumulative mismatch (RM billion) Buffer as % of total deposits

≤1 week1 >1 week to 1 month2 ≤1 week1 >1 week to 1 month2

Commercial banks 83.3 114.9 14.6 20.2Islamic banks 9.7 17.2 16.1 28.5Investment banks 11.5 13.5 34.7 40.9

Banking system 104.5 145.6 15.8 22.01 ≤3 days bucket for investment banks2 >3 days to 1 month bucket for investment banksNote: Numbers may not add up due to rounding

Interbank rate (1-week)

J J2007

% %

3.68

Chart 2.44Movements in Interbank Rate, Average LendingRate and Average Cost of Funds

2.8

3.0

3.2

3.4

D2006

M A MJ F A S O N D4

5

6

7

Average Lending Rate (ALR) minus Average Cost of Funds

ALR (RHS)

Average Cost of Funds

Total deposit growth (RHS)Total loan growth (RHS)

Gross interest margin Net interest margin

Chart 2.45Banking System: Movement in Gross and NetInterest Margins

Percentage point Annual growth (%)

Dec'05 Mar '06 Jun '06 Sept '06 Dec '06 Mar '07 Jun '07 Sept '07 Dec '07

0.0

0.5

1.0

1.5

2.0

2.5

3.0

5

0

10

15

20

25

Average quoted FD rate (%) RM million

Chart 2.46Banking System: Movement in PER andAverage Quoted FD Rates

200

250

300

350

400

3.0

3.1

3.2

3.3

3.4

3.5


PER (RHS)

6-month3-month

9-month

2007

banking institutions. While the adjustments helpedto ease the rising pressures on interest margins, theincrease of 16.9% in interest expense on depositsand intense competition in the lending marketcontributed to a 0.15 percentage point decline in thegross interest margin to 2.70 percentage points.Nevertheless, continued improvements in assetquality which reduced loan loss provisions partiallyoffset the decline to record a marginal increase in thenet interest margin of the banking system, albeitremaining tight at 0.39 percentage point (Charts2.44 and 2.45). Meanwhile, the lowering ofconventional deposit rates lessened the displacedcommercial risk (shifting of Islamic to conventionaldeposits due to higher returns on conventionaldeposits) on Islamic deposits. Consequently, theprofit equalisation reserves (PER) averaged at aboveRM300 million in 2007 (Chart 2.46).

Some of the portfolio inflows were alsodirected to the property market segment. Overallproperty prices remained largely stable, albeit witha slightly higher increase observed in the prices ofresidential properties in specific prime locationsdue to strong demand in the high-end segmentfrom both residents and non-residents. The


29

Malaysian House Price Index was sustained at122.2 in the first half of 2007, with a moderateincrease of 3.2% compared with thecorresponding period in the previous year. Whilethe average house price for the country stood atapproximately RM169,000 in the first half of theyear, the average house price for Kuala Lumpurwas higher at approximately RM342,000 whilethat for the state of Selangor was approximatelyRM248,000 reflecting the higher prices in theprime locations. Risks arising from financialinstitutions’ exposures to the property sector haveremained within prudent levels, with more robustcriteria applied by financial institutions in assessingand approving loan applications. Moreover, therisks are further balanced by the stable outlook forproperty prices. The favourable developments inthe property market will not only provide astronger impetus for growth in housing loans, butalso have positive effects on other supportingindustries, hence promoting further opportunitiesfor financial institutions.

Financial institutions generally benefitedfrom the vibrancy of the domestic financialmarkets albeit faced with higher credit andmarket risksThe bullish performance and higher trading activitiesin Bursa Malaysia led to higher financing demand forthe purchase of quoted securities and unit trusts. Thedrawdown of existing credit lines by both individualsand business entities also expanded stronglyespecially in the first quarter, resulting in the robustgrowth in disbursements of 261.9% during the year.In addition, growth in approvals was also high at305.3%. While credit risk exposures to the equitymarket increased, the level remained low at 4% oftotal outstanding loans (end-2006: 3.3%), with acorresponding improvement in the delinquency rateto 4.6% (end-2006: 9.5%).

In 2007, revenue from the fee-based businesssegment, particularly in corporate advisory services,remittances and wealth management services,expanded by 33.3% to account for 16.8% of totalincome (Chart 2.47). Income from treasury activities,supported by the bullish domestic financial marketperformance, posted a strong growth of 26.1% toaccount for 17.6% of total income (2006: 16.2%).Securities held for trading purposes grew by 55.2%to account for 4.3% of total banking system assets.The expanded size of the treasury portfolio ofbanking institutions translated into higher marketrisk exposures, in terms of both equity and interestrate risks, as reflected in the 31.3% expansion in

total market risk-weighted assets. Risk exposuresarising from equity holdings remained below 1% oftotal banking system assets in 2007. On aggregate,the banking system exposure to equity marketmovements from proprietary holdings and marginfinancing remained low, accounting for only 2.5% oftotal banking system assets. Total holdings ofsecurities, both fixed income and equities, by theinsurers grew by 14.7% to account for 65% of totalassets, the bulk of which was in the form of higherrated investment-grade corporate debt securities andMGS. The higher risk exposures of insurers werecompensated by the significantly higher net gainsfrom disposal of securities and investment income,which expanded by 63.8% to account for 59.3% oftotal income.

Exposures to currency fluctuations as apercentage of total market risk-weighted assetsremained stable across all banking institutions,reflecting an unchanged risk appetite in currencytrading and investment activities. While thedirectional open positions in certain majorcurrencies were evident in anticipation of a furtherweakening of the US dollar in the aftermath of thesubprime crisis, the potential impact of volatileforeign exchange rates remained low with thecorresponding net open position accounting foronly 4.5% of the capital base of the bankingsystem (Chart 2.48). In terms of capital charge,foreign currency-denominated exposuresaccounted for 0.8% of capital base.

The greater usage of interest rate swaps andfutures during the year led to lower interest raterisk exposures of banking institutions to account


RM billion %

00.51.01.52.02.53.03.54.04.5

0

10

20

30

40

50

60

70

Treasury income

Net interest income Fee income

Chart 2.47Banking System: Composition of Income

% of treasury income tototal income (RHS)

Market risk weighted assets as a% of capital base (RHS)

2007


30

for 4.5% of the capital base. The outstandingnotional amount of these contracts increased by9% during the year to RM507 billion. Spreadsbetween MGS and corporate bonds remainedfairly stable throughout 2007, both acrosstenures and credit grades. Nonetheless, awidening of such spreads, as observed in theearly part of 2008, may amplify the magnitudeof basis risk, thus affecting the effectiveness ofhedging strategies previously undertaken.

Underwriting discipline was sustained in anenvironment of intensified competition andinnovations in credit productsCompetitive pressures in the credit marketremained intense, especially in the retail lendingmarket where the products and services offeredare generally less differentiated. This wasevidenced by the more competitive rates offeredon housing loan packages, greater repaymentflexibility and aggressive marketing andadvertising strategies. Some of the attractivefeatures offered include the lengthening of loantenures, rebates on interest charged and flexiblegraduated repayment plans with an option todefer principal repayments. Meanwhile,competition was also visible in the non-banksegment that saw insurance companies offeringcross-generation loans with flexible repaymentoptions in addition to the traditional fixed-ratefinancing. The increased attractiveness ofhousing loan products resulted in an increase inhousing loan applications received by bankinginstitutions by 48.3%. Similarly, loanapplications for personal use registered a higherincrease of 59% in 2007. This was in partsupported by promotional activities by banking

institutions in attempts to expand the micro-credit portfolio by targeting new customers toestablish new banking relationships (Charts 2.49and 2.50). Meanwhile, on the funding side,strategies focused mainly on attracting depositsfrom high net worth individuals as a means tobroaden the customer base and prospects forwealth management activities. As at end-2007,deposits placed by individuals expanded by10.5% to RM330.6 billion.

These developments raised concerns on theunderwriting standards and risk managementpractices of banking institutions, particularly in thelight of the subprime problems in the US. Theproliferation of creative advertising which to someextent, lacked proper disclosures on importantinformation such as effective financing rates,interest computation methods and existence ofincidental costs or charges, was another area of

Chart 2.48Banking System: Market Risk Exposures

1 Amount of investment in quoted shares

Capital charge on trading book market risk

Equity holdings1

Foreign currency net open position

Duration weighted net position (interest rate risk)

02

-2

468

101214

Sept '05 Dec '05 Mar '06 Jun '06 Sept '06 Dec '06 Mar '07 Jun '07 Sept '07 Dec '07

Chart 2.49Banking System: Annual Growth of Loan Applications

Credit card

Purchase of residential property

Purchase of securities

Personal use

Purchase of transport vehicles

Annual growth (%)

-50

050

100

150200

250

300350

D2006


D2006


50

60

70

80

90

100

%

2007

Chart 2.50Banking System: Loan Approval Rates

Credit card

Purchase of residential property


Personal use

Purchase of transport vehicles


31

concern. An assessment of these concerns toidentify the possible excessive build up of risks andweaknesses in risk management practices ofbanking institutions revealed that on aggregate,the downside risks emanating from the housingand personal loan portfolios of bankinginstitutions remained subdued, underpinned bythe strengthened credit assessment capacity andunderwriting standards maintained by bankinginstitutions. The assessment was supported by anumber of factors:• the risk management infrastructure and practices

of banking institutions continued to strengthen.This included the adoption of a wider range ofcriteria and risk drivers in credit scoring and riskratings, particularly in preparation for theimplementation of Basel II (2008 for bankinginstitutions adopting the standardised approachesand 2010 for those adopting the Internal Ratings-Based approaches);

• greater accessibility to current and morecomprehensive information on the borrowers’debt levels and performance of their existingloans through the Central Credit ReferenceInformation System (CCRIS) that enables amore informed decision making process;

• the overall approval rate for household loanswas lower at 60% for the year compared to66.2% in 2006, despite the strong demand.The approval rate for personal loans wasmuch lower at 50.5%;

• unsecured personal loans accounted for asmall proportion of 7.5% of outstandinghousehold loans amidst a continuedimprovement in the NPL ratio to 6.3% as atend-2007 (2006: 7.7%); and

• NPLs for housing loans recorded a significantdecline of 13.4% in 2007 to RM12.2 billion,resulting in the NPL ratio for housing loansimproving to 7% (2006: 8.7%) from the peakof 9.9% in 2000. This was further supported bya fairly stable level of past due housing loans atapproximately 4% of total outstanding loans.

The prevalent "originate-and-hold" businessmodel adopted by banking institutions for thelending segment provides sufficient incentives forthe continued vigilance in assessing thecustomers’ repayment capacity and the constantmonitoring of the quality of the loan throughoutits lifespan. This is discussed in further detail in"Characteristics of Malaysian Housing Finance".

Characteristics of Malaysian Housing Finance

• "Originate-and-hold" versus "originate-and-distribute" business models❍ Financial institutions adopt the originate-and-hold business model where credit risks are

retained within financial firms’ balance sheets until the loan is fully repaid or refinanced withanother institution. This provides strong natural incentives for lending institutions to vigilantlyconduct thorough due diligence on prospective borrowers and to continuously monitor theperformance of mortgages until maturity or full settlement.

❍ The attractiveness of residential mortgage-backed securities and other forms of securitisationfor credit risk reallocation purposes has thus far been limited due to the strong capitalisationof financial institutions, improving loan quality and continuous improvements in riskmanagement infrastructure and practices.

• Deposit-based versus wholesale-based funding structure❍ The housing loan portfolio is funded largely from customer deposits given the high

proportion of deposits placed with the banking institutions, while the housing loan portfolioof insurance companies is funded from premiums received from policyholders.

❍ These limit the exposures of lending institutions to fluctuations in market liquidity.• Fixed versus variable rate financing

❍ Housing loans are typically based on variable rates and referenced against the Base LendingRate, except for home financing under the Islamic principles which is largely based on a fixedprofit rate, and those extended by insurance companies which are also based on fixed rates.As at end-2007, 82.8% of housing loans extended by banking institutions were on thevariable rate basis.


32

❍ Most housing loan products offered by banking institutions provide for a preferential/graduated lending rate in the initial three to five years of the loan. This is reflective of the sell-then-build concept characteristic of residential property development in Malaysia, where fulldisbursement of the housing loan generally occurs in year three.

• Risk management infrastructure❍ At the institutional level, risk management practices have strengthened with the adoption of

internal ratings-based and credit scoring models to facilitate underwriting processes anddecisions. Some financial institutions have also begun to incorporate behavioural aspects ofborrowers in their internal ratings. In addition, there has been a strong improvement in loanmonitoring, management and recovery.

❍ The Central Credit Reference Information System (CCRIS), to which all banking institutionshave access, provides extensive information on the debt level and quality of the debtexposures of all borrowers, regardless of the value and performance of the exposures.

• Lending to low and middle income groups❍ Credit decisions and risk management standards for housing loans extended to the low and

middle income segments are based on the same prudential considerations as other creditsextended by financial institutions to ensure that such exposures do not unnecessarily result inexcessive risk exposures to the institutions. Proof of income is a compulsory documentrequired in the processing of loan applications.

❍ Effective from 1 January 2008, the Government has set aside funds totalling RM50 million,through Syarikat Jaminan Kredit Perumahan and Prokhas Sdn. Bhd., to provide guarantees onhousing loans extended by financial institutions to deserving low and middle income borrowers.

• Providers of housing finance❍ Housing finance is largely provided by regulated entities, namely banking institutions and

development financial institutions, with a growing participation of life insurance companies inthe more recent periods. Collectively, lending by these institutions account for 85.2% of totalhousing finance.

❍ Other participants in the housing finance market include the Malaysia Building Society Berhad,the Treasury Housing Loan Division (that provides housing loans to public sector employees), theSabah Credit Corporation and the Borneo Housing Mortgage Finance Berhad.

• Institutional arrangements for consumer education and financial literacy❍ Bank Negara Malaysia has established bankinginfo, an information portal on financial

products and current rates offered by banking institutions, to facilitate comparisons byconsumers.

❍ The Credit Counselling and Debt Management Agency (CCDMA) provides counselling andadvisory services relating to budgeting and financial management. The CCDMA also providesassistance in the resolution of potential credit issues through debt management andrestructuring programmes for individual borrowers.

Downside credit risk remained low resultingfrom stronger risk management andsupported further by the sustained debtservicing capacity of households andbusinessesThe strengthened institutional setup andenhanced risk management capacity of bankinginstitutions contributed to the reduced downsiderisk of credit losses. This was further boosted bythe stronger financial position of householdswhich strengthened the flexibility of households toadjust to the gradual rise in the cost of living.Correspondingly, robust growth in the business

sector has bolstered the capacity of corporationsto service their debt obligations. Despite themoderation in exports, the financial performanceof the business sector was sustained whiledelinquency rates improved further. As a result,the level of NPLs has continued to decline withimprovements observed in SME and corporateloans (Chart 2.51).

Advancements in the risk managementinfrastructure and practices through the use ofretail credit scoring, improved information andportfolio management systems, as well as


33

enhanced loan administration, monitoring,management and recovery processes, have beenfundamental in supporting improvements in assetquality and lowering the potential risk fromcontinued loan growth. In line with ongoingefforts to fortify the loan management andresolution process, a number of bankinginstitutions disposed off their NPLs to investorsthat specialise in loans management and recovery.Furthermore, the expansion in credit risk transferinstruments in the domestic market had alsoencouraged more hedging activities amongfinancial institutions. Collectively, thesedevelopments strengthened credit riskmanagement by financial institutions andimproved recoveries and the reclassification ofNPLs to performing status, while loan losscoverage of the banking system strengthenedfurther to 77.3%.

Greater challenges in sustaining underwritingperformance by general insurers and takafuloperators, and in managing asset-liabilitymismatches by life insurersThe stronger solvency position and enhanced assetliability management contributed to the sustainedperformance of the insurance and takaful sector in2007. This was also boosted by the favourabledomestic financial market conditions that led to thegeneration of higher investment income. Newpremium growth for life insurers (+6.1%) andfamily takaful operators (+15.8%) was sustaineddue to the growing demand for investment-linkedproducts. Meanwhile, the general insurance andtakaful sector experienced weak performance in the

motor segment particularly in the first half of theyear, attributed to lower sales and prices of motorvehicles as well as higher claims primarily due to theincrease in theft and bodily injury claims. This wascompensated by strong growth in the medical andhealth, as well as the marine, aviation and transitbusiness segments, resulting in a modest growth inoverall gross direct premiums of 4.3% for thegeneral sector. Coupled with higher claimsreserving provisions by several large players, thesedevelopments exerted downward pressure onoverall underwriting margin (Chart 2.52). Movingforward, the general insurance industry is likely toface continued challenges from higher claimsexperience in an environment of more volatilefinancial market conditions, increasing competitionas well as a still relatively fragmented industry.

The life insurance industry continued to facechallenges in managing the mismatch betweenassets of the insurance funds and the longer-term insurance liabilities. While the availabilityof long-term financial instruments hasincreased, continued inflows of portfolio fundsintensified competition for high qualityinvestments, leading to lower yields in the debtsecurities market. This made it more difficult forinsurers to obtain acceptable securities thatadequately match the duration profile andreturn requirements. Recognising thesechallenges, life insurers are required to providecapital to mitigate the mismatch risk. As at theend of 2007, the basic capital charges forinterest rate risk in the life insurance funds(based on the Risk-Based Capital frameworkparallel run submissions by insurers) accountedfor almost 22.5% of total capital charges.

RM billion %

Chart 2.51Banking System: Non-Performing Loans (NPL)Level and Ratio

Net NPL 3-month Net NPL ratio 3-month (RHS)

Business NPL ratio (RHS) Household NPL ratio (RHS)

SME NPL ratio (RHS)

Dec2005

Mar2006


Jun Sept Dec0

10

20

30

40

02468101214

Chart 2.52General Insurance and Takaful Businesses:Claims Ratios

%

79.7

71.4

66.270.169.4

66.160.5

54.960.259.0

40

60

50

70

80

90

2003 2004 2005 2006 2007

Motor claims ratio Total claims ratio


34

Financial system expected to remain resilientunder adverse stress scenariosIn view of the increasing interconnectednessbetween the domestic and international financialmarkets and higher contagion risks, a series ofmacro stress tests were conducted to assess thepotential implications of adverse equity marketmovements for banking institutions, insurers,takaful operators and households, and their abilityto adjust under such conditions. These wereconducted in addition to the regular stress testsused as part of ongoing surveillance activities.Stress scenarios were simulated based on theFebruary-March 2007 sell-off, the stock marketfallout experienced during the Asian financial crisisand the 1993-94 equity price correction. As thetransmission of stress could also be through thefinancial institutions’ exposures to households,similar shocks were applied to the households’unit trust portfolio. Stress testing the scenarios onthe position of the households revealed thathouseholds could withstand shocks from asignificant decline in the net asset value of theirunit trust investments which accounted for 16%of total household financial assets, withoutsignificantly affecting the debt servicing capability.In addition, the impact from potential secondround effects on the debt servicing capacity of thehousehold and corporate sectors was alsoassessed. The shocks were applied to both theloan and debt securities portfolios of the financialinstitutions based on the high losses experiencedduring the Asian financial crisis. The outcome ofthe stress tests again indicated that the financialinstitutions and households have the capacity andability to make adjustments and adapt, given thewealth that had been accumulated over the pastseveral years. For banking institutions, the strongreserves position with capital in excess of theminimum Basel I requirement of RM38.5 billion,also would enable potential losses to be absorbedwith only a minimal impact on capitalisation,although the impact on profits from the maximumpotential loss would be larger.

For the insurance and takaful sector, moresevere shock scenarios were applied due to thehigher exposures to the equity market of 14.2%of total assets. These tests produced favourableresults, indicating a sufficient level of solvencysurplus of the insurance industry to buffer againstsignificant adverse movements in equity prices. Inaddition, micro level stress tests for the insuranceindustry were also performed based on a

combination of additional stress parameters, suchas bond downgrades and higher net claims.Despite the extent of the simulated scenarios, thesolvency margin ratios of insurance companiesremained sufficiently high with the exception of asmall number of institutions that may requiresome capital injection under the most extremescenario.

A series of stress testsconducted during the yearyielded positive resultsindicating that financialinstitutions and householdsare well-positioned to adjustand adapt to stress conditionsgiven the wealth accumulationover several years.

The series of financial market disruptions inthe second half of the year led to some briefperiods of net outflows from Malaysia. Outflowsof foreign funds drove MGS yields upward andcreated greater volatility in the domesticsecurities market, while credit spreads on below-investment grade PDS widened in July and earlyAugust. While the implications for the domesticfinancial system were negligible due to theminimal subprime-related exposures, theresultant higher volatility in the domestic equityand bond market was the key transmissionchannel for the subprime crisis.

In anticipation of a possible worsening ofexternal financial market conditions, another seriesof stress tests was conducted to assess therisk-bearing capacity of the financial system.Despite assuming high volatility shocks based onprevious major sell-off events, the banking systemremained well-positioned to absorb potentiallosses in their fixed income portfolios, with thepotential impact on RWCR not exceeding1 percentage point across all types of bankinginstitutions (Chart 2.53). Similarly, equity pricecorrection scenarios based on worst historicalevents were also simulated against bankinginstitutions’ direct investments in ringgit andforeign quoted shares. The maximum combinedpotential impact on the profitability of banking


35

institutions would not exceed 40%. In terms ofinsurance companies’ equity exposures, testsrevealed that the KLCI would need to contractsubstantially before fully depleting the unrealisedgains of the insurers. Even in the extreme scenariowhereby the entire market value of equityexposures were assumed to fall by 100%, theoverall insurance industry would still record asolvency surplus of RM1.1 billion, demonstratingthe resilience of the industry to shocks.

Risks emanating from payment systemsremained low underpinned by the robustinfrastructure and continued attention givento business continuity managementPreserving financial stability requires the stability ofnot only financial institutions and markets but alsothe payment systems. Thus, measures continuedto be focussed on enhancing the systemicallyimportant payment systems (SIPs) to minimisepotential payment and settlement disruptions thatmay pose risk to overall stability. These include theintroduction of a delivery versus payment (DvP)settlement service during the year to facilitate thesimultaneous delivery of Malaysian-issued USD-denominated securities deposited in the Real-timeElectronic Transfer of Funds and Securities(RENTAS) system with their corresponding USDpayments, thus eliminating potential settlementrisk associated with the trading of these securities.On operational risk, comprehensive and robustbusiness continuity management has been put in

place whereby regular runs of contingencyprocedures were conducted by the Bank andmembers of the payment systems. In addition toenhancing SIPs, measures were also put in place tostrengthen the retail payment systems particularlyto mitigate risks associated with fraud. The risks aswell as the mitigation measures are furtherelaborated in the chapter "Payment andSettlement Systems".

RISK ASSESSMENT GOING FORWARD

Economic outlook and potential risksThe 2008 global economic growth outlook isexpected to be less favourable, with heighteneddownside risks to global growth arising fromgreater uncertainty in the state of the USeconomy, continued adverse developments in theglobal financial markets, potential disorderlyunwinding of global imbalances and risinginflationary pressures emanating from higher food,commodity and energy prices. The financialmarkets are expected to remain volatile in 2008.The turbulence as experienced by some of themajor financial markets is expected to worsen withthe contagion having spread to the prime marketand instruments. This has been influenced by theindiscriminate behaviour of investors andparticipants as deteriorating credit conditions andcontraction in risk-taking are further compoundedby the increasingly complex interdependencies inthe financial system. The extent of the problem

Chart 2.53Potential Impact on RWCR

Sharp adjustments in equityprices

Defaults in corporate debtsecurities

NPL shocks

Combination of shock factors

0.0

Potential Impact on RWCR (in percentage points)

Sho

ck f

acto

rs

-3.0 -2.5 -2.0 -1.5 -1.0 -0.5


36

has also spread to a wider credit crunch in someeconomies. Continued uncertainty surroundingasset valuations, the scale and distribution offurther losses as well as the ratings of securitiesinsured by monolines remains high, and has notbeen fully accounted for by loss reports thus far.The further crystallisation of warehousing riskamong major banks may trigger more write-downs as the demand and price of leveragedloans intended for distribution decline further.Distress in major global financial institutions as aresult of more losses would further undermineinvestors’ confidence, potentially leading toprolonged volatility across all major asset classesand financial markets. This will exert greaterdownward pressure on the capital position of USfinancial institutions that may weaken further theirlending capacity. Effective ongoing measures torestore confidence in the creditworthiness andsolvency of such financial institutions will thereforebe crucial to ensure gradual improvements ininternational market liquidity and the creditintermediation process.

the lower demand for domestic exports and aprolonged period of high prices of rawmaterials and energy would pose challenges tobusinesses. While businesses have accumulatedlarge buffers over several years, strains onoperating revenue and the thinning of marginsmay impact the debt servicing capacity ofsome businesses. The increased internationallinkages would also expose the domesticfinancial markets to greater volatilities. Asinvestors’ risk aversion heightens further, thiscould potentially cause spreads for Malaysiancorporate securities to widen, hence increasingthe cost of borrowings from the capitalmarket. Continued pressures may compelbusinesses to pass on the increased costs toconsumers at large. While the outlook fordomestic employment and income levelsremains favourable, the environment ofincreasing expenses will need to be managedby households. On aggregate, closermonitoring of the potential contagion risksemanating from a weaker global economicenvironment and protracted period of marketturbulence would remain an area of prioritygiven the openness of the Malaysian economy.

Meanwhile, the more favourable outlook forgrowth prospects in the Asian region and emergingeconomies will continue to attract continuedinflows of capital into these economies, includingMalaysia. Broadly, such developments would befavourable and desirable for growth and wealthcreation, as well as for the performance of thedomestic financial markets. At the same time,sustained periods of highly mobile capital inflowscould potentially fuel the formation of asset pricebubbles in the domestic financial and propertymarkets which could have major adverseimplications for financial stability.

As the fragility of the external environmentremains an area of concern, any sudden reversals,especially that arising from higher risk aversionand the need to unwind investment positions tocover potential losses in other markets, mayresult in asset price corrections in the domesticfinancial and property markets. In addition, thepersistent surplus liquidity in the system couldalso induce imprudent behaviour and practiceswithin the financial institutions such as acompromise in underwriting standards forlending facilities. Balancing the trade-offsbetween realising the benefits from capital

Surveillance of the financialsector in 2008 will focus onassessing the transmissionimplications of developmentsin the external environment,persistent large capitalinflows, volatility in thefinancial markets andinflationary pressures for risksto financial stability. The useof forward lookingassessments will intensify toensure the Bank’s state ofreadiness to implement pre-emptive policy responses inmanaging any challengingimplications.

On the domestic front, the continuedfavourable growth prospect for the Malaysianeconomy is expected to provide a supportiveenvironment for financial stability. However,


37

inflows and at the same time, managing theassociated risks effectively will remain a keysupervisory challenge.

Outlook for financial stability remainsencouraging amidst heightened downsiderisksHeightened uncertainty in the globalmacroeconomic and financial environment willpresent a more challenging environment to theMalaysian financial institutions in the year ahead.While worsening credit conditions and asset pricevolatility in the global financial system are expectedto persist and could have wider ramifications on theinternational financial markets, the potentialdestabilising effects on the Malaysian financialsystem will be cushioned by the substantial financialbuffers accumulated and enhanced riskmanagement capacity. The improved risk bearingcapacity, supported by strong profit performance,adequate liquidity buffers and capitalisation atlevels well above the regulatory minimum, willenable the financial system to withstand furthershocks and contagion effects emanating from thevolatile external environment.

Recent trends in rising operating costs offinancial institutions, partly stemming from higheroverheads and marketing expenditures onrebranding and advertising to capture market share,will to some extent exert downward pressures onmargins. In addition, the limited supply of new andspecialised talent for the financial services industry,and the consequent higher remuneration packagesoffered to attract and retain competent andexperienced staff amidst the intense competitionand high mobility in the labour market are expectedto pose further challenges to financial institutions.This necessitates closer surveillance to ensure thatproductivity levels continue to improve and that thehigher staff cost and scarcity of talent in criticalareas do not result in unfavourable implications forinstitutional stability.

Moving forward, the macroprudentialsurveillance and supervisory activities of the Bankwill focus on several key areas:• strengthening the robustness of risk

transmission assessments, in terms of thechannel and magnitude of transmissions fromexternal developments to the Malaysianfinancial markets, businesses and householdsas well as the financial sector;

• ensuring that the risk-bearing capacity of

financial institutions to respond to these risksis enhanced further;

• overseeing the comprehensiveness andeffective implementation of enterprise-widerisk management within financial institutions;

• reviewing the effectiveness of current liquiditymanagement plans to deal with suddenliquidity pressures in the domestic or foreigncurrency markets; and

• strengthening further the Bank’s crisismanagement framework to secure its state ofreadiness to respond effectively tosystem-wide distress conditions.

These will be complemented by continuousenhancements in capacity building initiatives withinthe Bank. This includes efforts in enhancing theforward-looking aspects of the macroprudentialsurveillance framework which will encompass thedevelopment of quantitative assessment tools andleading indicators, as well as enhancedapproaches for gathering market-based and moregranular information. The development ofsurveillance tools, such as the vulnerabilityindicator for the banking sector (VIBeS) (discussedin further detail in the box article "Enhancing BankNegara Malaysia’s Surveillance Framework –Forward Looking Indicator of Banking SystemVulnerability"), will facilitate a more integratedand predictive approach towards risk assessment.In view of recent financial market developments,the methods and approach to macro and microstress tests will be further enhanced to ensure therobustness of the scenarios and assumptions used.These include the incorporation of sufficientlyextreme and contagion events, as well asbehavioural and second-round impacts to providemore realistic and holistic assessments.

Given the inter-linkages of the financialsystem with the real economy, the identificationand monitoring of key risk drivers in variousbusiness segments will provide early warningsigns of distress that may spill over into largercredit risk exposures borne by financialinstitutions. Efforts to enhance the assessment ofhousehold sector issues and collection of microlevel household balance sheet and income datawill also be another key area of focus for theyear. These include the development of vintageprofiles for housing loans and furtherenhancements to the CCRIS in terms of datagranularity and coverage. This would ensure thatthe assessment of emerging risks in the various


38

segments is not masked at the aggregate level.The enhanced information content in CCRIS willalso assist in credit assessments and riskmodelling by financial institutions. Another areaof focus will be further strengthening theinteraction between macro- and micro-

surveillance activities within the Bank. Thisprovides inputs for the implementation of a morestructured and forward-looking assessment offinancial institutions’ risk profiles and riskmanagement systems under the risk-basedsupervisory framework.

Risk Assesment of the Financial System

39

Enhancing the Surveillance Framework – Forward Looking Indicator of BankingSystem Vulnerability

The task of preserving financial stability has become more challenging to policy makers especially in anenvironment of a rapidly evolving financial landscape and greater volatility in financial markets. Thechallenge is even greater for an open economy with increasing integration and inter-linkages with theexternal environment. Having in place a robust and integrated macroprudential surveillance framework istherefore critical to facilitate the early identification of emerging threats and risks to financial systemstability. More importantly, it provides the lead time for appropriate policy responses and theimplementation of pre-emptive measures to preserve the intermediation function and financial stability.

Macro-Surveillance FrameworkStrengthening the Bank’s macroprudential surveillance capabilities is a key priority of the Bank. Thestrategy adopted has been all-encompassing in terms of the framework and infrastructuredevelopment, capability enhancement, governance structure and communication. In formulating themacroprudential surveillance framework, the Bank takes cognisance of the potential threats that mayemanate directly or indirectly from increasingly complex interlinkages between the financial systemand the real sector, greater global trade and financial integration, as well as from payment andsettlement systems. Essentially, the focus of the Bank’s macro-surveillance activities encompasses:• monitoring macro-financial linkages associated with developments and emerging trends in the

external sector, domestic economy and financial markets, and corporate and household sectors,as well as assessing their potential contagion implications for the financial system; and

• monitoring and evaluating the development of sector specific issues within the financial sectorand the potential implications for overall system wide stability.

An assessment of the extent of risk to financial stability is reached by incorporating bothquantitative and qualitative information using static and trend analyses, as well as scenario andsensitivity analyses through integrated macro stress tests and market intelligence. These assessmentsare also integrated with the micro-surveillance oversight functions of the Bank.

Micro level assessments of:� risk areas and risk management practices� business strategy and governance issues� risk absorbing capacity

Macro level assessments of:� exogenous and endogenous risks and vulnerabilities� contagion effects, transmission channels and impact on financial institutions and systemic stability

FINANCIALSTABILITY

SURVEILLANCE

Macro-surveillance Activities

Monitoring macro-financial linkages and assessing potential contagion from the real and external sectors

Monitoring and evaluating development of sector specific issues and their potential impact on system wide stability

* These forward looking surveillance tools are currently being developed for use by Bank Negara Malaysia

Microprudential

Macroprudential

Historical and current

Forward looking

Macroprudential Analysis

� Static and trend analyse� Market intelligence

� Macro stress test � Resilience Score* � Vulnerability Indicator of Banking Sector (VIBeS)*


40

Assessments of the potential risks to financial stability are conducted in a holistic manner,internally within the Bank and with other domestic regulators. The key potential risks to financialsystem stability once identified, assessed and ranked in the order of importance, are used as inputsto achieve coherent policy formulation and coordinated pre-emptive actions among keystakeholders including financial institutions, other domestic regulatory and supervisory authorities aswell as with regulators from other jurisdictions. The outcome also ultimately forms the basis forcommunication of risks to financial system stability to the general public.

There is recognition that forward looking quantitative tools form a key component of a robustmacro-surveillance framework. Accordingly, the continuous development of these tools to aidcoherent and integrated analysis is given importance. The following describes the development ofone of these surveillance tools which measures the level of vulnerability of the banking sector, themethodology and underlying assumptions adopted, as well as present efforts being undertaken toensure the robustness of the tool.

Vulnerability Indicator for Banking SectorThe vulnerability indicator for the banking sector, or VIBeS, is a composite of risk indicators thatmeasures the intensity of systemic distress at a particular point in time. Recognising the limitationsof the previously developed binary variable Early Warning System in elucidating intensities of variousdistress symptoms and capturing the complexities of banking crises, a more robust compositeindicator is being developed to quantify systemic vulnerability that may emerge from differentsources. This measure of banking sector conditions aims to enable early prognosis of distress build-up prior to the occurrence of a crisis. Using information derived from macroeconomic and financialimbalances, VIBeS will assist in forecasting future conditions in the banking sector. The generalapproach used in developing the VIBeS framework is adapted from a Bank for InternationalSettlements research paper1, with modifications to enable its applicability in the context of theMalaysian banking sector.

Methodology and assumptionsThe development of VIBeS involves a three-step approach as outlined below:

Methodology involved in developing VIBeS

Step 1: Selection of risk indicators

� Define and measure vulnerability level using risk indicators that satisfy pre-determined selection criteria

Step 2: Construction of vulnerability indicator

� Transform, normalise and aggregate the individual risk indicators

Step 3: Assessment of future vulnerability and stress testing

� Establish empirical relationship between vulnerability indicator and macroeconomic imbalances for forecasting and scenario analysis

1 See Monnin, P and E Hanschel (2004), “Measuring and forecasting stress in the banking sector: evidence from Switzerland”, BIS Paper No22.


41

Selection of risk indicatorsThe risk indicators are selected mainly based on their ability to explain symptoms of instabilityduring identified systemic distress periods. Other selection criteria include the availability of a longtime series with quarterly frequency and widely used financial stability indicators. In our preliminaryanalysis, the various dimensions of banking vulnerability and risk indicators cover capitalisation,profitability, credit quality, liquidity and market-based information.

Based on historical trend analyses of various measures of capitalisation, annual growth in Tier-1capital provides a more sensitive indication of change in capital levels during past distress periods. Forexample, the relatively stable risk-weighted capital ratio (RWCR) of banking institutions observed duringthe Asian financial crisis as a result of recapitalisation efforts by Danamodal Nasional Berhad did notadequately reflect the decline in the core capital positions of banking institutions. In terms of creditquality, the gross non-performing loans (NPL) ratio, after adjusting for loans sold to, and recovered by,Danaharta, was found to be more reflective of the occurrence of higher delinquencies during the samecrisis. While accumulation in provisions has been widely used in some banking crisis literature to indicatebanks’ early detection of credit deterioration, it is also subject to potential biased signals of vulnerabilitydue to reduced provisioning capacity in distressed periods, and differing provisioning behaviour in goodtimes through the adoption of income smoothing or stricter provisioning policies.

In relation to liquidity risk, net interbank deposits of banking institutions is currently used togauge possible liquidity shortages and funding problems in the system. Meanwhile, the sensitivityand applicability of other indicators such as weighted averages of interbank rates and spreads,liquid assets ratios and liquidity buffers as a percentage of deposits, are also being explored. As ameasure of profitability and efficiency, return on assets is adopted as it takes into account regulatoryand structural changes in the banking sector, for example, the rationalisation or emergence of newplayers. Market-based indicators of financial distress, such as the spread of debt securities issued bybanking institutions or index of banks’ share prices are also being considered to capture investors’evaluations of banks’ idiosyncratic risks and their intrinsic value.

Construction of VIBeSVIBeS is in essence a composite indicator. The construction of VIBeS involved the following process:• transforming all components of the composite indicator to reflect higher vulnerability when

symptoms of distress intensify;• normalising all indicators with respect to their averages and standard deviations into

comparable units; and• aggregating normalised components using equal weights.

Assessment of future vulnerability and stress testingWhile VIBeS is constructed to provide a snapshot of the current level of banking system vulnerability,it also aims to facilitate forward looking assessments of potential stress within the system. For this,the relationship between macroeconomic and financial imbalances, and the distress level of thebanking system is currently being empirically modelled and tested. Any weakening of economicconditions, coupled with the accretion of macro imbalances and abrupt adjustments are oftenassociated with destabilising consequences on financial stability. By focusing on early signals ofpotential instability amassing in macro imbalances which normally precede systemic distress, theempirical model will be able to identify the potential source of vulnerability.

The empirical relationship is established by regressing VIBeS on selected macroeconomic andfinancial indicators2 that are robust determinants of past systemic distress episodes. These indicators are

2 Indicators of macroeconomic and financial imbalances considered, inter alia, include (1) Gross domestic product (GDP), (2) ratio of domesticcredit to GDP, (3) Kuala Lumpur Composite Index, (4) Malaysian House Price Index and (5) ratio of private investment to GDP.


42

computed to measure potential macroeconomic and financial imbalances by taking the deviation ofselected macroeconomic and financial variables from their respective long term trends3. Subsequently,forecasts of the future vulnerability level are generated based on the regression model that satisfies thepredetermined “best model” criteria4. The following diagram summarises the framework adopted toassess the future vulnerability level in the banking sector using these measures of imbalances.

Assessment of future vulnerability using macroeconomic and financial imbalances

Proxied by Measured by

Common risk exposure

Influence vulnerability in the financial system

Prevalent macroeconomic and financial system

conditions

Banking sector vulnerability level

Macroeconomic and financial

imbalances

Estimate empirical relationship to forecast future vulnerability level

VIBeS

Abrupt unwinding of imbalances and

risk materialises

Higher vulnerability in

the banking sector

Accretion of imbalances precedes

systemic distress

To complement other variants of macro stress tests, additional scenario analysis is conducted via thisframework to assess the impact of adverse macroeconomic developments on VIBeS. Regression coefficientsfrom the best estimate model are used in simulating specific macroeconomic shocks and the results arecompared with historical vulnerability levels to assess the current degree of resilience of the banking system.

Future Refinements to the FrameworkEfforts are currently focused at further improving the robustness of the forecast capability of VIBeS byleveraging on higher frequency macroeconomic variables, for example, data on monthly portfolio flowsand the consumer price index. Refinements are also being made to the regression model to adequatelycapture the non-linear interactions of macroeconomic and financial imbalances with that of systemicvulnerability. In addition, the framework’s applicability in supervisory assessments of individual bankinginstitutions is being explored to facilitate further integration of the Bank’s macro- and micro-surveillanceactivities. Mindful of the transformation of the financial sector and constantly changing financialenvironment, attempts are also being made to broaden the scope of coverage by incorporating non-financial indicators including measures of structural changes and financial liberalisation, into VIBeS.

No tool, regardless of its sophistication, may predict the future with absolute precision. Given anincreasingly complex financial landscape, the use of forward looking indicators such as VIBeS, servesonly as a means to assess the level of vulnerability within the banking system in an unbiased andobjective manner, and as a supplement to other surveillance tools within the Bank’s framework. Theultimate aim is to achieve an in-depth and informed macroprudential as well as microprudentialanalysis of each component of the financial system and the interactions and feedback effects toensure that emerging threats and risks are well anticipated and pre-emptively acted upon.

3 The long run fundamental trend of each macroeconomic and financial variable considered is determined using the rolling Hodrick-Prescott filter.See Borio, C and P Lowe (2002), “Asset prices, financial and monetary stability: exploring the nexus”, BIS Working Paper No 114, for full details.

4 These include: (1) Minimum significance level of 10% for all regression coefficients, (2) Maximum lags of 16 quarters, (3) Minimum of fourregressors, (4) Highest adjusted R-squared and (5) Comparable estimates between post-crisis and entire period samples.


43

Malaysia’s Anti-Money Laundering / Counter Financing of Terrorism(AML/CFT) Programme

OverviewMalaysia has in place a comprehensive AML/CFT regime. The AML/CFT programme implemented inMalaysia is reinforced by the Anti-Money Laundering and Anti-Terrorism Financing Act 2001 (AMLA)and its related AML/CFT regulations, which are consistent with international standards, namely, theFinancial Action Task Force on Money Laundering (FATF) Forty Recommendations on MoneyLaundering and Nine Special Recommendations on Terrorist Financing (FATF 40+9Recommendations). The FATF is the inter-governmental body that sets the international standard forthe development of national and international policies to combat money laundering and terrorismfinancing.

A coherent AML/CFT programme is achieved through a robust and comprehensive legalframework, preventive measures as well as effective domestic and international inter-agencycooperation to support capacity building, surveillance and enforcement activities of the respectiveauthorities. The legal and institutional framework for AML/CFT in Malaysia has been incrementallyimplemented and strengthened since 2002 and is applied to financial institutions as well asdesignated non-financial businesses and professions (DNFBPs).

In early 2007, the second round of the Asia/Pacific Group on Money Laundering (APG) MutualEvaluation Exercise was carried out on Malaysia. The APG Mutual Evaluation Exercise provides anindependent assessment of the state of Malaysia’s AML/CFT programme and its compliance withinternational standards. Malaysia’s ratings were comparable with many developed countries.Based on the Mutual Evaluation Reports (MER) of 40 countries that were published as at July 2007,Malaysia was one out of only three countries that were rated "Largely Compliant" against the FATFRecommendation on customer due diligence, while no country has been assessed to be fully compliant.

Overall, Malaysia obtained nine "Compliant", 24 "Largely Compliant", 15 "Partially Compliant"and one "Non-Compliant" ratings against the FATF 40+9 Recommendations. The results of the APGMutual Evaluation affirm Malaysia’s significant efforts in developing and implementing acomprehensive legal system in criminalising money laundering and terrorism financing, lawenforcement, financial intelligence, freezing, seizure and confiscation of proceeds of crime, as well asimplementing effective preventive measures for financial institutions and DNFBPs, which have servedto safeguard Malaysia’s financial system against the threat posed by money launderers and terroristfinanciers. As an ongoing effort, Bank Negara Malaysia will continue to be vigilant in monitoring andensuring effective implementation of the AML/CFT legal and regulatory framework, while directingattention towards capacity building as well as domestic and international cooperation.

AML/CFT Legal and Regulatory FrameworkThe AML/CFT legal and regulatory framework is regularly reviewed and where necessary,appropriate amendments to the laws and regulations are made to ensure that they remain effectiveand relevant in dealing with money laundering and terrorism financing threats. In this regard, theAnti-Money Laundering (Amendment) Act 2003 and consequential amendments to four otherrelated acts, namely, the Penal Code (Amendment) Act 2003, Criminal Procedure Code(Amendment) Act 2006, Courts of Judicature (Amendment) Act 2004, and Subordinate Courts(Amendment) Act 2004 were brought into force in March 2007. The amendments were made toincorporate provisions dealing with the offence of terrorism financing. The new Part VIA in the Anti-Money Laundering (Amendment) Act 2003 provides for measures to be taken for the prevention ofterrorism financing offences and for the forfeiture of terrorist property and property involved in, orderived from terrorism financing offences. Consequently, Malaysia’s anti-money launderinglegislation became known as the Anti-Money Laundering and Anti-Terrorism Financing Act 2001.


44

These amendments have put in place a set of comprehensive laws and in particular, recognisesthe procedures for freezing of terrorist-related property, thus enhancing Malaysia’s compliancewith the FATF Special Recommendations on Terrorist Financing while facilitating Malaysia’saccession to the United Nations International Convention for the Suppression of the Financing ofTerrorism.

The list of predicate offences under the AMLA has also been expanded to include a broaderrange of offences commonly associated with money laundering and terrorist financing. Theseoffences include corruption, fraud, criminal breach of trust, illegal gambling, credit card fraud,currency counterfeiting, robbery, forgery, human trafficking, extortion, smuggling and drug-relatedcrimes. The list of predicate offences may be expanded by the authorities from time to time asdeemed necessary.

In 2007, an offence relating to piracy or the counterfeiting of non-artistic goods was includedas a predicate offence in the AMLA. With this inclusion, the list of offences in the AMLA is fullycompliant with the FATF Recommendations. The comprehensive coverage of predicate offences inthe AMLA will facilitate the more timely detection of money laundering and terrorism financingactivities through the receipt of suspicious transaction reports (STRs) in relation to such offencesfrom all reporting institutions. The STRs will also facilitate prompt investigations and prosecutionsby law enforcement agencies into suspected money laundering or terrorism financing offences.

Preventive Measures for Financial Institutions and DNFBPsMalaysia’s AML/CFT preventive measures are uniformly applied to both conventional and Islamicfinancial institutions, and to the DNFBPs. In 2006, Bank Negara Malaysia issued the AML/CFTGuidelines and relevant Sectoral Guidelines for banking institutions and insurers. Under theGuidelines, financial institutions in Malaysia are required to consistently apply AML/CFT proceduresand controls across all domestic and foreign branches as well as their subsidiaries. This wouldinclude the requirement for financial institutions to appoint compliance officers in each branchand subsidiary with appropriate independence and authority to access records and submit STRs.

Out of the 19 FATF Recommendations on preventive measures for financial institutions thatwere assessed in the APG MER, Malaysia was rated "Compliant" and "Largely Compliant" against15 Recommendations. The remaining four Recommendations were rated "Partially Compliant",due mainly to the inability of the APG assessment team to fully establish the effectiveness of theimplementation of the Guidelines as the APG MER was conducted during the earlyimplementation phases of the AML/CFT Guidelines issued by the Bank. With the Guidelines havingbeen fully implemented, the Bank is confident of being able to achieve broad compliance againstthese recommendations.

The effectiveness of the implementation of the relevant AML/CFT Guidelines and controls atfinancial institutions are evaluated under the risk-based supervisory framework, as part of theassessment of the overall safety and soundness of individual financial institutions. With theincreasing focus on ensuring adequate AML/CFT internal control programmes, financial institutionshave significantly strengthened their internal mechanisms for the detection of suspicioustransactions, resulting in an improved quality of STRs submitted to the Bank and more timelyprovision of requested information for investigation purposes.

Obligations to establish an AML/CFT compliance programme for the DNFBPs sector came intoforce in early 2007 following the issuance of the AML/CFT Sectoral Guidelines to a licensed casino,licensed gaming outlets, lawyers, accountants and company secretaries. These AML/CFT Sectoral


45

Guidelines, which were issued to the relevant reporting institutions between February and April2007, specify the regulatory requirements that are in line with the AMLA and the relevant FATF40+9 Recommendations.

During the year, Bank Negara Malaysia undertook both on-site and off-site complianceexaminations, targeted at selected reporting institutions, in particular, institutions engaging inpredominantly cash-based transactions where the risk of money laundering and terrorism financingmay be more prevalent. Such institutions include accountants, company secretaries and lawyers, aswell as licensed gaming outlets. These compliance examinations enabled Bank Negara Malaysia todetermine the state of compliance of DNFBPs with the AML/CFT legal and regulatory requirements.

Domestic Cooperation and Capacity BuildingWhile Bank Negara Malaysia is the designated competent authority under the AMLA, the NationalCo-ordination Committee to Counter Money Laundering (NCC) consisting of 13 Ministries andGovernment agencies was set up in 2000 in order to achieve a coordinated approach towardsensuring the effective implementation of national AML/CFT measures. The NCC provides anintegrated platform for the relevant Ministries, Government agencies and supervisory authorities toensure that Malaysia implements an effective national AML/CFT system in line with the internationalstandards. Bank Negara Malaysia, as the Secretariat to the NCC, continued to play an instrumentalrole in this process by promoting a collaborative culture between the Government and private sectortowards achieving AML/CFT compliance. Among other things, regular engagements, dialogues andconsultations with self-regulatory organisations (SROs) and associations were held during the year toenhance AML/CFT awareness while emphasising the importance of preventive measures.

In 2007, the NCC formulated a national action plan to address the various recommendationsput forward in the APG MER over the next few years. The action plan includes legislativeamendments, measures to strengthen regulatory guidelines and compliance monitoring, measuresto enhance the investigative powers of law enforcement authorities and, in the longer term, theestablishment of a national asset management corporation for seized and forfeited assets.

To further support the effective implementation of the AML/CFT programme, the developmentof the necessary expertise and capabilities within supervisory and regulatory agencies, lawenforcement agencies (LEAs) and other related Government agencies and Ministries continued toreceive priority. In 2007, training programmes on AML/CFT continued to focus on the supervisoryand regulatory framework, legal aspects, typologies, financial investigative methods and analyticalskills. These training programmes were organised by the relevant domestic agencies in collaborationwith multilateral/regional bodies so as to promote a broader exchange of experiences andknowledge on implementation of effective AML/CFT programmes.

During the year, another 29 officers successfully completed the Certified Financial InvestigatorProgramme (CFIP) and graduated as Certified Financial Investigators (CFIs) (2006: 24 officers). Toreinforce the skill sets and competencies developed among the CFIs, two training programmes onforensic accounting and case analysis using the i2 software were organised by the Sub-Committeefor Inter-Agency Training under the NCC as part of the continuous development programme forAlumni members.

International CooperationIn view that money laundering and terrorism financing activities are transnational in nature, BankNegara Malaysia continues to promote the exchange of financial intelligence with its internationalcounterparts. In 2007, six Memoranda of Understanding (MoUs) on the exchange of financial


46

intelligence were signed, bringing the total number of MoUs signed by Bank Negara Malaysia to 13,as follows:

No International Counterparts Country Date Signed

Australian Transaction Reports and Analysis Centre Australia1. 2 August 2002

Pusat Pelaporan dan AnalisisTransaksi Keuangan

(Indonesian Financial Transaction Reports and Analysis Centre)

Republic ofIndonesia

2. 31 July 2003

Anti-Money Laundering CouncilRepublic of

the Philippines3. 4 August 2004

Anti-Money Laundering Office Kingdom ofThailand

4. 18 April 2005

China Anti-Money LaunderingMonitoring and Analysis Center-

People's Bank of China

People’s Republicof China

5. 30 June 2006

Korea Financial Intelligence UnitThe Republic

of Korea6. 30 April 2007

Japan Financial Intelligence Centre7. 29 May 2007

Serious Organised Crime Agency

Japan

8. 30 May 2007

Finanspolisen Rikskriminalpolisen(National Criminal Intelligence

Service, Financial Unit)

UnitedKingdom

9. 30 May 2007

Financial Crimes EnforcementNetwork

Sweden

10. 2 July 2007

Unidad de Análisis Financiero(Financial Analysis and Intelligence Unit)

United Statesof America

11. 21 August 2007

The Central Bank of Sri Lanka

Republic ofChile

12. 18 January 2008

Ministry of FinanceBrunei

Darussalam

Sri Lanka

13. 4 February 2008

The voluntary and unsolicited sharing of financial intelligence between competent authoritiesrepresents an important tenet of the MoUs signed by the Bank. In the recent past, this has resultedin valuable leads provided for further investigations into money laundering offences by the relevantLEAs, and the subsequent prosecution and conviction of perpetrators in foreign countries. Thisexperience underscores the importance of cross-border information sharing and mutualcooperation.

Bank Negara Malaysia has also participated in regional capacity building programmes toenhance AML/CFT knowledge and technical capability in selected ASEAN member countries. TheBank in collaboration with the Australian Transaction Reports and Analysis Centre, providedtechnical assistance to the Anti-Money Laundering Office (AMLO) of Thailand in September 2007,focusing on enhancing the framework and infrastructure for reporting suspicious transactions to theAMLO.


47

Challenges AheadBank Negara Malaysia, as the competent authority, together with the NCC remains vigilant toevolving money laundering and terrorism financing threats. Money laundering and terrorismfinancing typologies have indicated ongoing threats in high cash concentrated activities such ascasinos, cash couriers, as well as informal remittance systems. In this regard, among others, the NCChas established a task force on cross border transportation of currency and bearer negotiableinstruments to address the only "Non-Compliant" rating against the FATF Special RecommendationIX on Cash Couriers. The task force, which consists of Bank Negara Malaysia, the Royal MalaysianCustoms, Ministry of Home Affairs and Immigration Department, will be making recommendationson appropriate regulatory and enforcement measures to prevent as well as to detect cash couriersmoving funds illegally for criminal activity.

To mitigate the potential risk of criminal abuse from the prevalent use of alternative andinformal remittance services provided through money changers, these businesses will be subject tomore stringent supervisory measures, while the use of formal remittance channels such as bankinginstitutions and licensed non-bank remittance operators will be further encouraged.

The effective compliance monitoring of DNFBPs remains a challenge due to the sheer number ofthese entities. There are approximately over 30,000 DNFBPs nationwide established either as soleproprietorships, partnerships or limited liability companies. The Bank will continue to promote amore active role on the part of the SROs or the trade bodies to ensure the compliance of DNFBPswith legal and regulatory AML/CFT requirements. This will be supplemented with the developmentof a comprehensive risk-based compliance framework that appropriately reflects the uniquecharacteristics of this sector.

As financial institutions strengthen their internal AML/CFT programmes in line with the morestringent regulatory measures and international standards, it can be expected that perpetrators ofillegal activities will seek alternative channels to further financial crimes. There is therefore a need toensure on a continuous basis that the AML/CFT supervisory framework remains comprehensive interms of reporting institutions covered and the effective enforcement of the AML/CFT measures. Thechallenge is, however, to ensure that the costs associated with increased regulatory and compliancemeasures are also balanced with the money laundering and terrorism financing risk. To this end,Bank Negara Malaysia and the NCC will continue to work with the relevant business communities ininstituting appropriate AML/CFT measures that are commensurate with the size, complexity and riskexposure of the reporting institutions.

Development of the Financial Sector

Institutional DevelopmentPositioning Malaysia as an International Islamic Financial Centre White Box: Sukuk: Efficient Diversification Mechanism and New Asset ClassEnhancing Operational Efficiency and EffectivenessEnhancing Financial Market InfrastructureStrengthening Inter-Agency CooperationHuman Capital DevelopmentBroadening Access to Financial ServicesChallenges and Outlook White Box: The Landscape of the Malaysian Financial System Today

515253

59616262666870

10th divider - Development of the Financial Sector


C 20M 80Y 10

C 10M 100

M 100Y 100K 70

10th divider - Development of the Financial Sector


C 20M 80Y 10

C 10M 100

M 100Y 100K 70

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The globalisation of financial markets, thechanging economic landscape, furthertechnological advancements and greater customerexpectations continued to drive developments inthe Malaysian financial sector. With the increasingintegration and complexity of the global financialsystem, the challenge for the Malaysian financialsystem is to adapt to the changing market realitiesand at the same time to support domesticeconomic development. The Malaysian financialindustry itself has also emerged as an importantsource of economic growth, accounting for 10.7%of gross domestic product (GDP) in 2007. Giventhe increasing economic significance of thefinancial sector, Bank Negara Malaysia continuedto accord attention to capacity building measuresto further enhance the competitiveness andresilience of the financial system to supportdomestic-led growth. Efforts were in particular,directed towards developing and furtherstrengthening the financial infrastructure and thefinancial markets. To position Malaysia as aninternational Islamic financial centre, a number ofstrategic initiatives were also implemented duringthe year. These contributed towards reinforcing afinancial system that is comprehensive, diverse,robust and ready to compete in a more liberalisedand globalised environment.

INSTITUTIONAL DEVELOPMENT

Continued enhancements were made by financialinstitutions to strengthen their financial andmarket positions, thus enhancing their prospectsfor long-term growth and stability. Within thebanking sector, the top five banking groups byasset size have increased their market share oftotal outstanding loans to 61.1% in 2007 from52.5% in 2001. These banking groups alsorecorded increasing profitability with return onequity up from 14.4% in 2001 to 19.4% in 2007as a result of efforts to improve cost efficienciesand generate higher revenue streams, in responseto competitive pressures and demands forimproved shareholder value.

Capitalising on the healthy performance overseveral years, Malaysian financial institutions havetaken the opportunity to strengthen and furtherconsolidate their financial position in 2007.Notably, several domestic banking groups invested

significant resources in strengthening riskmanagement capabilities and enhancing businessoperating models. Capital injections received bysome institutions from existing and newshareholders provided added financial flexibility tosupport further business expansions, investmentsin technology, capacity building initiatives andtalent development. More efficient managementof capital was also achieved through capitalrestructuring exercises which saw further issuancesof subordinated bonds by several financialinstitutions. The governance of the financial groupstructures was also strengthened, whileinvestment banks made significant progresstowards completing the amalgamation of thepeople, systems and processes that werepreviously operating in separate banking andstockbroking entities.


Domestic banking groups haveemerged stronger withstrengthened financialpositions and sustainedmarket shares despite a morecompetitive operatingenvironment.

As a result of these developments, domesticbanking groups have emerged stronger withstrengthened financial positions and sustainedmarket shares despite a more competitiveoperating environment. These improvements wererecorded across the board, including byinstitutions that had earlier received capitalinjections from Danamodal Nasional Berhad(Danamodal) during the Asian financial crisis. Inline with its mandate to promote the long-termstability of the financial system, Danamodal hadinjected a total of RM7.49 billion into viablebanking institutions based on commercial termsand market principles. As a strategic shareholder,Danamodal also infused best managementpractices and competencies into these institutionswhich resulted in enhanced risk management andoperating efficiencies. Having emerged on astronger footing, all of the recapitalisedinstitutions have paid in full the capital injected byDanamodal. The successful turnaround,


52

strengthened financial conditions and positivefuture outlook of the banking institutions havealso attracted strong interest by several foreignfinancial institutions to establish strategicpartnerships. The successful transformation ofthese recapitalised institutions contributed topositive net results of Danamodal, which recordedpre-tax profits of RM200 million.

The conversion of all Islamic banking windowsof the domestic banking groups into Islamicsubsidiaries in 2007 has increased the focus onIslamic banking business, supported by cleareraccountabilities achieved under separate Boardand management structures. This brings the totalnumber of licensed Islamic banks in Malaysia to16, including four new Islamic subsidiaries that areexpected to commence operations in 2008. To tapthe strong growth potential in Islamic finance, twolocally-incorporated foreign banks (LIFBs)established Islamic banking window operations in2007. In addition to the above, seven investmentbanks also offer Islamic banking services throughthe window structure.

and takaful licences were offered to attractleading global players to establish operations inMalaysia. During the year, 16 approvals weregranted to conduct international currencybusiness operations. These include aninternational Islamic banking license to aninvestor from Bahrain, as well as approvals forother domestic financial institutions to establishdedicated international currency business units.Two additional retakaful licences were alsogranted in 2007 to qualified local and foreignplayers, further consolidating Malaysia’s positionas an international retakaful hub, whilecontributing to the development of enhancedunderwriting and claims practices, and productinnovations in the takaful industry. To furtherfacilitate the conduct of takaful business, a taxtreatment that recognises the uniquecharacteristics of takaful operators has beenintroduced. The tax treatment provides for theappropriate recognition of income and expensesarising from takaful business, having regard tothe distinct role of takaful operators as riskmanagers in contrast to conventional insurerswhich are risk underwriters. Other currentinitiatives include the review of the taxtreatment for the business of leasing which aimsto address taxation issues that currently impedethe development and growth of leasing andijarah business.

The Malaysian Government continues toprovide strong support for the MIFC vision bygranting flexibilities to improve businessefficiencies and to attract the best talent toMalaysia. In 2007, the Government introducedan "executive green lane" for immigrationprocedures for foreign experts in Islamic finance,and has made available long-term employmentpasses with multiple entry visas and professionalvisit passes. In addition, the Government hasalso relaxed several Foreign InvestmentCommittee rules for MIFC players, which includeallowing 100% foreign equity ownership inIslamic financial institutions established underthe MIFC and granting flexibilities in theacquisition of properties and land, both for ownuse and commercial purposes. In addition,further tax incentives were also granted topromote Malaysia as a centre for origination,distribution, and trading of sukuk (details on thetax incentives are provided in the box article"Sukuk: Efficient Diversification Mechanism andNew Asset Class").

All Islamic banking windowsof the domestic bankinggroups have converted intoIslamic subsidiaries.

POSITIONING MALAYSIA AS ANINTERNATIONAL ISLAMIC FINANCIAL CENTRE

Malaysia is at the frontier in the globaldevelopments in Islamic banking and finance.The Islamic banking system has emerged as avibrant alternative financial system in Malaysia,with Islamic banking assets (including Islamicassets held by development financialinstitutions, DFIs) currently accounting for15.4% (11.5% in 2003) of the total bankingassets (including assets held by DFIs) of theMalaysian financial system.

Capitalising on the ready infrastructure andcomprehensive Islamic financial system inMalaysia, the strategic development of Malaysiaas an international Islamic financial centre wastaken to a new level with the launch of theMalaysia International Islamic Financial Centre(MIFC) initiative in 2006. To accelerate thedevelopment of Islamic finance, new banking


53

Sukuk: Efficient Diversification Mechanism and New Asset Class

Rapid Growth of the Global Sukuk MarketThe global sukuk industry experiencedenormous growth over this recent five yearsand is now at the centre of the rapiddevelopment of the Islamic financial system.The size of the global sukuk market, includingsukuk denominated in domestic currencies,has grown from only USD336 million (orRM1.3 billion) in 2000 to an estimated USD82billion (or RM281 billion) as at end-2007,representing an average annual growth of40%. Total issuances in 2007 are valued atUSD47 billion (or RM161 billion), an increaseof 73% over the total value issued in 20061.

Initially regarded as a niche capital market instrument catering to corporate issuers,governments, state-owned enterprises and financial institutions in Islamic economies for capital-raising exercises, the appeal of sukuk has since extended to large international banks and corporateissuers. Established international financial centres have also taken a more active role in developingthe market for this asset class, including enacting enabling legislative provisions which havecontributed towards accelerating the development of the global sukuk market.

Record Growth of Malaysian Sukuk IndustryMalaysia continues to be at the forefront of the development of Islamic finance. Malaysia is theworld’s largest sukuk market with 68.9% or USD62 billion (RM213 billion) of the global outstandingsukuk as at end-2007 having been originated in Malaysia. Total issuances of corporate sukuk inMalaysia amounted to more than RM30 billion in 2007. Malaysia’s lead in the development of thesukuk market extends beyond just volume, including as well the introduction of innovative andcompetitive sukuk structures that appeal to a wider investor base.

1 Source: Islamic Finance Information Service

Sukuk Salient Features

• Sukuk is certification or trust of ownershipfor an asset or usufruct.

• It is an asset-based instrument structured incompliance with the precepts of Shariah.

• Returns on sukuk are tied to the underlyingasset. Therefore, sukuk needs to be backedby a specific asset or usufruct throughoutits entire tenure.

Chart 1Malaysia: Outstanding Sukuk vs. BondsRM billion

2001 2002 2003 2004 2005 2006 2007

Bond Sukuk

050

100

150200250300

350400

RM billion

0

20

40

60

80

100

120

140

160

2001 2002 2003 2004 2005 2006 2007

Public Sector Private Sector

Chart 2Malaysia: Total Outstanding Sukuk

Beginning with a modest issue size of RM125 million by Shell MDS Sdn. Bhd. in 1990, the Malaysiansukuk market has grown in size and sophistication. The depth of the sukuk market was clearlydemonstrated by the recent issuance of the largest sukuk to date, valued at RM15.4 billion (USD4.7billion), by Binariang GSM Sdn. Bhd., an investment-holding company that facilitated the privatisation ofa cellular phone operator. Despite its significant size, the Binariang sukuk was twice oversubscribed.


54

Chart 3Sukuk Approved in 2007 Based on Various Shariah Principles

Musharakah, 58%

Source: Malaysian ICM Quarterly Bulletin (January 2008), Securities Commission Malaysia

Bai' Bithaman Ajil, 2%

Murabahah, 19% Mudharabah, 1%

ljarah, 11%

Istisna', 9%

The primary sukuk market in Malaysia is now one of the world’s fastest growing, with anaverage annual growth in issuances of 22% recorded for the period 2001-2007. Having introducedthe world’s first global sovereign sukuk in 2002, Malaysia has continued its pioneering efforts infacilitating innovative structures such as the exchangeable sukuk musharakah by Khazanah NasionalBerhad, the investment-holding arm of the Malaysian Government. This landmark issuance is theworld’s first sukuk that incorporates full convertibility features that were previously common only toconventional equity-linked transactions.

Secondary trading in the Malaysian sukuk market has increased in depth and liquidity, with morecorporations, including foreign-owned corporations, continuously tapping the market for funding. Asignificant number of corporate issues have been undertaken to finance long-term funding needs. Thewide array and increasing size of sukuk transactions also offer attractive value proposition for investorsseeking to diversify their asset portfolios, thus creating a vibrant secondary market.

Key Growth Factors Underpinning Strong Sukuk DevelopmentThe strength of sukuk lies in its distinct structure. Sukuk is an asset-based instrument, bringing uniquevalue proposition to both investors and issuers. For investors, sukuk offers added portfolio diversificationbenefits and investment opportunities in the form of new asset classes, while issuers can benefit fromincreased liquidity by tapping into the growing demand among an increasing number of high net-worthindividuals and institutional investors for Shariah-compliant investment products.

The strong growth of sukuk, particularly in the recent five years has been supported by thefollowing key factors:

I. Growing Sophistication of StructuresThe flexibility of sukuk structures is a key factor that has led to its growing acceptance. Sukuk aretailored to meet the requirements and preferences of specific target markets. Over the years, sukukstructures have evolved from debt-based structures which are premised on cost-plus saleagreements (murabahah), to lease-based (ijarah), profit-sharing (musharakah) and manufacturingcontracts-based (istisna’) sukuk, as well as hybrid structures based on combinations of Shariahcontracts that appeal to a wider range of investors.


55

� Attracts both general bond investors and investors who invest in Shariah compliant funds. � Opens up access to a new source of funds.� Provides additional risk management options (for example in the case of sukuk musharakah, where the issuer shares the business risk with investors) and new mechanisms for price discovery.� In the case of Malaysia, the high demand, as evidenced by issuances being over subscribed by two to thirteen times, has lowered the cost of issuance by at least 10 to 20 basis points.

� Allows a share in an asset along with the cashflows, with risk commensurate with such ownership. This limits exposure to the value of the underlying asset, as the issuer cannot leverage in excess of the asset value. � Scarcity of sukuk has contributed to higher pricing in the sukuk secondary market, thereby generating good investment returns for investors.� A new asset class for portfolio diversification.

Sukuk: Excellent Value Proposition Growth Factors

For Issuers

Wider investor base

Asset-based instrument

Competitive pricing

Attractive returns

Growing sophistication of structures

Clarity of regulatory treatment

Strategic focus to develop comprehensive Islamic

financial system

For Investors

II. Clarity of Regulatory TreatmentGreater clarity on the regulatory treatment of sukuk has provided regulatory certainty to Islamicfinancial institutions with regard to their investments in these instruments. This has been achievedthrough the adoption of the Capital Adequacy Standard issued by the Islamic Financial ServicesBoard (IFSB), which specifies the prudential treatment of sukuk investments for regulatory capitalpurposes. Further work has also been undertaken by the IFSB to develop prudential standards forsukuk securitisation.

III. Strategic Focus to Develop Comprehensive Islamic Financial SystemThe broader range of instruments as well as structured products offered by the Islamic financialmarket in response to customer demands has also led to greater demand for sukuk. Sukuk has nowbecome important in supporting the growing number of structured products offered by Islamicbanks, takaful operators as well as fund management companies. For example, investments bytakaful operators in sukuk have provided a good match for the medium- and long-term liabilities oftakaful funds.


56

Conducive environment for sukuk issuance

Breadth and depth of financial market

Well-definedShariah

governanceframework

Competitivepricing

Innovative structures andhuman capitaldevelopment

Incentives forinvestmentactivities

Facilitative rules for issuance process

Comprehensive infrastructure

Malaysiaas a

globalsukukhub

Malaysia’s Leading Edge as a Global Sukuk HubMalaysia has emerged as a vibrant sukuk hub, offering a total solution for sukuk activities throughits conducive issuance environment, facilitative policies for investment activities and comprehensiveIslamic financial infrastructure. This has attracted global investors and issuers to Malaysia as apreferred sukuk issuance and investment destination. Global issuers have included internationalfinancial institutions such as the International Finance Corporation and the International Bank forReconstruction and Development.

To further strengthen Malaysia’s international position, the Malaysia International IslamicFinancial Centre (MIFC) initiative was launched in 2006. MIFC serves to promote Malaysia as acentre for the offering of Islamic financial products and services in the global marketplace byfacilitating the growth of investments in Islamic financial markets and by connecting internationalIslamic financial centres. The promotion of domestic and foreign currency sukuk origination,distribution and trading is one of the MIFC’s key focus areas.

Total Solution Approach

Facilitative Rules for Issuance ProcessThe MIFC Secretariat and Promotion Unit, located in Bank Negara Malaysia, undertakes thecoordination and promotion of MIFC’s strategic initiatives, including in the area of the sukukmarket. Formalised arrangements between the regulatory agencies in Malaysia through MIFCensures a coordinated approach in continuously improving the delivery channel and efficiency inraising sukuk denominated in any currency in Malaysia. In 2007, flexibility under the foreignexchange administration rules was accorded to multilateral development banks, multilateralfinancial institutions, sovereigns, quasi-sovereigns and local or foreign multinational corporations toissue foreign currency-denominated sukuk in Malaysia.


57

Chart 4Yield Curve for Corporate Bonds and Sukuk

AAA Islamic AAA Conventional

AA Islamic AA Conventional

3y 5y 7y 10y 15y 20y4.04.24.44.64.85.05.25.45.65.86.0

%

Source: Bondweb Malaysia (as at 31 December 2007)

Simplified issuance procedures are adopted for international issuers with good credit ratings.Applications by issuers with a credit rating of at least ‘A-’ are deemed approved upon proper filingof requisite documents with the Securities Commission at least two working days prior to theissuance of foreign currency sukuk. Applications are also deemed approved upon receipt by theSecurities Commission for issuance of ringgit sukuk by AAA-rated foreign sovereign or quasi-sovereign agencies.

To further facilitate the issuance process, no restrictions are placed on the ability to useinternational rating services, hedge positions and swap issuance proceeds into foreign currency.

Well-defined Shariah Governance FrameworkMalaysia’s well-defined Shariah governance framework has been instrumental in promoting thedevelopment of Islamic finance in general, including sukuk. Sukuk issuances must be approvedby Shariah advisors at the respective originating financial institutions. For issuances involving newconcepts or structures, further endorsement by the Shariah Advisory Council of the SecuritiesCommission, which advises the Commission on matters pertaining to Islamic capital markets, isrequired. Together with the Shariah Advisory Council of Bank Negara Malaysia (which is theauthoritative body on Shariah matters for financial institutions regulated by the Bank), theCouncils serve to ensure compliance with Shariah principles which form the tenets of Islamicfinance, while supporting innovation through their pronouncements on the Shariah-compatibilityof innovative structures.

Competitive PricingOne of the hallmarks of an efficient international financial centre is a conducive environment forcost efficient fund-raising platforms. In this regard, the high demand for sukuk, as evidenced by theover subscription of sukuk issuances, has kept the cost of issuance below that of similar ratedconventional bonds.

Various tax and regulatory incentives have further reduced the cost of issuance and time-to-market for sukuk issuances. These include the following:• Special Purpose Vehicles (SPVs) used for the issuance of sukuk are not subject to the

administrative tax procedures under the Income Tax Act 1967;• Companies that establish SPVs are given tax deductions on the cost incurred by the SPV for

the issuance of sukuk;


58

• The issuance cost for all Islamic securities approved by the Securities Commission are alsoeligible for tax deduction; and

• Stamp duty exemption is given on instruments relating to Islamic securities issued under the MIFCuntil 31 December 2016.

These measures and incentives are expected to further stimulate international currency sukukissuances, thus expanding the diversity of the sukuk base in Malaysia.

Innovative Structures and Human Capital DevelopmentApart from the more common Shariah structures based on musharakah, mudharabah, istisna’ andijarah, Malaysia has pioneered many of the world’s innovative sukuk structures. Among the varioussukuk structures that were originated in Malaysia are:

1990 – First bai’ bithaman ajil Islamic debt securities by Shell MDS Sdn. Bhd. (RM125 million)1994 – First sukuk mudharabah by Cagamas Berhad (RM30 million)2001 – First corporate sukuk ijarah by Kumpulan Guthrie Berhad (USD150 million)2002 – First sovereign sukuk ijarah by the Government of Malaysia (USD600 million)2003 – First tradable sukuk istisna’ by SKS Power Sdn. Bhd. (RM5.6 billion)2005 – First sukuk musharakah by Musharakah One Capital Berhad (RM2.5 billion)2006 – First exchangeable sukuk by Khazanah Nasional Berhad (USD750 million)

This would not have been possible without the pool of requisite human capital available in theMalaysian Islamic finance industry. Skills and expertise in this area of finance is in high demandglobally, resulting in the need to deepen the talent pool further to sustain current and future needs. Inthis context, strategic initiatives under the MIFC also include developing Malaysia into an internationalcentre for Islamic finance education. The establishment of the International Centre for Education inIslamic Finance (INCEIF) in 2006 is aimed at supporting the dynamic and evolving global Islamicfinance industry through the development of high calibre Islamic financial professionals. To achievethis, INCEIF offers the Chartered Islamic Finance Professional (CIFP) qualification programme, which isits flagship programme, as well as postgraduate Masters and PhD programmes.

Given the parallel financial system in Malaysia featuring both conventional and Islamic finance,the human capital requirements for the country’s sukuk and Islamic financial activities are not onlymet by the pool of Islamic financial professionals, but are also supported by the workforce inconventional financial institutions. This ability to leverage on cross-sectoral expertise has beenimportant in driving product innovation with sound structures and risk management foundations,while complying with Shariah requirements.

Incentives for Investment ActivitiesTo further stimulate and attract investments in sukuk by global investors, several incentives andmeasures have been announced. These include the following:• No withholding taxes are imposed on non-resident investors for the profit or income received

on foreign currency sukuk originated in Malaysia and approved by the Securities Commission;• Foreign investors in Malaysia are allowed to hedge their positions with onshore banks with

respect to committed flows of funds, such as the repatriation of investment proceeds,dividends and profits from Malaysia as well as the purchase of ringgit assets in Malaysia; and

• Free inward and outward movement of funds relating to both foreign direct investments andportfolio capital investments.

Comprehensive InfrastructureMalaysia’s Islamic capital market continues to register strong growth as seen from the increasingyear-on-year growth in assets and diversity of products offered. This can be attributed to theexistence of a complete and well-established Islamic financial system with considerable depth and


59

The MIFC portal (www.mifc.com) waslaunched in 2007 as the primary public source ofinformation on the latest MIFC initiatives anddevelopments. Closer linkages are also being fosteredwith other Islamic financial centres to promoteinternational economic and financial cooperation inthe field of Islamic finance. Memoranda ofUnderstanding (MoUs) were signed between BankNegara Malaysia and two Islamic financial servicesauthorities, namely, the Dubai Financial ServicesAuthority and the Qatar Financial Centre RegulatoryAuthority. The MoUs signify the authorities’ jointcommitments to promote the development of theglobal Islamic financial services industry and pave theway for better cooperation between Islamic financialcentres operating in different time zones. Areascovered under the MoUs include capacity building,human capital development and initiatives to enhancethe breadth and depth of financial markets as well aspromote Shariah harmonisation.

ENHANCING OPERATIONAL EFFICIENCY ANDEFFECTIVENESS

With increasing competition in the financialsector placing continued pressure on profitmargins, measures to enhance operationalefficiencies have become more critical to financialinstitutions’ long-term viability. In the bankingsector, gross interest margins continued todecline from 3.2% in 2001 to 2.7% in 2007. Thishas increased the need for more strategicmanagement of cost structures, product risks,and group synergies. To support the ability offinancial institutions to respond quickly tochanging market conditions, several regulatoryguidelines and processes have been reviewed toaccord financial institutions greater operationalflexibilities. These included:• Flexibility allowed for insurance companies to

outsource fund management activities to

breadth in the capital market, a responsive and facilitative regulatory environment, as well as anincreasing number and sophistication of intermediaries which continue to push the frontiers ofproduct innovation.

A carefully planned and strategic approach which has been adopted in Malaysia to developa comprehensive Islamic financial system that co-exists with the conventional system within thebroader financial system has produced positive results. Malaysia has increased its appeal as aninvestment destination, offering a wide range of investment opportunities with considerablemarket depth and breadth. Of importance, the building blocks necessary for an efficient andwell-functioning market, are now well entrenched.

A facilitative platform for sukuk issuance and trading activities has also supported moreefficient issuances and enhanced the price discovery process. Malaysia’s payment andsettlement systems, including the Real-time Electronic Transfer of Funds and Securities(RENTAS) system, provide an efficient platform for the trading of bonds, with a high level ofpost-trade transparency and market liquidity. For global investments, flexibility is also accordedfor foreign investors to leverage on international clearing and settlement systems.

Malaysia has continuously strengthened the legal, regulatory and Shariah frameworkunderpinning the Islamic financial system. Its securities laws are formulated to incorporate bestpractices, and are comparable to those of developed markets, with regularly refinements madeto ensure their continued efficiency and relevance. This is necessary to take into account therapid pace of financial innovation and evolving practices of financial institutions. Malaysia’ssecurities laws were recently updated with the passage of the Capital Markets and Services Act2007 that came into effect in September 2007. The new Act reinforces a sound investorprotection framework and orderly market development, while promoting international bestpractices in the capital market and among its participants. The Act also clarifies the legislativeframework applicable to Islamic securities and provides for the universal nature of the Islamicbanking licence accorded under the Islamic Banking Act 1983. With the coming into force ofthis new legislation, Islamic banks are positioned to take on a more pivotal role in thedevelopment of the Islamic capital markets.


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related entities within their respective financialgroups, in order to leverage on groupexpertise and resources;

• Introduction of a "launch-and-file" systemwhich removed the regulatory notification andapproval requirements prior to theintroduction of new products by bankinginstitutions and DFIs, thus improving the time-to-market. The new "launch-and-file" systemis applicable to all conventional bankingproducts with the exception only ofinvestment products that expose consumersto losses exceeding the principal sum investedand designated payment instruments whichmust be approved pursuant to provisionsunder the Payment Systems Act 2003; and

• Simplified regulatory procedures forapplications to appoint and reappointdirectors, senior management and expatriatesof financial institutions. This has reduced thetime taken for processing the applications.

Increasing customer sophistication and the morecomplex operating environment demands new andinnovative products to cater to the evolving needs ofthe public and to support economic transformation.In this regard, further flexibilities were accorded tofinancial institutions, including:• Flexibility for insurance companies to offer

universal life and retirement financingproducts, which can be customised andhave more features to meet the differentneeds of policyholders. For instance, thenew universal life products allowpolicyholders to pay flexible or fixedpremiums, while offering guarantees.Meanwhile, retirement products allowpolicyholders to choose from variouscombinations of accumulation and payoutperiods that are most suited to theirrequirements; and

• Liberalisation of the Guidelines on NegotiableInstruments of Deposits (NIDs) to allowfloating rate NIDs to be priced against anyindices other than the Kuala LumpurInterbank Offered Rate (KLIBOR), and theissuance of NIDs in foreign currencies, thusbroadening the product range to meetcustomers’ differing risk appetites.

The Bank also introduced several new moneymarket instruments for liquidity management andinvestment purposes, which in turn has broadenedthe range of money market instruments, including:

• The Commodity Murabahah Programme(CMP) which is a cash deposit productauctioned in the Islamic Interbank MoneyMarket via the Fully Automated System forIssuing/Tendering (FAST) and is the firstcommodity-based transaction that uses crudepalm oil as the underlying asset, thuscontributing further towards deepening theIslamic money market; and

• Introduction of floating rate Bank NegaraMonetary Notes, which are offered throughcompetitive Dutch auctions (uniform price) viathe principal dealer network.

To further support sustainable growth infinancing, a joint venture was formed betweenCagamas Berhad and the Hong Kong MortgageCorporation to develop mortgage guaranteebusiness in Malaysia and around the region. Forfinancial institutions, the mortgage guaranteecover will provide an alternative tool to hedgecredit risk exposures, while allowing institutionsto tap into a wider market base and avail ofgreater growth opportunities, particularly in theIslamic housing finance markets. Thisdevelopment reflects the increasing role of thecapital market in complementing the role oftraditional financial institutions as a source offinancing and in expanding avenues for betterrisk management. Over the medium term,affordable consumer access to home ownershipfinancing will also be enhanced.

The Bank continued further liberalisation ofthe foreign exchange administration rules tofacilitate business activities and create a conduciveenvironment for economic growth. In 2007, theBank announced a series of liberalisationmeasures, which included allowing residents andnon-residents to raise foreign currency-denominated bonds and sukuk in Malaysia,abolishing the net open position limit imposed onlicensed onshore banks and increasing the limit onforeign currency borrowing that can be obtainedby resident corporations from RM50 million toRM100 million equivalent in aggregate. Theforeign exchange administration operationalprocedures were also simplified with the abolitionof registration requirements for certaintransactions including forward foreign exchangecontracts by residents, foreign currency borrowingby residents and prepayment and repayment offoreign currency borrowing by residents. TheMonthly Report on Balances of Foreign Currency


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Accounts of Residents was also abolished, whilethe individual reporting threshold for transactionsbetween residents and non-residents wasincreased from RM50,001 to RM200,001 pertransaction (or its equivalent in foreign currency).Details of the liberalised foreign exchangeadministration rules can be accessed atwww.bnm.gov.my/fxadmin.

These and other measures introduced by theBank to provide greater flexibilities and improvebusiness efficiency have contributed towards thefurther development of the foreign exchange andbond markets. In 2007, the turnover of foreignexchange transactions by non-residents more thandoubled over the previous year. In addition, effortsto position Malaysia as a centre of origination andtrading of debt securities, including sukuk, hasresulted in a growing interest by foreigncorporations to issue debt securities in Malaysia. In2007, approvals for the issuance of foreigncurrency-denominated debt securities by foreigncorporations totalled USD12.3 billion (of which68% was foreign currency-denominated sukuk),an increase of 58% from 2006. The moredeveloped debt securities market and theconducive market environment have alsoencouraged a proliferation of structured productsbeing offered. Structured products approved forissuance quadrupled in value from RM22 billion in2006 to RM94.2 billion in 2007. Other forms ofcapital market innovations included asset-backedsecurities (ABS) and collateralised loan obligations.One such instrument is the issuance of pass-through ABS by financial institutions. The financialmarket also saw the issuance of more longerdated private debt securities (PDS), with anincrease in the issuance of PDS with maturities of10 years or more as a percentage of total PDSissuances from 8.4% in 2006 to 16.4% in 2007.

ENHANCING FINANCIAL MARKETINFRASTRUCTURE

Significant efforts have been undertaken tosupport the development of a more diversified andstable financial system. The Asian financial crisishad highlighted the risks associated with over-reliance on the banking sector and the importanceof diversifying the country’s sources of financing tothe capital market. As at end-2007, totaloutstanding debt securities was RM557 billioncompared to RM225 billion as at end-1999.Issuances of debt securities have also been on an

increasing trend, with issuances totaling RM302billion in 2007, an increase of about 65.3% from2006. Public debt securities accounted for 59% oftotal issuances. The reduced reliance on thebanking sector for financing by corporates is alsoevident from the increased size of private debtsecurities as a percentage of total bank loans andfinancing to corporates, from 36% in 1999 to56.2% as at end-December 2007.

Issuances of debt securitieshave also been on anincreasing trend, withissuances totalling RM302billion in 2007.

Bank Negara Malaysia, Bursa Malaysia and theSecurities Commission also collaborated todevelop an electronic trading platform (ETP) forunlisted bonds. The ETP will assume the functionof the Bond Information Dissemination System,currently maintained and managed by the Bank,as the central database on bond tradinginformation. The ETP is expected to furtherenhance the price discovery mechanism that willfacilitate real-time decision making by marketparticipants. This, in turn, will enhance bondtrading activities, leading to a more dynamic andvibrant capital market.

To support the Bank’s policy making andsurveillance functions, the Information andSurveillance System for Debt Securities (INSIDES) isbeing developed to pull together data andinformation relating to the debt securities marketinto one central database to provide acomprehensive view of the market. Onceoperationalised, the INSIDES system will facilitate amore efficient analysis of trends and impactassessments, while providing useful inputs for theformulation of policies by the Bank. FAST is alsobeing upgraded to cater for new instruments andproducts in the financial market.

In line with efforts to enhance regulatorytransparency, the Bank launched the RegulatoryHandbook in June 2007 to enable more timelyand efficient dissemination of regulatoryguidelines to financial institutions under itspurview. The Regulatory Handbook is madeavailable through the Bank’s enterprise portal,FI@KijangNet, with functionalities that allow for


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speedier interactions between the Bank andfinancial institutions as well as greater accessibilityto the regulatory framework for all relevantofficers within the institutions.

Broader collaboration and cooperation wasalso achieved at the national level to addressspecific issues impacting the operation andfinancial viability of licensed institutions. Inparticular, to address the escalating incidences ofvehicle theft at the national level, the VehicleTheft Reduction Council of Malaysia Berhad wasestablished in 2007. The Council comprisesrepresentatives from the Royal Malaysia Police,Bank Negara Malaysia, Royal Malaysian Customs,Ministry of Transport, Road TransportDepartment, General Insurance Association ofMalaysia, Malaysian Takaful Association,Malaysian Automotive Association andAssociation of Malaysian Loss Adjusters. Animmediate priority of the Council will be tocoordinate the formation of a National VehicleTheft Information Exchange. This exchange willprovide the platform for all relevant parties toshare up-to-date information on stolen vehiclesfor theft detection, deterrence and also toprevent the sale of stolen vehicles.

HUMAN CAPITAL DEVELOPMENT

Recognising the paramount importance ofhaving in place a sufficient pool of skilledtalent to drive and support the long-termgrowth and development strategies of financialinstitutions, significant attention has beendirected at achieving a more structured andwell coordinated effort in human capitaldevelopment to meet the industry’srequirements. Similar to other fast growingemerging markets, the demand andcompetition for highly-skilled financialprofessionals has become more acute. Basedon a survey conducted by the Bank in July2007, the banking and insurance industriesreported approximately 2,300 vacancies at theentry-level and approximately 1,700 vacanciesat the mid-management level. To meet thisdemand, a holistic approach to talentdevelopment has been taken, encompassinginitiatives that are tailored to the differentlevels of personnel in the financial servicesindustry. The human capital developmentinitiatives have also considered the specificrequirements of financial services professionalsas they progress through the different stagesin their career development, from thepre-employment stage through to leadershippositions.

STRENGTHENING INTER-AGENCYCOOPERATION

As the financial system becomes increasinglyintegrated, there is a greater need for a moreholistic and comprehensive approach to theregulation and supervision of licensed financialintermediaries. Enhanced collaboration andcoordination between the regulatory agenciesin maintaining financial system stability hasbecome more important as more playersengage in activities that extend beyond theirtraditional roles with greater resulting overlapsin the scope of business. At the same time,increasing linkages between players andmarkets, both domestically and internationally,have posed challenges in detecting the sourcesof potential vulnerabilities.

As part of efforts to put in place an efficientand effective collaborative framework, BankNegara Malaysia and the Securities Commissionsigned three MoUs relating to investment banks,payment and settlement systems as well asfinancial advisers and financial planners. Theagreements provide for both agencies to enhancecooperation in areas relating to the jointsurveillance of the capital market, strengtheningthe corporate governance framework for publiclisted companies and public interest entities, anddeveloping Malaysia as an international Islamicfinancial centre. Similarly, a strategic allianceagreement between Bank Negara Malaysia andthe Malaysia Deposit Insurance Corporation hasbeen put in place to outline the accountabilitiesand responsibilities of both agencies in promotingsound risk management practices in the bankingindustry and in ensuring financial stability.

The Bank launched theRegulatory Handbook in 2007to enable more timely andefficient dissemination ofregulatory guidelines tofinancial institutions under itspurview.


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At the entry-level, institutions of higher learningare the primary source of new talent for the financialindustry. To ensure that graduates are well-equippedfor the challenges of the more demanding financialservices industry, collaborative efforts between thefinancial services industry and institutions of higherlearning were enhanced. During the year, BankNegara Malaysia, in collaboration with the Ministryof Higher Education, organised a well-receiveddialogue between the financial services industry andthe institutions of higher learning to address criticalcompetency gaps among new graduates trained infinancial disciplines. The dialogue paved the way forthe following collaborative initiatives between thefinancial services industry and institutions of higherlearning aimed at closing the gaps identified:• Involvement of industry practitioners in the

development of higher learning curriculum,identification of research areas, design of casestudies, and as teaching resources; and

• Implementation of a lecturers internship andresearch programme under which lecturers frominstitutions of higher learning will be providedwith opportunities to pursue workingattachments with financial institutions to obtainpractical exposure, or to undertake appliedresearch work in areas relevant and current tothe financial services industry. The programmewill enable participating financial institutions,lecturers and researchers to combine theirrespective specialisations, refine existing skillsand knowledge, and develop new approaches,models and tools to better understand and dealwith new challenges and business opportunities.

development. One such partnership was theparticipation of the Institute of Bankers Malaysia(IBBM) in the University of Nottingham FinancialServices Research Forum.

To meet immediate demands for resources atthe entry-level, the Financial Sector TalentEnrichment Programme (FSTEP) was developed toequip fresh graduates with the essential technicalknowledge and skills needed to assumeprofessional roles in the financial services industry.FSTEP, an industry-led initiative supported by theBank, is a 12-month programme which integratesclassroom training and practical internships withfinancial institutions. Participants will gainexposure through the programme to the businessof commercial banking, investment banking,Islamic banking, insurance and takaful, thusproviding them with a comprehensive overview ofthe financial services industry. In addition,participants will also receive training on keybehavioural competencies required to performeffectively in the financial services industry. Thefirst batch of participants commenced training on10 December 2007.

To ensure that the Malaysian financial industryworkforce is at par with their internationalcounterparts while providing a more systematicand structured approach to support thedevelopment of capable knowledge workers in theindustry, the Banking and Finance IndustryCompetency Framework was developed by IBBM.These competencies, which are benchmarkedagainst international best practices, highlight theessential traits and skills that employees in thebanking and finance industry would require. Moreimportantly, the framework will assist trainingproviders and financial institutions in developingtraining and assessment programmes and inmanaging staff development in a more effectivemanner. The Banking and Finance IndustryCompetency Framework was launched inNovember 2007.

In September 2007, Bank Negara Malaysiaand the Securities Commission jointly issuedproposals to enhance existing institutionalarrangements for the professional training anddevelopment of financial industry personnel.Broadly, the proposals aim to strategicallyposition the industry training institutes, namelythe IBBM, Malaysian Insurance Institute, IslamicBanking and Finance Institute Malaysia and

A holistic approach to talentdevelopment has been takento meet the specific needs offinancial services professionalsat different levels and as theyprogress through differentstages in their careerdevelopment.

Partnerships and strategic alliances werealso established between corporate learningcentres, industry-based learning organisationsand universities to strengthen efforts inresearch and development, training, and topromote the exchange of ideas and informationon issues relating to human capital


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Securities Industry Development Centre, tomeet present and future demands for talent ina more efficient and effective manner, havingregard to the increasingly integrated provisionof financial services. This strategic initiative isexpected to further enhance the quality oftraining provided, reduce duplication, addressgaps in existing programmes and qualifications,and evolve more comprehensive trainingsolutions for the industry.

International Centre for Education in Islamic Finance (INCEIF)

MissionAs an Islamic financial education centre, INCEIF aims to elevate and advance Islamic financialknowledge globally by developing high-calibre practitioners, professionals and researchers whoare well-versed in modern finance and Shariah principles, thereby contributing to the supply oftalent and expertise in the Islamic financial services industry.

Programmes• More than 1,300 students from 53 countries around the world including from Japan, Saudi

Arabia and the United States of America have enrolled in INCEIF’s flagship Chartered IslamicFinance Professional (CIFP) programme to date. The CIFP’s holistic and comprehensive syllabus isspecifically tailored to combine both practical and theoretical aspects of Islamic finance.

• Introduced the PhD by Coursework and Dissertation and PhD by Research programmeswhich aim to spur advances in theoretical and applied practice of Islamic finance, based ondoctoral research conducted in specific areas of Islamic finance. 29 candidates haveenrolled in the programme’s first cohort.

• A Masters programme is currently being developed and is expected to commence in 2008.

Strategic Partnerships• Established 11 strategic partnerships to date with various Islamic financial institutions, central banks,

institutions of higher learning and training institutes, reflecting the global relevance of INCEIF’sprogrammes and its growing international recognition. The strategic partnerships are with:i. Indonesian Banking Development Institute (Lembaga Pengembangan Perbankan Indonesia)ii. National Institute of Banking, State Bank of Pakistaniii. Meezan Bank Pte. Ltd., Pakistaniv. Ceylinco Sussex Business School, Sri Lankav. Emirates Institute of Banking and Financial Studies, United Arab Emiratesvi. Sudan Academy of Banking Financial Studiesvii. Central Bank of Syriaviii. Al-Ghurair University, United Arab Emiratesix. University of Science and Technology, Yemenx. La Trobe University, Australiaxi. Universiti Malaysia Terengganu

• Other collaborations included a five-day Continuing Professional Development Programmeworkshop organised with the University of Reading, United Kingdom and the NationalAssociation of Securities Dealers of New York which further contributed towards promotingdialogue and the transfer of skills and expertise in Islamic banking and finance at theinternational level.

The International Centre for Leadership inFinance (ICLIF) and the International Centre forEducation in Islamic Finance (INCEIF) which wereestablished by the Bank in 2003 and 2006respectively have continued to play aninstrumental role in meeting the human capitaldevelopment needs of the industry, both inMalaysia and across the region. The mandates andachievements of INCEIF and ICLIF to date aredetailed in the box below.


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Promoting Talent Development and Research in Islamic Finance• Provided training opportunities to deserving candidates:

i. 38 students from Malaysia, Algeria, Thailand, Pakistan, Uzbekistan and Indonesiawere sponsored under the Bright Scholars scholarship programme to participate inthe CIFP;

ii. Established the INCEIF Fisabilillah Fund (RM400,000) to support the development of a poolof skilled scholars;

iii. Established the International Shariah Research Academy for Islamic Finance (ISRA) as adedicated and specialised Shariah research centre within INCEIF to conduct applied Shariahresearch in various areas of Islamic finance. ISRA will:a. spearhead research into current Shariah issues in Islamic finance, including in the

areas of risk mitigation techniques and tools, product innovations, liquiditymanagement and hedging;

b. strengthen human capital development in Shariah and Islamic finance; andc. provide a platform for dialogue and knowledge sharing among practitioners, scholars,

regulators and academicians, thereby promoting Shariah convergence and mutual respect.• In addition, Bank Negara Malaysia has awarded 14 Shariah scholarships and two Shariah

research grants under the Fund for Shariah Scholars in Islamic Finance which was established inpart to contribute towards the development of Shariah experts in fiqh muamalat.

International Centre for Leadership in Finance (ICLIF)

MissionTo provide a focused and coordinated approach to the development of a generation of world classleaders for all sectors and corporations, but with special focus on the financial services sector so asto cater for the needs of the rapidly transforming Asian region by providing learning opportunitiesand experience through effective leadership development programmes.

Programmes• Developed the ICLIF Leadership Competency Model which outlines the essential competencies

for leadership and supports all developmental aspects of leadership.• Conducted seven Global Leadership Development Programmes to foster the development of

leadership skills and strategic management capabilities required to achieve and maintainhigh-performing organisations in a rapidly changing environment. The programme isdesigned and delivered by ICLIF in collaboration with several world-renowned learninginstitutions and leading consultants.

• Designed and delivered other cutting edge programmes on Leading Change, LeadingInnovation, Scenario Thinking and Planning, and Talent Management.

• Entered into a five-year contract with the Indian Railways to conduct six Scenario Thinking andInnovation Workshops for more than 1,000 of its employees.

Strategic Partnerships• Established strategic partnerships with international organisations to:

i. develop and deliver comprehensive and high quality courses in leadership development inbanking and finance;

ii. facilitate the exchange of data, intelligence, education material, resource persons andexperts; and

iii. facilitate reciprocal study visits by alumni and groups of banking executives.• To date, strategic partnerships have been established with:

i. the South East Asia Central Banks (SEACEN) Research and Training Centre for itsAdvanced and Intermediate Leadership Courses on Central Bank Management andPolicy Programmes;


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BROADENING ACCESS TO FINANCIALSERVICES

Promoting broad-based and balanced economicgrowth remained an important agenda of theBank to elevate the standards of living of allsegments of the population, therebycontributing to social and political stability.Thus, broad access to financial services whichenables the pursuit of economic activities by alllevels of society, has been a key policy focus ofthe Bank. Building on the positive results ofprevious initiatives, measures continued to beundertaken in 2007 to further promote thepotential of small and medium enterprises(SMEs) and micro enterprises. Financing to SMEsby banking institutions registered stronggrowth, with loans approved increasing by37.1% to RM55.1 billion during the year. Duringthe same period, loans approved by the six DFIsunder the purview of Bank Negara Malaysia1

increased by 17.9% to RM8.1 billion.

SMEs, initiatives have been put in place to ensurethe effective channeling of funds to SMEs, providefinancial advisory support and promote greaterawareness on financial products and programmesavailable for SMEs.

The Credit Guarantee Corporation MalaysiaBerhad (CGC) embarked on a transformationexercise in 2005 to further enhance its role insupporting the growth and development ofcompetitive SMEs. As the main provider ofguarantee services to SMEs, the transformation aimsto position CGC as a more responsive and financiallysustainable institution that can better serve thecurrent and evolving needs of the SMEs. Since thetransformation, CGC has introduced a wider rangeof credit enhancement products and advisoryservices on financial and business development.These include the launch of the Credit EnhancerIslamic Scheme (Enhancer-i) and Direct AccessGuarantee Scheme Start Up (DAGS Start-Up) in2007. Enhancer-i provides access to financing of upto RM10 million and guarantee coverage of up to90%, while DAGS Start-Up is targeted at new SMEsand provides guarantees for financing of up to RM2million and coverage of up to 100%.

Access to funding by SMEs was also enhancedwith the creation of the RM1 billion OverseasProject Fund established by the Bank in December2006. The Fund, placed with Export-Import Bankof Malaysia Berhad (EXIM Bank), guarantees andprovides co-financing facilities for Malaysiancompanies to fund their overseas projects. Theparticipating financial institutions will providefinancing up to 90% of the contract value inmajor currencies. As at end-December 2007, atotal of RM190.9 million in loans were approvedwith guarantee coverage of RM143 million. Inaddition, Cagamas Berhad launched its firstsecuritisation programme for SME loans valued atRM600 million. The securitisation providesbanking institutions with greater flexibility inmanaging their SME loan portfolios, therebyfurther enhancing their capacity to lend to SMEs.

1 Bank Pembangunan Malaysia Berhad, Bank Perusahaan Kecil & Sederhana Malaysia Berhad, Export-Import Bank of Malaysia Berhad, Bank PertanianMalaysia, Bank Kerjasama Rakyat Malaysia Berhad and Bank Simpanan Nasional.

Measures continued to beundertaken in 2007 to furtherpromote the potential of smalland medium enterprises andmicro enterprises.

ii. the Indonesian Banking Development Institute (Lembaga Pengembangan PerbankanIndonesia); and

iii. the Indian Institute of Banking and Finance.

With SMEs constituting more than 99% oftotal business establishments and providingemployment to more than 5.6 million people inMalaysia, the development of the SME sector isessential to promote domestic-led growth and tostrengthen the resilience of the economy. Basedon the Census on Establishment and Enterpriseconducted in 2005, the Malaysian SMEs’contribution to GDP was 32% as compared toother countries such as Japan (55.3%) andGermany (57%), indicating the immense potentialfor a higher contribution of the SME sector toeconomic growth. To complement improvementsmade to the existing institutional infrastructure for


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The lack of organised financial records, andperceived higher financial risk associated withSMEs have made complete credit risk assessmentsof SMEs by financial institutions more challenging.To address these constraints, CGC has entered intoa strategic alliance on 3 July 2007 with a providerof credit information services, to set up the SMECredit Bureau. The SME Credit Bureau is a creditdatabank of SMEs which sources and pools datafrom various sources, including the CompaniesCommission of Malaysia, financial institutions andbusinesses’ trade credit data. Information onindividual SMEs and their credit ratings would bemade available to financial institutions andbusinesses to facilitate underwriting decisions forloans and trade credit respectively. Further supportto SMEs is provided through the establishment ofthe SME Business Advisers Network, a one-stopweb-based directory in the SMEInfo Portal(www.smeinfo.com.my) that serves as a platformfor SME business advisers to share expertise, thusfacilitating the provision of comprehensiveadvisory services to SMEs. To further enhanceaccess to commonly used banking services atminimal costs, the "Basic Banking ServicesFramework" was also extended to SMEs in 2007.

Moving forward, the Small and MediumIndustry Development Corporation (SMIDEC) willbe transformed into a SME Central CoordinatingAgency, a single Government agency dedicatedto spearhead the development of SMEs acrossall sectors of the economy. This initiative isaimed at accelerating the development of theSME sector by focusing on coordinating SMEpolicies and Government programmes across allsectors, and providing one-stop information andadvisory services to SMEs. The SME CentralCoordinating Agency will report directly to theNational SME Development Council and will beplaced under the Ministry of International Tradeand Industry.

To assist financially distressed SMEs, thefinancial institutions participating in the SmallDebt Resolution Scheme (SDRS) that wasestablished by the Bank in 2003 to facilitateviable on-going SME businesses to restructuretheir non-performing loans (NPLs) was extendedto include Bank Kerjasama Rakyat MalaysiaBerhad, Bank Pertanian Malaysia and EXIM Bank,in addition to the commercial banks, Islamicbanks and the SME Bank that are alreadyparticipating in the scheme. As at end-2007, out

of 726 applications received, 565 applicationsinvolving NPLs of RM324 million had beenapproved for restructuring under the SDRS.

Small businesses also received specialfinancial support during the widespread floodingthroughout the country during the year. InJanuary 2007, a Special Relief Guarantee Facility,with the participation of CGC and financialinstitutions, was established to alleviate thefinancial difficulties faced by small businessesthat were affected by the floods. The facilityprovides a guarantee of 80% on new loans takenby the affected businesses for the purpose ofresuming their business operations. A total of4,640 loans valued at RM472 million wereapproved under the facility.

To further enhance access to financial servicesfor the agriculture sector which is primed to beone of the key economic growth drivers for thecountry under the Ninth Malaysia Plan, newapproaches and business models are required todeliver financial services in the most effectivemanner. An important step in this direction wastaken with the initiative to restructure andstrengthen Bank Pertanian Malaysia resulting in itscorporatisation in December 2007. With thecorporatisation, the paid-up capital of BankPertanian Malaysia was increased from RM42.5million to RM1 billion, thereby expanding thefinancial resources needed for it to play a moresignificant role as an enabler of growth in theagricultural sector. Bank Pertanian Malaysia’scorporatisation will complement the twoagriculture venture capital funds totalling RM300million established in September 2006 by BankNegara Malaysia together with two bankinggroups. The funds are aimed at modernising andevolving a more integrated approach to agriculturebusiness in Malaysia, particularly in farming,fisheries and livestock, as well as to finance newtechnology-intensive agriculture projects, includingbiotechnology. As at end-December 2007, totalinvestments from these funds of RM72.9 millionhad been approved in seven companies.

The microfinance initiative which wasintroduced in 2006 has gained significantmomentum. At present, nine financial institutions(six banking institutions and three DFIs) offermicrofinance products. As at end-2007, totalfinancing outstanding amounting to RM224.7million had been provided to 22,788 microfinance


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The approach to financialsector liberalisation will bedriven by the objectives ofpromoting a more efficientand competitive financialsystem, while ensuringbalanced growth and financialstability.

customer accounts, with an average financing sizeof RM9,800. To create greater public awarenesson the availability and benefits of microfinance, anational microfinance logo was launched inSeptember 2007. Since the launch of the logo,financial institutions that offer microfinance havedisplayed the logo and their microfinance clientcharters to signify their participation andcommitment towards the provision ofmicrofinance services. Microfinance customerswho have obtained such financing may alsodisplay the logo at their business premises.

Vibrant and Sustainable Microfinance Industry" inthe Bank’s Annual Report 2007, jointly publishedwith this Report.

CHALLENGES AND OUTLOOK

The development focus in 2008 will be directed atfurther enhancing domestic capacity, developingthe financial infrastructure, minimising structuralweaknesses as well as strengthening capitalmarket fundamentals. Further, given theuncertainties of the external financial environmentand increasing inter-linkages resulting fromfinancial globalisation, efforts will also be gearedtowards strengthening regional and globalcooperation and enhancing the timely exchangeof information as part of the continuing efforts topromote financial stability.

The microfinance initiativegained significant momentumin 2007.

Greater convergence and the blurring of linesbetween the banking, insurance and securitiesindustries will continue to define the changingfinancial landscape. Bank Negara Malaysia willcontinue to facilitate ongoing consolidationexercises by creating the appropriate operatingenvironment. In addition, the approach to financialsector liberalisation will be driven by the objectivesof promoting a more efficient and competitivefinancial system, while ensuring balanced growthand financial stability.

In the area of Islamic finance, the Bank willcontinue to strengthen the legal and Shariahinfrastructure to reinforce sound financialpractices in this sector, while encouragingfurther innovation in products and services tosupport specialised Islamic fund and wealthmanagement services. The development of thesukuk market will be accelerated as animportant conduit to mobilise longer-term fundsto match funding needs and facilitate effectiverisk transfers. Infrastructure development to

Measures to expand the outreach of financialservices to the non-urban areas were alsopursued. As Malaysia strives to be anindustrialised nation, financial inclusion willremain a priority on the Bank’s agenda in theyears to come. The vision is for the public to haveeasy and convenient access to banking, insuranceand other financial services. Financial institutionsalso stand to benefit from the vast opportunitiesto be tapped from those segments of thepopulation which are currently underserved. Anumber of banking institutions have formedstrategic alliances with a variety of serviceproviders to provide selected banking andremittance services to customers in the non-urban areas. Efforts to further expand theseservices as well as similar initiatives by otherfinancial institutions are currently being pursued.

Advancements in information andcommunications technology have also enhancedthe delivery of financial services. Recentadvancements in banking services include cross-border transfers of money via mobile phones andmobile banking services via short messagingservices for account enquiries, bill payment andfunds transfers. Through the adoption of thelatest technology, products and services can bedelivered at lower cost with a wider reach toareas which otherwise may not have had accessto financial services.

Developmental initiatives and trends relatingto SMEs and microfinance are discussed in furtherdetail in the box articles "Development of Smalland Medium Enterprises" and "Development of a


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facilitate an increase in the supply of suitableIslamic financial instruments to address fundingmismatches and promote sound asset-liabilitymanagement practices will continue to beenhanced. Efforts will also be intensified toachieve greater alignment and harmonisation ofbusiness models, processes and principles forthe orderly development of the industry.

With continued prospects for increasedconvergence in products and delivery systems,bancassurance and bancatakaful will beencouraged to enhance the distribution capacity

and increase insurance penetration. Work is alsoongoing to promote the provision of affordablehealth-related insurance products and privatepension products in view of the changingdemographic structure of the population. Tosupport balanced economic development,initiatives will continue to be undertaken toprovide the segment of the population that iscurrently underserved with greater access toaffordable financial products and services. Effortswill also continue to be put in place to supportthe growing SME and microfinance sectors thatwill become more significant in the economy.


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The Landscape of the Malaysian Financial System Today

IntroductionThe financial system has undergone significant transformation since the 1990s to meet the needs ofan expanding economy and changing market demands. Today, the financial system has evolved tobecome more diversified, efficient and resilient, thus enabling it to effectively perform theintermediation function and reinforcing its role as a key contributor to economic growth. With anaverage annual growth rate of 7.4% since 2001, the financial sector now contributes 10.7% to realgross domestic product (GDP). This has been accompanied by enhanced access to a wider array offinancial products, services and delivery channels, improved quality of customer service and greatertechnological innovations.

Diversified Institutional Players and Vibrant Financial Markets Supporting the Needs of theEconomyStructural reforms after the Asian financial crisis, prompted by business considerations andregulatory initiatives, have reshaped the financial landscape and enhanced the competitivecapabilities of institutional players. While the commercial banking, investment banking and Islamicbanking institutions form the nucleus of the financial system, the financial system has become morediversified. Today, the banking system constitutes about 50% of the financial system’s assets. Theconsolidation and rationalisation of the domestic banking industry and the introduction of theinvestment banking framework have strengthened the performance of domestic bankinginstitutions and enhanced their role in the economy. Assets of the banking system grew at anaverage annual rate of 8.2% since 2000, driven mainly by strong growth in loans and holdings ofprivate debt securities (PDS), while total deposits increased by an average annual rate of 8.5% overthe same period.

The blurring of the traditional boundaries between the different types of financial activities andthe increasing demand for financial services that are offered under one roof have brought about theformation of financial conglomerates. Today, all domestic banking groups undertake the full range ofcommercial banking (including retail financial services), investment banking and Islamic bankingactivities. Many of the conglomerates also have insurance companies, fund management and unittrust companies within their groups. This has contributed towards the realisation of the benefitsderived from greater economies of scale, as well as the diversification of risks and sources of revenue.

Table 1Financial Sector: Number of Players

Financial Institutions 1999 2007

Commercial Banks 34 22Finance Companies 32 01

Investment Banks/Merchant Banks 12 14Universal Brokers 5 1Discount Houses 7 0Islamic Banks 2 11Insurance Companies 56 41

Life 7 8General 38 25Composite 11 8

Reinsurance Companies 11 7Takaful Operators 2 8Retakaful Operators 0 2Development Financial Institutions 14 132

1 Rationalisation of finance companies and commercial banks within a bankinggroup.

2 Of which six development financial institutions are regulated under theDevelopment Financial Institutions Act 2002 (DFIA).


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Operating in parallel with conventional finance, Islamic finance has experienced rapid growthover the more recent period, enhancing its significance in the Malaysian financial system. Theestablishment of dedicated subsidiaries by banking groups to offer Islamic banking products andthe entry of new foreign players in the Islamic banking, takaful and retakaful sectors has spurredthe growth of Islamic banking assets, which expanded at an average annual rate of 19.3% since2003 to constitute 15.4% of assets of the total banking system in 2007. Total assets of the takafulsector grew by 18.9% on average annually since 2003 to account for 6.9% of total assets of theinsurance and takaful industry. The diversity of players has added a new dimension to financialservices, not only in the delivery of financial products but also in the introduction of innovativefinancing structures such as mudharabah and musharakah to meet the varying needs of theeconomy.

The Malaysian Financial Landscape Today

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Commercial Banks

Investment Banks/

Merchant Banks

Insurance Companies

Reinsurance Companies

Offshore Banking

Foreign Exchange Market

Funds Clearing System

Cheque Clearing System

Securities/Equities Clearing System

Derivatives Clearing System

* Includes Islamic Financial Markets

Money Market Bond Market

Payment System Operators

Payment Instrument Issuers

Equity Market Derivatives Market

Offshore Insurance

Development Financial

Institutions

Takaful Operators

Retakaful Operators

Islamic Banks

Money Lenders

Stock Broking

Companies

Cagamas Bhd

Provident & Pension Funds

Venture Capitals/

Private Equity

Financial Planners/ Advisors

Fund Managers

Universal Brokers

Money Brokers

Insurance Adjusters

Insurance Brokers

Leasing Companies

Factoring Companies

Unit Trust Companies

Cooperatives

Credit Guarantee

Corporation Bhd


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The development financial institutions (DFIs) in the Malaysian financial system have alsoundergone a significant transformation in the recent few years. Six out of the 13 DFIs in the countryare placed under the Bank’s supervisory oversight since 2002. The policy focus to strengthen theDFIs through rationalisation and greater realignment of their roles and functions, has enabled themto better serve the economy and complement banking institutions in the mobilisation and allocationof funds to key growth areas in the economy, such as agriculture, international trade and, mostnotably, small and medium enterprises (SMEs). SME loans granted by the six DFIs regulated by theBank now account for 12.1% (RM13.8 billion) of total outstanding loans channelled to the SMEindustry, while total outstanding loans by the six DFIs to the agriculture sector accounted for 12.9%(RM3.9 billion) of total loans granted to this sector as at end-2007.

More recently, the Malaysian Cooperatives Commission, proposed by Bank Negara Malaysia,was set up in January 2008 as a central body to spearhead the development of cooperatives in aholistic manner, focusing in particular on the stability and soundness of the cooperative sector.Cooperatives, given their wide distribution network across the nation, provide an additional avenuefor micro enterprises to have access to financing, thus complementing the role of the bankinginstitutions and DFIs. The Commission, which regulates more than 4,000 cooperatives nationwide, isexpected to enhance the support to the cooperative sector, thereby enabling it to contribute to thesocio-economic development of the nation.

Table 2Assets of the Financial System

1999 2007p

RM billion

Banking system 803.4 1,651.8Bank Negara Malaysia 147.0 424.9Commercial banks 471.0 1,050.2Islamic banks 11.7 81.8Investment banks n.a. 94.9Finance companies 115.9 n.a.Merchant banks1 39.2 n.a.Discount houses1 18.6 n.a.

Non-bank financial intermediaries 367.2 824.1Provident, pension and insurance funds 243.6 526.1

Employees Provident Fund 168.6 318.3Other provident and pension funds 28.5 76.4Life insurance funds 32.3 110.02

General insurance funds 14.2 21.32

Development financial institutions3 22.4 128.3Other financial intermediaries 101.24 169.75

Total 1,170.6 2,475.91 These institutions have been rationalised to become investment banks.2 Includes assets of takaful funds.3 Includes DFIs not directly regulated by Bank Negara Malaysia.4 Includes unit trusts (ASN, ASB, ASW 2020 and ASM Mara), building societies,

savings institutions, Pilgrims Fund Board, Credit Guarantee Corporation, CagamasBerhad, leasing companies, factoring companies and venture capital companies.

5 Includes unit trusts (ASN and ASN Mara), cooperative societies, leasing andfactoring companies and housing credit institutions (comprising Cagamas Berhad,Borneo Housing Mortgage Finance Berhad and Malaysia Building Society Berhad).

p Preliminaryn.a. Not availableNote: Numbers may not necessarily add up due to rounding


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With the evolution of a more diversified financial system, the capital market has assumed anincreasingly significant role in mobilising and allocating resources to finance capital expenditures forboth the public and private sectors. In the debt securities market, total outstanding debt securitiesincreased from RM225 billion as at end-1999 to RM557 billion as at end-2007. Of significance is therapid growth in the issuance of sukuk, which accounted for 40.7% of total debt security issuances in2007 (RM122.9 billion) compared to only 13.4% in 1999 (RM20.3 billion). Malaysia is now theglobal leader in sukuk issuance, with 68.9% of the global outstanding sukuk having been originatedin Malaysia in 2007, in line with the agenda to develop Malaysia as an international Islamic financialcentre and a major centre for sukuk issuance, origination and trading. In the secondary market, thevolume of debt securities traded has increased significantly in recent years, with higher sale andpurchase transactions amounting to RM387.5 billion in 2007 (1999: RM151.2 billion). MalaysianGovernment Securities (MGS) still remain the most actively traded papers, accounting for 57.8% oftotal trading activities and with a turnover ratio of 1.16 times in 2007 (1999: 0.81 times).

RM billion

Chart 1Malaysia: Total Outstanding Debt Securities

050

100150200250300350

1999 2000 2001 2002 2003 2004 2005 2006 2007

Public Sector Private Sector

The corporate sector has increasingly tapped the bond market to raise funds. The finance,insurance, real estate and business services sector has been the main issuer of PDS since 1999,accounting for 37.7% of the total funds raised in 2007 (1999: 21.5%). The transport, storage andcommunication sector accounted for 31.8% of the total funds (1999: 35.7%), while 15.2% wasattributed to the utilities sector (1999: 0.3%). While PDS issuances with tenures between one and 10years continue to constitute the bulk of new PDS issues, the PDS yield curve has lengthenedconsiderably over the last few years. This provides long-term investment options for investors,especially insurance companies that require long-dated investment instruments to reduce their asset-liability mismatches.

RM billion

Chart 2Size of Corporate Debt Securities Market againstCorporate Loans

0

50

100

150

200

250

1999 2000 2001 2002 2003 2004 2005 2006 2007

Corporate Debt Securities Corporate Loans


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Consequently, life insurance companies are today active investors in the capital market afterbanking institutions and the Employees Provident Fund. Investments by direct insurers in MGS grewfrom RM6.2 billion in 1999 to RM18.7 billion in 2007, to account for more than 10% of total MGSholdings as at end-2007. Similarly, insurers’ investments in PDS increased from RM6 billion toRM32.3 billion over the same period to constitute more than 16% of total PDS outstanding as atend-2007.

Demonstrating the increased attractiveness of the Malaysian market to foreign institutionalinvestors in view of the conducive operating and legal environment, foreign investor holdings in thedebt securities market have risen from RM0.8 billion or 0.3% of total outstanding debt securities asat end-2001, to RM81.4 billion or 14.7% as at end-2007. As larger players in the debt securitiesmarket, these investors contribute towards enhancing the overall liquidity of the market through anexpanded investor base and by providing an alternative source of demand for papers. The expansionof the Real-time Electronic Transfer of Funds and Securities (RENTAS) settlement infrastructure toinclude USD-MYR transactions via the implementation of Payment versus Payment and Deliveryversus Payment links with Hong Kong in 2006 and 2007 respectively also facilitates thesimultaneous settlement of ringgit and US dollar payments and securities during Malaysian businesshours. This has allowed market participants to better manage their foreign exchange settlement risk.

The other components of the financial markets, namely the equities, money, foreign exchangeand derivatives markets have demonstrated improved performance over the past decade. The totalmarket capitalisation of Bursa Malaysia has risen from RM553 billion as at end-1999 to RM1.1 trillionas at end-2007. The robust development of the money market has also facilitated the channelling ofshort-term funds between financial institutions to meet their funding and portfolio adjustmentrequirements, with the total volume of money market transactions in 2007 growing to RM2.8 trillion(1999: RM1.4 trillion). Similarly, the foreign exchange market has witnessed an increase in foreignexchange transactions, including hedging transactions. The narrowing of bid-offer spreads in theforeign exchange market indicate a more refined and maturing market. Derivative contracts,uncommon previously, have increased with the advent of financial innovation that has led to moreadvanced and sophisticated product offerings in the derivatives market. Apart from being used ashedging instruments, derivatives are also used by financial institutions to further expand the variety ofinvestment products offered to sophisticated clients.

> 5-10 yrs22.6%

> 1-5 yrs15.2%

> 20 yrs4.0%

> 15-20 yrs2.4%

>10-15 yrs10.0%

< 1 yr45.8%

> 10-15 yrs17.8%

> 5-10 yrs32.7%

> 1-5 yrs6.4%

> 15-20 yrs0.7%

< 1 yr60.1%

Chart 3PDS Issues by Tenure

1999 2007


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Strong Players with Domestic and Regional PresenceThe growing business complexities arising from the increased convergence of activities andintensified competition have compelled financial institutions to reengineer themselves to focus ontheir core competencies, optimise operational efficiencies and diversify revenue streams in order toincrease productivity. Among other things, greater efficiency and productivity have been achievedthrough the outsourcing of non-core business operations such as data processing, the marketing ofproducts and services and information and communication technology infrastructure to externalparties, both onshore and offshore. Domestic and locally-incorporated foreign banking institutionshave also established centralised data processing centres in Malaysia which cater to their businesseslocally and abroad. This development augurs well towards promoting Malaysia as a shared servicesand outsourcing centre.

The evolution of the financial system has also been driven by the diversity of shareholders thatbring new strategic and management perspectives, new innovations and increased businessopportunities. Flexibilities granted for financial institutions to enter into strategic alliances with bothforeign and domestic institutions have brought about greater opportunities for synergistic andcollaborative arrangements that maximise the potential of domestic institutions. Domestic playersare able to leverage on the international expertise and capabilities that these institutions bring, andbenefit from the transfer of knowledge, skills, technology and innovation.

The strengthened capacity of domestic financial institutions brought about by the rationalisationexercise and capacity building efforts has enabled the expansion of domestic financial institutions’business operations abroad. To date, six domestic banking groups have a presence in 19 countries inthe form of branches, representative offices and subsidiaries. The intensified regional and overseasexpansions by domestic banking groups are in recognition of the growing business opportunitieswithin the region brought about by increasing liberalisation and integration amongst the regionaleconomies. Such ventures will diversify their earnings capacity and enhance their business potentialbeyond the domestic market. Total assets of the overseas operations of domestic banking groupsamount to approximately RM111.6 billion, while the average contribution of total overseas profitsto total group profits is 10.7% (2002: -4.3%). Revenue and profit contributions from overseasoperations are expected to grow further in significance over the next few years with thestrengthening of the presence of domestic financial institutions abroad, and as investments in thesecountries progressively mature.

Comprehensive Range of Products and Services to Support Economic NeedsDeposit products offered by banking institutions have evolved over the years to cater for changesin customers’ risk-return and liquidity preferences. Today, deposit products have broadened inrange from plain vanilla deposits to structured products that offer returns tagged to theperformance of underlying assets, currency movements or indices. In line with robust economicgrowth, total deposits placed with banking institutions during the period 2000-2007 grew at anaverage annual rate of 8.5%. Deposits now account for 172.5% of GDP. With the establishmentof the Malaysia Deposit Insurance Corporation in 2005, depositors are guaranteed for up toRM60,000 on total deposits placed with a single member institution, that is commercial banksand Islamic banks.

In terms of financing, the growth over the recent decade has been predominantly attributed tolending to the household sector, fuelled by higher consumer spending that is supported by risingincomes and positive labour market conditions. The share of outstanding loans to individuals and thehousehold sector increased from 35% in 1999 to 55.9% of total outstanding loans as at end-2007.As the larger corporates turn to the capital market to meet their funding needs, lending strategieshave also focused on capturing a greater share of the market for SMEs. As at end-2007, loans to SMEsaccounted for 43.6% of outstanding business loans compared to 30% in 1999. Most banking


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institutions have expanded their financing role to include providing developmental and advisoryservices to their SME clients, thus contributing towards strengthening the growth potential of the SMEsector. Given that about 80% of the SMEs in Malaysia are micro enterprises, several bankinginstitutions have also begun to offer microfinance products to capitalise on opportunities in thisuntapped market.

Banking institutions have further evolved from their traditional lending role to providing morecomprehensive financial solutions that offer end-to-end value added services to their customers.Given the increasingly sophisticated and affluent consumer market, portfolio and wealthmanagement services as well as private banking catering to the needs of high net worth clients,have expanded considerably over the last few years.

In terms of delivery channels, the traditional concept of bank branches has evolved to caterfor customised market segments of banking institutions. The reconfiguration of branches intospecialised, customer-centric centres now allows banking institutions to serve customers in a moreefficient and effective manner. Technological advancements have also provided a further impetusfor the evolution of the branch network, with electronic terminals and 24-hour internet bankingfacilities increasingly substituting the services which were previously performed over the counter.The offering of insurance products through the branches of the banking institutions underbancassurance arrangements has also grown in importance in recent years. More recently,banking institutions have formed strategic alliances with unit trust and wealth managementcompanies to offer a wider array of investment-linked and capital market-related products to

Table 3Sources and Uses of Funds of the Financial System

1999 2007p

RM billion

Sources:Capital, reserves and profit 113.2 227.6Currency 30.5 42.2Deposits 561.3 1,147.1Borrowings 31.9 112.8Funds from other financial institutions1 69.6 122.7Insurance, provident and pension funds 213.9 486.2Other liabilities 153.9 337.2

Total 1,174.3 2,475.9

Uses:Currency 9.4 9.0Deposits with other financial institutions 178.8 468.8Loans and advances2 489.4 861.4Securities 261.3 661.2

Treasury bills 3.7 2.0Commercial bills 12.8 10.9Malaysian Government Securities (MGS) 75.4 202.0Corporate3 163.0 355.8

Private Debt Securities (PDS) n.a. 175.1Equities n.a. 180.8

Foreign 1.5 5.2Others 4.9 85.3

Gold and forex reserves 113.8 334.4Other assets4 121.5 141.11 Equal savings, fixed and other (NIF, LPHT, etc.) deposits + NIDs + repos.2 Includes statutory reserves of banking institutions.3 Breakdown of Corporate Securities between Private Debt Securities (PDS) and

Equities available from 2003.4 Effective 2006, portions of ‘Other assets’ have been re-classified.

p Preliminaryn.a. Not availableNote: Numbers may not necessarily add up due to rounding


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customers. Other tie-ups include using retail stores as cheque collection points and providingremittance services in collaboration with specialised service providers. These activities havecontributed towards increasing the fee-based income generated by the banking system by anaverage annual rate of 11.3% since 2000.

Insurance companies have also expanded their product lines to include mortgage financing. Themortgage financing facilities are typically long-term assets of the life insurers, providing them with anatural maturity-hedge for their long-term insurance liabilities. Mortgage loans extended by lifeinsurers grew by 7.4% in 2007 to account for 3.4% share of the total assets of life insurance funds(1999: 2.8%). Insurance products have also advanced from the traditional life products which offerpure protection coverage to those which are investment-linked in nature. As at end-2007,investment-linked premiums account for 50% of total new business premiums written, as comparedto 9.6% in 1999.

Chart 4Distribution of New Business Premiums of Direct Life Insurers

Others16.4%

Temporary27.1%

Whole Life23.0%

Investment-linked9.6%

Endowment23.9%

Investment-linked50.0%

Endowment16.2%

Whole Life7.5%

Temporary13.9%

Others12.5%

1999 2007

In line with the objective of promoting greater financial inclusion and more equitable growth inthe economy, strategies to encourage financial institutions to widen their outreach to consumershave begun to yield encouraging results. Various initiatives have been taken to encourage bankinginstitutions to leverage on alternative modes of bank branches such as mobile units and otherservice providers to serve a wider segment of the population. Today, the estimated population sizeserved per bank branch nationwide has decreased from 8,262 in 1999 to 7,931 as at end-2007. Asat end-2007, 27% of bank branches are domiciled in non-metropolitan areas.

ConclusionThe Malaysian financial system has developed and grown in maturity since the Asian financial crisis.The sector has advanced from being an enabler of economic growth to a source of growth in itsown right, sustained by continuous and progressive achievements in institutional development aswell as infrastructure building and enhancement. Players in the financial system have continued toinnovate and reinvent themselves to better serve consumers and the economy as a whole, as well asto remain relevant in the increasingly competitive financial landscape. Financial markets have alsocontinued to develop in depth and breadth, complementing the role of the banking sector infinancing economic activities. As the financial system advances to the next stage of development,this evolution will be important to ensure that it continues to support the needs of the economy,while maintaining financial stability.


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Institutional Developments

Key Developments in the Malaysian Financial Sector

• Industry-wide consolidation into nine domestic financial conglomerates• Rationalisation of commercial banks and finance companies • 14 investment banks from integration of discount houses, merchant banks, stock broking companies and universal brokers• Establishment of Islamic banking subsidiaries • Strategic alliances with foreign institutions/specialised service providers• Six domestic banking groups with presence in 19 countries • Restructuring and rationalisation of DFIs• Growing sophistication and diversification of products and services of financial institutions • Expanded and more efficient delivery channels

Financial Market Developments

• Third largest bond market in Asia in relative terms to GDP (Asian Bonds Online)• Largest sukuk issuer globally, accounting for 68.9% of total global sukuk outstanding as at end-2007 • Stronger participation of corporate sector in debt securities market with corporate debt securities accounting for 56.2% of total corporate financing (1999: 36%) • Foreign investor holdings in debt securities market account for 14.7% of total outstanding debt securities (2001: 0.3%) • Market capitalisation of Bursa Malaysia: RM1.1 trillion (1999: RM553 billion)• Volume of money market transactions: RM2.8 trillion (1999: RM1.4 trillion)• Volume of spot and swap transactions in Kuala Lumpur foreign exchange market: RM1.2 trillion (1999: RM647.8 billion)

Infrastructure Developments

• Access to financing o Credit Guarantee Corporation Bhd o Cooperatives Commission (2008)• Access to assistance in financial matters o Small Debt Resolution Scheme (2003) o Financial Mediation Bureau (2005) o Malaysia Deposit Insurance Corporation (2005) o Credit Counselling & Debt Management Agency (2006)• Access to financial information o Islamic Interbank Money Market website (2004) o Fully Automated System for Issuing/Tendering (FAST) (2005) o Laman Informasi, Nasihat & Khidmat (LINK) (2005) o BNM TELELINK (2007) o Bond Info Hub (2007) o BankingInfo, InsuranceInfo & SMEInfo portals• Credit risk management o Central Credit Reference Information System (CCRIS) (2001)• Human capital development o International Centre For Leadership In Finance (ICLIF) (2003) o International Centre for Education in Islamic Finance (INCEIF) (2006) o Financial Sector Talent Enrichment Programme (FSTEP) (2008)• Review of legislative framework o Development Financial Institutions Act 2002 o Payment Systems Act 2003

Prudential Regulation and Supervisory FrameworkImplementation of Principle-Based Regulation White Box: Prudential Standards Issued in 2007Risk-Based SupervisionEnsuring a Cohesive Prudential and Supervisory FrameworkImplementation of Revised Capital Adequacy Frameworks Priorities in 2008 White Box: Distinct Features of Islamic Financial Transactions: Perspective on Musharakah Mutanaqisah (Diminishing Partnership)

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Maintaining a robust, effective and efficientregulatory and supervisory framework remained akey priority for Bank Negara Malaysia in 2007.Given the continuing evolution of the financiallandscape as well as the greater volatility in thefinancial markets, the Bank remained focused onensuring that its prudential regulations andsupervisory framework are responsive to changingeconomic conditions in maintaining the resilienceof financial institutions, while providing aconducive environment for financial innovationand growth.

The Bank is responsible for the regulation andsupervision of commercial banks, investmentbanks, Islamic banks, insurance and reinsurancecompanies as well as takaful and retakafuloperators. Since 2002, the Bank also assumedresponsibility for the regulation and supervision ofsix development financial institutions which arecharged with specific mandates within the broaderfinancial sector. The Bank also regulates insurancebrokers, loss adjusters, money brokers andpayment system operators which are covered inthe chapters "Market Conduct and EnhancingFinancial Capability" and "Payment andSettlement Systems".

The evolution of the regulatory andsupervisory framework in the recent period hasbeen cognisant of the fundamental changes to thefinancial landscape, characterised by the followingtrends:• the increasing diversity of the financial sector

which has seen the emergence and moresignificant presence of new players in themarket such as investment banks, privateequity firms, boutique investment advisors aswell as new international players in Islamicfinance;

• increasing linkages between the banking,insurance and capital market sub-sectors as aresult of financial conglomeration and with it,greater financial innovation at a much fasterpace than previously experienced;

• the significant growth of Islamic bankingwhich now accounts for 15.4% of the assetsof the banking system, which has furthercontributed to the increasing level of productsophistication and innovation;

• the growing importance of market-basedfinance, with the capital markets assuming amore significant role in the financing ofeconomic activities. This in turn, has resultedin banking institutions shifting more towardstreasury-based activities while stimulating thegrowth of the derivatives market; and

• the growing volume of cross-border capitalflows with greater global financial integrationboth in terms of the increased foreignparticipation in the Malaysian financial sectorand the increased regional expansion bydomestic players.

In adapting to these new trends, the Bank’sapproach to regulation and supervision hasfocused on three main complementary strands:• firstly, achieving an optimal balance between

principle-based and rule-based regulation toappropriately reflect the greater complexityand diversity of the financial sector, whilehaving the agility to continuously adapt tochanging economic and market conditions;

• secondly, the implementation of an enhancedrisk-based supervisory framework with moregranular assessments of individual institutions’unique risk profiles and risk managementcontrol functions, thus ensuring thatsupervisory attention continues to beproportionately focused on financialinstitutions that are of higher risk; and

• thirdly, strengthening the conditions foreffective market discipline to play a moreimportant role in ensuring sound financial andbusiness practices by financial institutions.

Progress achieved on each of these strandshas also resulted in the closer alignment of theBank’s regulatory and supervisory framework withinternational standards and guidance issued by theBasel Committee on Banking Supervision, theInternational Association of Insurance Supervisorsand the Islamic Financial Services Board.

IMPLEMENTATION OF PRINCIPLE-BASEDREGULATIONPrinciple-based regulations have gained greaterprominence within the prudential framework.Under a more principle-based regulatory regime,prudential standards issued by the Bank have

Prudential Regulation and Supervisory Framework


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Since 2001, more than 50 prudentialstandards have been developed or reviewed undera more principle-based regulatory approach. In theprocess, a majority of prescriptive limits andregulatory requirements or restrictions have beenreplaced with broad principles that emphasise theresponsibility of the board and seniormanagement to manage risks in a mannerappropriate to the circumstances and exposures ofa particular institution. Among the regulatoryprescriptions that have been abolished under themore flexible, principle-based regulatory regime

progressively shifted towards establishing highlevel principles, in place of detailed prescriptions,which frame the Bank’s supervisory expectationsregarding sound financial and business practices.This shift is not synonymous with less supervisionor regulation, but aims to achieve greater focus onan institution’s ability to effectively manage itsrisks instead of a mechanical compliance withdetailed rules. This, in turn, would result in aregulatory framework that is more robust againstthe vagaries of changing market conditions, whileaddressing the limitations of a "one-size-fits-all"rule-based regulatory system through anappropriate differentiation between institutionsaccording to their size, complexity and risk profile.Financial institutions have considerable flexibilitywithin this framework to determine the mostappropriate means by which the Bank’ssupervisory expectations can be met in a way thatis also in line with the institution’s own strategicobjectives and business models. The Bank believesthat ultimately, this approach is more sustainableover time in reinforcing financial stability andpromoting a more competitive financial system.

The implementation of a more principle-basedregulatory regime for the financial sector inMalaysia remains at a relatively early stage. Whilecommitted to this process, significant attentioncontinues to be directed at strengthening thepreconditions necessary to support the movetowards a more principle-based regulatoryframework without compromising financialstability outcomes. This is reflected in the clearemphasis placed on corporate governance overthe recent few years, beginning with substantiverevisions to the Bank’s prudential standards oncorporate governance. The new standards focus inparticular on the role of the board and seniormanagement in ensuring a sound riskmanagement and internal control environmentwithin financial institutions. These standards setout the Bank’s expectations regarding effectiveboard compositions that include strongindependent members, the presence of relevantcompetencies on the board and seniormanagement team, transparent board processesand clearly delineated accountabilities foroperating and internal oversight functions.

The Bank’s supervisory processes have alsoconcurrently been enhanced to ensure thatdirectors and chief executive officers of financialinstitutions fulfil fit and proper criteria on an

ongoing basis. In addition to supervisory reviewscarried out to check the suitability of proposedchief executives and directors prior to theirappointments, the Bank also engages morefrequently with the board and senior managementof financial institutions, either individually orcollectively, on key strategic and risk developmentsaffecting the institution. This has facilitated moreeffective assessments of how the board and seniormanagement are discharging their responsibilitiesin practice, while providing deeper insights intopotential governance issues within an institution.

Based on the Bank’s ongoing supervisoryassessments, the effectiveness of board oversightand senior management has, on the whole,continued to improve. More specifically, aheightened awareness of risk with clear strategiesfor managing key risks, enhanced disclosures,closer scrutiny of management by the board andprompt actions to detect and remedy internalcontrol deficiencies have been evident amongfinancial institutions. Financial institutions whichdid not meet the Bank’s supervisory expectationswere required to maintain a higher proportion ofindependent directors, or replace board membersor chief executives who no longer fulfilled the fitand proper criteria. These developmentsunderpinned the presence of stronger governancestructures within institutions and supported thegrowing momentum towards principle-basedregulations in more recent periods.

The shift towards moreprinciple-based regulations isnot absolute, but rather aimsto strike an optimal balancebetween principle-based andrule-based regulations.


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are the individual counter limits imposed oninvestments in shares by banking institutions,restrictions placed on credit facilities to connectedparties, prescribed scenarios for stress testing andprior notification requirements for the introductionof new products.

The shift towards more principle-basedregulations is not absolute, but rather aims tostrike an optimal balance between principle-basedand rule-based regulations in order to preserve asound prudential framework at the differentstages of development of the financial sector.Prescriptive rules and requirements are accordinglyretained in specific areas. For example, baseline, orPillar 1, capital adequacy requirements for the

Prudential Standards Issued in 2007

(i) Guidelines on Investment inShares and Interest-in-Shares(issued in February 2007)

(ii) Guidelines on Stress Testing(issued in March 2007)

(iii) Guidelines on the Role of theAppointed Actuary for TakafulOperators(issued in March 2007)

(iv) Property Development andProperty Investment Activitiesby Islamic Banks(issued in March 2007)

(v) Revised Risk-Weighted CapitalAdequacy Framework(issued in April 2007,implementation from January2008)

■ Provides greater flexibility for banking institutions toundertake equity-related activities according to theinstitution’s internal risk management policies.

■ Introduces a more robust stress test regime by givingfinancial institutions greater flexibility in designing their stresstest framework that would be most appropriate for theirbusiness profile, while encouraging financial institutions tobetter understand the risk drivers of their institution.

■ Sets out the expected quality of actuarial investigationsinto the financial condition of family takaful funds by,among others, setting out:• the qualifying criteria for the appointment of

appointed actuaries; and• their responsibilities to continuously evaluate the

financial well being of the family takaful business,having due regard to certificate holders’ reasonableexpectations and developments in the business thatmay impact the financial condition of the funds.

■ Sets out the duty of the boards of Islamic banks to ensurethat adequate governance, sound internal controls and astrong risk management infrastructure are in place tosupport Islamic banks’ direct participation in propertydevelopment and property investment activities which isallowed under the Islamic Banking Act 1983.

■ Sets out the methodologies for quantifying theminimum regulatory capital requirements for credit,market and operational risk for conventional bankinginstitutions.

banking and insurance sectors which are afundamental cornerstone of the prudentialframework remain largely prescriptive in nature.The Bank considers certainty and consistency inthis particular area essential to maintainconfidence in the financial system and avoidmaterially distortive competitive effects in thesystem. Regulatory reporting requirements havealso remained prescriptive to facilitate the Bank’smicro- and macro-surveillance functions. Whereappropriate, the Bank has retained prudentiallimits as well – for example, on exposures to singlecounterparties – in certain areas as a minimumsafeguard against excessive risk-taking. Morespecific prudential requirements have alsocontinued to serve a useful purpose in achieving


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(vi) Risk-Based CapitalFramework for Insurers(issued in April 2007,implementation fromJanuary 2009)

(vii) Valuation of Liabilities forMortgage Reducing TermTakaful (MRTT)(issued in April 2007)

(viii) Capital AdequacyFramework for Islamic Banks(issued in June 2007,implementation fromJanuary 2008)

(ix) Guidelines on CreditTransactions and Exposureswith Connected Parties(issued in August 2007)

(x) Policy on Musharakah andMudharabah Contracts(issued in September 2007)

(xi) Guidelines on SingleCounterparty Exposure Limit(concept paper issued inSeptember 2007)

■ In October 2007, the market risk component wasincorporated in the framework with enhanced guidanceon trading book governance and the provision forbanking institutions to adopt the Internal ModelsApproach, subject to the Bank’s approval.

■ Replaces the existing solvency framework with theparallel run commencing from June 2007.

■ Sets out more transparent and risk-adjusted capital andvaluation requirements that address all major financialrisks of insurers.

■ A similar framework for takaful operators is beingdeveloped, with a concept paper expected to bereleased in 2008.

■ Specifies the minimum valuation requirement based on thenet premium valuation method to be adopted by takafuloperators in determining the reserves that must be providedfor to meet future liabilities under MRTT contracts.

■ Sets out the capital adequacy requirements for Islamicbanks covering credit, market and operational risks,which are consistent with the Capital AdequacyStandards issued by the Islamic Financial Services Board.The framework addresses risk characteristics unique toIslamic finance contracts.

■ Introduces specific capital requirements for inventory andcommodities risks to reflect exposures to pricefluctuations associated with the ability of Islamic banksto undertake the sale and purchase of assets.

■ Provides greater flexibility for banking institutions toextend credit in the ordinary course of business toconnected parties (previously prohibited) based on arm’slength principles and subject to sound risk managementpractices and concentration limits.

■ Sets out the Bank’s expectations regarding keygovernance, risk management and internal controlfunctions to support the sound conduct of investmentand financing transactions based on musharakah andmudharabah contracts.

■ Strengthens the prudential requirements for controllingconcentrated exposures to single names in line withinternational standards and best practices.

■ Proposed changes include the requirement to observethe limits on a consolidated basis, greater considerationof interconnected exposures based on financial andcommercial interdependence, refinements to the basisfor the computation of limits, and the application ofpermitted credit risk mitigation techniques to reduceexposures to a particular counterparty.


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(xii) Corporate GovernanceStandards for LicensedIslamic Banks(issued in September 2007)

(xiii) Guidelines on Introductionof New Products(issued in November 2007)

(xiv) Appointment of ExternalAuditors(issued in November 2007)

(xv) Guidelines on RiskGovernance(concept paper issued inDecember 2007)

(xvi) Policy on the Recognitionand Measurement of ProfitSharing Investment Accountsas Risk Absorbent(issued for implementationfrom January 2008)

■ Outlines the broad principles and minimum standardsfor sound corporate governance which addressmanagement oversight, accountability, audit andtransparency.

■ Strengthens the Shariah compliance frameworkthrough requirements for the establishment of aShariah committee, Shariah internal audits andenhanced disclosures relating to Shariah matters in theannual report.

■ Introduces a more efficient regulatory process for theoffering of new products by banking institutions anddevelopment financial institutions.

■ Institutions are now allowed to offer new products inthe market immediately upon submission of requiredinformation to the Bank (thereby replacing the former21-day prior waiting period for supervisory reviews),subject to meeting the Bank’s supervisory expectationsset out in the guidelines.

■ A similar system will be introduced for insurers in 2008.

■ Addresses the responsibility of financial institutions inevaluating the integrity, objectivity and professionalcompetence of external auditors appointed under therelevant financial sector legislation.

■ Outlines high level principles on risk managementgovernance for the board and senior management aswell as supervisory expectations regarding the riskmanagement control functions of banking institutions,insurers and takaful operators.

■ More specific risk management guidelines on credit,market and operational risks are concurrently beingdeveloped to provide further guidance on supervisoryexpectations in each risk area, with the concept papersexpected to be released in 2008.

■ Islamic banks that satisfy the minimum requirements ofthe framework would be allowed to deduct the creditand market risk-weighted assets funded by profitsharing investment accounts from the total risk-weighted assets for the computation of the risk-weighted capital ratio, in recognition of the effectivetransfer of risks from the Islamic banks to theinvestment account holders.

The Shariah Advisory Council of the Bank also issues pronouncements on Shariah matters to beobserved by financial institutions regulated by the Bank. Please refer to the box on "ShariahPronouncements in 2007".


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certain minimum standards of sound managementin certain sectors which are less developed interms of risk management sophistication (e.g.development financial institutions), where specificguidance remains necessary to build capabilities(e.g. valuation standards for takaful funds), or toaddress present and emerging risks (e.g. specificrequirements that may be imposed underconditions of distress).

To reinforce the dynamic nature of the balancebetween principle- and rule-based regulations, theBank will continue to enhance the structure of theprudential framework to provide greater clarity onthe interplays between the regulations issued bythe Bank. The priority will be towards developing acomprehensive set of general prudential standardswhich establish high level principles covering thekey risk management control functions thatshould exist within all financial institutions. To thisend, significant efforts have been taken in recentyears to review and develop standards in the areasof board oversight, senior management, internalaudit and risk management, which would providethe overarching prudential framework for allregulated financial institutions.

The overarching framework will becomplemented by more specific prudentialstandards that address the Bank’s supervisoryexpectations regarding the management ofsignificant activities undertaken by financialinstitutions. These may be specific to therespective banking, insurance or takaful sectors,and may include appropriate prudential limits andmore detailed requirements prescribed by theBank. Over time, the Bank expects to evolve amore cohesive and consistently expressedprudential framework that:(i) addresses all the main elements of effective

risk management control functions which areapplicable across all significant activities offinancial institutions (general standards);

(ii) is appropriately tailored, while avoiding anyoverlaps, to specific areas of activity (specificstandards); and

(iii) provides for regulatory prescriptions whereneeded as minimum prudential safeguards.

The Bank generally expects that financialinstitutions would require some time to adapt to amore principle-based regime. Going forward, thepace of transition toward a more principle-basedregime will depend on several key factors. The first is

a corresponding change in the behaviours offinancial institutions from a focus on compliance-based outcomes, to one that focuses on the effectivemanagement of risks by institutions in an integratedmanner. Greater reliance will be placed on boards toset the "tone at the top", while ensuring that thereis broad-based engagement within the organisationsacross various levels and functions in setting riskstrategy, establishing acceptable levels of risk-takingand defining accountabilities. Following from this,the Bank will expect financial institutions to have thenecessary processes, systems and expertise effectivelyin place to support sound operating decisions andjudgements, thus maintaining financial stabilityunder the more principle-based regime.

For institutions to operate with a reasonabledegree of certainty as to acceptable practices undera less prescriptive framework, there is also a need forgreater dialogue between the Bank and the industry,particularly in the initial stages of transition, to builda common understanding of the range of acceptablepractices and approaches which would satisfy theregulatory principles established by the Bank. TheBank will continue to actively engage the industry onthis front, while ensuring consistent supervisoryassessments and actions to reinforce good practices.

The Bank further envisages significant scope forthe key industry associations and relatedprofessional bodies to play a more active role inpromoting dialogue within the industry andproviding industry-specific guidance on howprinciples promulgated by the Bank may be appliedin practice. These entities include the Association ofBanks in Malaysia, the Malaysian InvestmentBanking Association, the Life Insurance Associationof Malaysia, the General Insurance Association ofMalaysia, the Actuarial Society of Malaysia, theMalaysian Takaful Association, the Association ofIslamic Banking Institutions Malaysia and theprofessional accounting bodies. While the Bankencourages the development of useful guidance bythe industry, individual financial institutions willremain responsible for ensuring that the applicationof such guidance provided by the industryadequately addresses the institution’s own riskexposures, having regard to the specificcircumstances under which the institution operates.

RISK-BASED SUPERVISIONA risk-based approach to supervision has beenadopted by the Bank since 1997. In 2004, anenhanced risk-based supervisory framework (RBSF)


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was implemented for insurers and takaful operators,followed progressively thereafter by the adoption ofthe framework for banking institutions anddevelopment financial institutions. The RBSF furtherstrengthens the Bank’s risk and impact-focusedapproach to supervision, underpinned by morecomprehensive and holistic risk assessments ofindividual financial institutions under the purview ofthe Bank. It is applied to all financial institutionsregulated by the Bank, thereby ensuring that similarrisks are addressed in a consistent manner across thefinancial sector. The framework also facilitates theappropriate concentration of supervisory attentionon institutions that are of higher risk. Supervisoryresources and activities are thereby more efficientlyand effectively managed, with greater scrutiny onweaker and systemically important institutions.

The RBSF is a dynamic supervisory tool thatidentifies and assesses the emerging risks in afinancial institution based on an in-depthunderstanding of the institution, the industry andenvironment in which it operates, and factors thatcould adversely alter the risk profile. A key outputof the RBSF is an assessment (known as thecomposite risk rating) of an institution’s ability tomeet its obligations to depositors, creditors andpolicyholders on a continuing basis, includingunder stress conditions. The composite risk rating(CRR) is derived from an assessment of the risksinherent in an institution’s significant activities, theoverall quality of its operational management andrisk management control functions to mitigate theinherent risks, and the extent of capital andearnings support available to the institution toabsorb unexpected losses (Chart 4.1). The CRRprovides the basis on which the Bank determinesthe appropriate level of intensity of supervisionover a particular institution and supervisoryactions, including the imposition of additionalcapital requirements, that need to be taken toaddress residual risks. The CRR is also a factorconsidered by the Malaysia Deposit InsuranceCorporation in the application of the differentialpremium charges on member banking institutionsfor deposit insurance.

The RBSF further strengthensthe Bank’s risk and impact-focused approach tosupervision, underpinned bymore comprehensive andholistic risk assessments ofindividual financial institutions.

* For Islamic banks

Identify SignificantActivities

Assess theInherent Risks

Assess theOperational

Management

Assess the RiskManagement Control

Functions

· Credit · Board of Directors · Market · Liquidity · Senior Management

· Operational· Information

· Risk Management

Technology

· Internal Audit

· Strategic

· Compliance

· Insurance &

· Information &

Takaful

Communication

· Equity Investment*· Rate of Return*

Composite Risk Rating

RISK-BASED SUPERVISORY FRAMEWORK

Business linemanagers responsiblefor day-to-dayoperations

Assessment of Capital & Earnings

Significant activities couldinclude any line of business,unit or process having asignificant potential impact onthe institution's earnings andcapital positions as well asthe achievements of theirstrategic plans.

Chart 4.1 Supervisory Framework under RBSF


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In implementing the RBSF, the Bank has alsoenhanced its supervisory documentation to ensurethat supervisory assessments are well-supported,and provide a clear trail of risk issues, developmentsand actions taken in relation to each individualinstitution. Greater integration between the Bank’smacro-surveillance and supervision functions wasalso achieved with enhanced two-way flows ofinformation that provided supervisors with up-to-date developments of emerging risks within thebroader financial system that could impact the riskprofile of individual institutions, while institution-specific insights from supervisors contributedtowards a deeper understanding and more effectivemonitoring by the Bank of potential risks tofinancial stability.

Under the RBSF, greater reliance is placed onan institution’s internal oversight functions toidentify emerging risks and safeguard aninstitution’s financial condition. To support suchreliance, the Bank has continued to regularlyengage the board and senior management as wellas those principally responsible for internal audit,risk management, compliance and managementinformation support within institutions, on riskissues concerning the institution. Greater relianceis also placed by the Bank on the work of externalauditors and actuaries appointed by financialinstitutions. In this connection, the Bank hasregular discussions with external auditors andactuaries to enhance awareness and clarity of theBank’s expectations of their roles, and the degreeof reliance placed on their work for supervisorypurposes.

ENSURING A COHESIVE PRUDENTIAL ANDSUPERVISORY FRAMEWORKThe framework for prudential regulation andsupervision is both interdependent and mutuallyreinforcing. In implementing the RBSF and more

Greater integration betweenthe Bank’s macro-surveillanceand supervision functions wasalso achieved with enhancedtwo-way flows of informationthat provided supervisors withup-to-date developments ofemerging risks.

The RBSF is centrally supported by "relationshipmanagers" in the Bank whose primaryresponsibilities are to carry out supervisoryassessments of institutions, conduct ongoingsupervisory reviews, recommend appropriateinterventions and maintain open lines ofcommunication with the institutions to ensure thatdevelopments – both internal and external to theinstitutions – are quickly identified and factored intosupervisory assessments on a continuing basis.

Based on the Bank’s supervisory assessmentsunder the RBSF, the vast majority of financialinstitutions remained in a healthy position as atend-2007, with the capacity to manage theincreased risks associated with the more volatileexternal environment.

During the year, the Bank continued tostrengthen the supporting structure, processes andcore capabilities required to effectively implementthe RBSF through:• the institution of a quality assurance

framework which provides for more rigorousinternal processes to promote accurate riskassessments and feedback across the Bank’ssupervisory departments, as well as timely andeffective interventions. Among other things,the framework provides for internal peerreviews of supervisory assessments to validatethe judgements exercised by relationshipmanagers in respect of individual institutions.These panel reviews ensure that supervisoryassessments are appropriate, having regard tothe supervisory expectations established inguidelines issued by the Bank, the institution-specific exposures and risk managementpractices, and assessments of otherinstitutions with similar risk profiles;

• significantly strengthened technicalcapabilities residing in specialised risk (credit,market, operational and insurance) andeconometrics units established within theBank. These units are staffed by qualifiedsupervisors and subject matter experts whoprovide key support to the relationshipmanagers on more technical aspectsassociated with statistical modelling, complexrisk assessments and the evaluation of internalrisk models; and

• improved supervisory information systems andinfrastructure with enhanced capabilities tosupport more efficient supervisoryassessments.


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principle-based approach to regulation, significantattention is directed at ensuring the effectiveintegration of the regulatory and supervisoryprocesses to achieve a coherent framework thatcontributes to financial stability.

to financial institutions under the Bank’s purviewto ensure an enabling legislative framework that issupportive of the more principle-based regulatoryapproach as well as risk-based supervision. Morethan 166 provisions of the Banking and FinancialInstitutions Act 1989 and the Insurance Act 1996were reviewed with the aim of:• aligning the legal provisions with the more

principle-based regulations and developmentsin international supervisory standards;

• ensuring that the Bank will have the necessaryauthority to act under the risk-based approachto supervision when necessary;

• enhancing cross-sector consistency;• enhancing clarity of the law; and• reducing the administrative burdens on

financial institutions where appropriate.

The Islamic Banking Act 1983 and Takaful Act1984 have also been concurrently reviewedtogether with an exercise to update andstrengthen these respective legislations. The Bankexpects to complete the legislative process toeffect these amendments in 2008.

To ensure the efficiency and integrity of theprudential framework, the Bank made furtherprogress in efforts to rationalise and update theprudential framework across the industriesregulated by the Bank, as well as in relation to thecapital market intermediaries regulated by theSecurities Commission. During the year, the Bankcompleted an exercise to identify divergentregulatory requirements in common areas ofactivity involving its regulated institutions,reviewed 18 regulatory requirements andidentified a further 14 areas for review in 2008.

The Bank continued to obtain relevant inputfrom the financial industry and other keystakeholders to maintain a robust framework thatis reflective of changing market realities and isimplementable in practice. During the year, sixconcept papers were issued to the industry, withanother eight in the final stages of completion forexpected issuance within the first half of 2008.Responses received from stakeholders continuedto provide important insights into the efficiencyimplications of proposed policies, consistencyacross industries as well as their likely impact onbusiness and financial activities. Whereappropriate, policies were modified to addresssignificant issues raised.

In line with the transition from a "one-size-fits-all", compliance-focused regulatory regime, toone that is more differentiated according to riskand more reliant on the exercise of supervisoryjudgements, enhanced processes have beenadopted to further integrate critical supervisoryinputs into policy thinking and formulation.Specifically:• prudential policy priorities are confirmed

against key risks to financial stabilityhighlighted through supervisory observationsand assessments;

• policy development is jointly approachedbetween the regulatory and supervisoryfunctions of the Bank, thus allowing forbroader-based assessments of proposedpolicies while ensuring a commonunderstanding of the specific outcomes ofprudential policies. This, in turn, facilitatessupervisory assessments of individualinstitutions under the RBSF that will bealigned with, and reinforce, the supervisoryexpectations set out under the principle-basedregulations; and

• the exercise of sound supervisory judgement isfurther reinforced through the inclusion ofstaff involved in policy development in thesupervisory review panels and interventiondeliberations. This further contributes towardsensuring that supervisory assessments andinterventions are appropriate, having regardto specific outcomes intended by theprudential standards issued.

During the year, the Bank also completed anassessment of revisions to the legislation applied

Significant attention is directedat ensuring the effectiveintegration of the regulatoryand supervisory processes toachieve a coherent frameworkthat contributes to financialstability.


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The Bank remained mindful of the trade-offbetween the benefits and costs of regulation. Asin previous years, a large part of feedback receivedduring the consultation process highlighted theconcerns of institutions regarding practicalimplementation issues. The Bank held dialogueswith the industry and individual institutions tounderstand these concerns more fully and developimplementation solutions that appropriatelybalanced the costs of implementation with risks tofinancial stability. In an environment of increasedvolatility and competition, however, financialinstitutions clearly recognised the urgent need toenhance risk management systems andgovernance structures within their organisations.

Outside the Bank, closer coordination withother regulatory and supervisory agencies was alsoachieved with the conclusion of formalagreements with the Securities Commission andthe Malaysia Deposit Insurance Corporation thatclearly set out the roles, responsibilities andcooperation arrangements aimed at minimisingregulatory overlaps and inconsistencies. Thearrangements have continued to work well inenhancing regulatory efficiency and facilitating thesharing of information between agencies whereappropriate. The Bank also signed a Memorandumof Understanding with the State Bank of Vietnamto facilitate greater cross-border supervisorycollaboration.

IMPLEMENTATION OF REVISED CAPITALADEQUACY FRAMEWORKSDuring the year, substantial progress was achievedin final preparations for the implementation of therevised capital adequacy frameworks for bankinginstitutions and insurers. The revised frameworkswill align regulatory capital requirements moreclosely with the specific risk profiles of individualinstitutions and adopt underlying valuations thatare consistent with international financialreporting standards.

Revised Risk-Weighted Capital AdequacyFramework (Basel II) for Banking InstitutionsThe revised risk-weighted capital adequacyframework (Basel II), which is applicable tocommercial banks and investment banks, becameeffective from 1 January 2008 for a total of 27banking institutions that are adopting the simplerapproaches, namely the Standardised Approachfor credit risk and either the Basic Indicator,Standardised or Alternative StandardisedApproaches for operational risk. The remainingseven banking institutions (including four locally-incorporated foreign banking institutions) havebeen allowed to remain under the existing capitaladequacy framework (Basel I) until their migrationto the more advanced Internal Ratings-Based (IRB)approaches for credit risk under Basel II from 1January 2010. The option for direct migrationwhich is intended to minimise the cost of Basel IIimplementation, was granted only to bankinginstitutions that had met preconditions set by theBank, such as the availability of resources andexpertise to meet the supervisory expectationsunder IRB approaches as well as the ability todemonstrate a high level of commitment anddiscipline in implementation preparations.

With respect to Islamic banks, 10 out of 12Islamic banks have adopted the revised frameworkfor Islamic banks (Capital Adequacy Framework forIslamic Banks or CAFIB) which specifies thestandardised approach to capital computations,while reflecting the differences in the underlyingcontracts and incorporating specific elementspeculiar to Islamic banking such as the capitalrequirements for inventory risks as well as thetreatment of profit sharing investment accounts. Theremaining two Islamic banks have been allowed tomigrate directly to the IRB approach in January 2010.

The Bank anticipates that most bankinginstitutions would experience only modest

At the regional level, supervisory cooperationthrough the various regional groupings of whichthe Bank is a member, such as the ExecutiveMeeting of East Asia and Pacific Central Banks(EMEAP) and South East Asian Central Banks(SEACEN), deepened further. Cooperationfocused in particular on facilitating theimplementation of Basel II within the region aswell as strengthening the regional frameworksfor macro-surveillance and crisis management.During the year, the Bank also maintained itscommitment to strengthen the region’s influencein the development of international standardsthrough its participation in various workinggroups, and by providing feedback on more than15 draft standards and surveys issued by theinternational standard setting bodies.

Supervisory cooperation at theregional level deepenedfurther.


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increases in their regulatory capital requirementsfollowing the adoption of the revised capitalframeworks, based on results from the parallel runexercise in 2007. While the revised frameworksintroduce a new operational risk charge, theanticipated additional capital requirements areexpected to be partly mitigated by savings on thecredit risk capital charge derived from the lowerrisk weights applied for residential mortgages andretail exposures. In this connection, there has beengreater emphasis for banking institutions toimprove the collection of data on operationallosses. While this is not a pre-requisite for theimplementation of the Basic Indicator Approachunder the revised frameworks, the Bank views thecollection of loss data as critical in allowingbanking institutions to better understand theiroperational risk profiles as a basis for thedevelopment of enhanced operational riskmanagement capabilities.

For some institutions, the ability to quantifythe effects of comprehensive credit risk mitigationtechniques used, and the holdings of a significantportion of investment-grade debt securities, wouldgenerate further capital savings. The parallel runcalculations also indicated a minimal impact oncapital arising from the revised requirements formarket risk which, among other things,incorporate a new capital requirement forcommodity risk positions and recognise offsettingliability positions in the trading book. For Islamicbanks, the inclusion of physical assets as eligiblecollateral and the recognition of profit sharinginvestment accounts as a risk absorbent under therevised framework would also allow for additionalcapital relief.

internal risk modelling and analytical capabilities.The Bank will monitor these preparations closely toensure that these banking institutions remain ontrack to comply with the IRB approaches by 2010.

Risk-Based Capital (RBC) Framework forInsurersThe Risk-Based Capital (RBC) framework was issuedto the insurance industry in April 2007. Theframework provides for regulatory capitalrequirements that are more sensitive to theunderlying risk exposure of insurers, compared tothe existing solvency requirements. This allows formore flexible investment rules, while introducingrevised valuation requirements that are marketconsistent. All insurers are currently conducting aparallel run exercise in preparation for the effectiveimplementation of the framework in January 2009.

While the Bank anticipates some increase incapital requirements among several insurers, theparallel run exercise indicated that the majority ofinsurers would be able to comfortably meet theminimum regulatory capital requirement. Whileinsurance risk contributed most significantly to theoverall regulatory capital requirement, market riskalso represented a significant source of risk for lifeinsurers, mainly associated with equity exposuresand interest rate mismatches.

Most banking institutionswould experience only modestincreases in their regulatorycapital requirements followingthe adoption of the revisedcapital frameworks.

The majority of insurers wouldbe able to comfortably meetthe minimum regulatorycapital requirement.

For banking institutions that have been allowedto migrate directly to the IRB approaches,significant attention and resources have beendirected towards the proper construction of riskand data management systems and infrastructuralenhancements, as well as strengthening the

The adoption of market consistent valuationsof assets and liabilities may also result in someincreased volatility in the financial results ofinsurers. For life insurers in particular, theinsufficient volume of long-term debt instrumentsin the domestic market currently, coupled with theprevailing low interest rate environment, hascontinued to place some pressure on guaranteedbusiness, resulting in higher exposures to asset-liability mismatch risks. However, most insurersshould experience only modest increases involatility as asset positions adjust proportionatelyagainst corresponding liability positions.

PRIORITIES IN 2008Bank Negara Malaysia’s regulatory andsupervisory priorities in 2008 will continue to


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focus on strengthening the Bank’s capabilitiesand capacity to respond pre-emptively toemerging risks in the financial system. This wouldinclude:• ensuring that regulatory requirements

continue to remain appropriate over time andin relation to the changing environment, aswell as clearly setting out the Bank’ssupervisory expectations with regard to themanagement of key risks;

• ensuring, through vigilant supervision, thatinstitutions are adequately managing theirrisks in practice in line with the supervisoryexpectations of the Bank; and

• continuously building capacity within the Bankto support both of these activities.

The implementation of the revised capitalframeworks for the banking and insuranceindustries will remain a key priority in 2008.Banking institutions which have been grantedapproval to adopt the IRB approaches for creditrisk will be required to submit their internalmodels to the Bank for review before the modelscan be used to determine regulatory capitalrequirements. Significant supervisory resourceswill be devoted to the review and validation ofthese models ahead of the 2010 deadline forimplementation of the IRB approaches. The Bankwill also continue to closely monitor thequantitative impact of regulatory capitaladjustments within institutions and across theindustry for both banking institutions adoptingthe standardised approaches and insurersapplying the RBC framework on a parallel runbasis in 2008. The Bank expects to providegreater clarity to the industry on its approach tothe determination of additional capitalrequirements under the supervisory assessmentprocess (Pillar 2) for specific institutions, as wellas advance forward its work on marketdisclosures to reinforce sound financialmanagement (Pillar 3). Remaining

implementation and calibration issuessurrounding the revised frameworks will also beresolved. The Bank further intends to initiatework to develop an equivalent RBC frameworkfor the takaful operators.

Other priorities for the Bank in 2008 are thecompletion of reviews of the relevant financialsector legislation to reinforce the Bank’s newapproaches to regulation and supervision;development of a revised and more cohesivecompendium of risk management standards; andpreparations for the implementation ofinternational financial reporting standards onfinancial instruments and insurance contracts.The Bank also expects to engage the industry onthe proposed approach to the supervision offinancial groups, focusing in particular on theapplication of the revised capital adequancyframeworks and the RBSF in the context offinancial groups.

Another priority will be in the area ofcorporate governance. While the Bank does notenvisage substantive changes to its current set ofprinciples applicable to financial institutions,further efforts will be taken to harmonisestandards across institutions regulated by the Bankand, to the extent appropriate, with the updatedrequirements under ongoing reforms to theCompanies Act 1965 and developments innational codes of corporate governance. The Bankalso expects to take forward initiatives in the areaof directors’ education which are aimed atsupporting effective board functions.

Shariah Pronouncements in 2007

The Shariah Advisory Council (SAC) is the sole authoritative body on Shariah matters pertaining toIslamic banking, takaful and Islamic finance. Its jurisdiction covers all financial institutions regulatedand supervised by Bank Negara Malaysia. As the reference body and advisor to the Bank on Shariahmatters, the SAC is also responsible for validating all Islamic banking and takaful products to ensurecompatibility with Shariah principles.

The implementation of therevised capital frameworks forthe banking and insuranceindustries will remain a keypriority in 2008.


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In 2007, the SAC convened 12 meetings and among its major decisions were:

(i) Application of Ijarah Mausufah fi Zimmah in house financingThe SAC approved the application of ijarah mausufah fi zimmah (forward lease) as a supportingcontract in house financing based on ijarah as the primary contract. The decision bearsparticular significance for the financing of uncompleted assets as it will resolve the issue ofrental payments made for the period commencing from the execution of the contract to thecompletion of the asset. Prior to the decision, rental charges for the period before completionof the asset were not justifiable as the tenant could not enjoy the usufruct during this interimperiod. With the application of the forward lease, however, such payments can be treated asfuture rentals. The decision has been recognised by scholars from different schools of thoughtand will further refine existing contracts incorporating Shariah principles.

(ii) Application of Wakalah bi Istithmar contractThe SAC also approved the application of the wakalah bi istithmar (agency for investment)contract in deposit accounts. This contract involves deposit-taking mobilised through wakalah(agency), in which the funds mobilised are invested in instruments that would generate anagreed minimum rate of return. In contrast to deposits mobilised through wadiah or qardh, thewakalah contract feature would allow Islamic financial institutions to offer additional benefitssuch as takaful coverage with wakalah deposit accounts to enhance the product’sattractiveness to customers. However, the implementation of such contracts must be carriedout prudently to avoid any element of guarantee by the agent on the investment returns. Theresolution by the SAC is expected to further diversify Shariah-compliant products and at thesame time allow Islamic banks to be more creative and innovative in their product offerings.

Recognising the importance of Shariah compliance in Islamic finance, Bank Negara Malaysia, inMarch 2007, published a compilation of resolutions made by the SAC in a book entitled "ShariahResolutions in Islamic Finance". The book is intended to serve as a reference for the Islamic financecommunity, especially Shariah officers and practitioners. To inform the market in a timely manner,the Bank has also disseminated recent resolutions made by the SAC through press releases as part ofits continuing effort to increase transparency and enhance the understanding of Shariah issuesamong market players.

To promote quality research on Shariah compliance while improving regulatory efficiency, thepresentation of Shariah issues and new product proposals by Islamic banks to the SAC are requiredto be submitted in a standard format which incorporates issues, opinions and views of renownedShariah scholars. Institutions offering Islamic products are also required to state clearly the views ofthe institutions’ Shariah committee and the rationale behind such views. This will contribute towardsdeepening the understanding of the issues being discussed, thus promoting sound Shariahresolutions.

The SAC is supported by Shariah research carried out by Bank Negara Malaysia on Shariahaspects of product innovations as well as on immediate and long-term policy issues. In 2007,research undertaken on the application of the wakalah bi istithmar concept in savings depositproducts supported the approval given by the SAC for this product, considered the first wakalah-based savings product in the world. The Bank also conducted research to establish the applicabilityof existing financial reporting principles as a guide to develop Islamic financial reporting standards.Based on the Bank’s research, the SAC pronounced that these principles are consistent with Shariahand can serve as guiding principles to develop similar standards for Islamic financial reporting. TheSAC also highlighted the need for existing financial reporting standards to be enhanced in order tosupport Shariah requirements.

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Distinct Features of Islamic Financial Transactions:Perspective on Musharakah Mutanaqisah (Diminishing Partnership)

"The very objective of the Shariah (Maqasid Shariah) is to promote thewelfare of the people which lies in safeguarding their faith, their life, theirintellect, their posterity and their property. Whatever ensures the safeguard ofthese five serves public interest and is desirable." - Al Ghazali

Islamic finance is founded on Shariah principles which express an explicit intention to meet thefinancial needs of participants with integrity and in a manner that is just, fair, trustworthy andhonest, while ensuring a more equitable wealth distribution. Chart 1 briefly summarises theessential features of Islamic finance.

Chart 1Essential Features of Islamic Finance

� Towards achieving the objectives of Shariah (Maqasid Shariah) � High ethical values - justice, fairness, trust, honesty and integrity

Overarching Principles

� Economically productive underlying activities� Avoidance of interest-based transactions� No involvement in illegal and unethical activities� Genuine trade and business transactions� Avoidance of speculative transactions

Materiality and Validity of Transactions

� Entitlement of profit contingent upon risk taking� Honouring both substance and form of contract

Mutuality of Risk Sharing

Embedded governance Disclosure & transparency requirements

Unlike conventional finance, Islamic finance is governed by Shariah rules that prohibit interest-basedtransactions. Islamic financial transactions are also required to be accompanied by genuine underlyingtrade and business activities that generate fair and legitimate profits. This reinforces the close linkbetween financial and productive flows which underpin Islamic finance, thereby insulating the Islamicfinancial system from risks associated with excessive leverage and speculative financial activities. The risk-and profit-sharing characteristics of Islamic financial transactions (such as in mudharabah andmusharakah contracts) which are clearly defined at the onset, serve as additional in-built mechanismsthat further strengthen incentives for the adoption of sound risk management practices by Islamicfinancial institutions. In particular, these features demand the exercise of appropriate due diligence byIslamic financial institutions and higher standards of disclosure and transparency to be observed which, inturn, act to enforce market discipline and minimise informational asymmetries.

Collectively, these intrinsic features and requirements of Islamic finance act as natural stabilisersand restraints against the risks and excesses associated with excessive leverage, financial speculationand mis-selling that can threaten the effective functioning of financial systems.

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The range of Islamic financial products has broadened considerably in recent years in responseto the more diverse and differentiated requirements of participants. For example, Islamic financingcontracts have expanded from simple-mark up contracts to include those that are equity-based.While Islamic finance has continued to evolve rapidly, the distinct features of Islamic financialtransactions have been preserved in the new innovations in order to ensure that the religious andethical principles of participants are not compromised. This is illustrated in the following example ofmusharakah mutanaqisah, an equity-based contract which has been widely accepted in manyjurisdictions.

A Study on Musharakah Mutanaqisah

Musharakah mutanaqisah can be applied in home financing products. Based on the joint-ownershipconcept, the banking institution and the customer contribute their respective shares of the capitalrequired to acquire the property according to a pre-determined ratio agreed to between them at thebeginning of the contract. The banking institution leases the property to the customer whoundertakes to incrementally acquire the full ownership of the property from the banking institutionover an agreed period. Once the customer has fully acquired the banking institution’s share of theproperty, the partnership comes to an end with the customer becoming the sole owner of theproperty. This contract incorporates elements of both sale and lease (ijarah) contracts, which areintegral in ensuring that no element of riba (interest) is involved in the musharakah mutanaqisahtransaction. The dynamics, at different transaction stages, of a musharakah mutanaqisah contractfor completed property is illustrated in Chart 2.

The application of Shariah principles in musharakah mutanaqisah contracts creates distinctrelationships, rights and obligations of the parties to the contracts. As a result, banking institutionsare exposed to both market risk associated with the joint ownership of the underlying asset, as wellas credit risk associated with the obligation on the part of the customer to acquire, and on thebanking institution to sell, its share of ownership in the asset. This distinct risk exposure requires thebanking institution to adopt more robust methodologies supported by reliable and adequate dataand systems that are able to detect and provide best estimates of potential losses arising fromadverse developments in the credit profile of the customer. The risk management processes andinfrastructure of a banking institution offering such a product must also be dynamic in identifying,measuring, controlling and managing all the relevant risks associated with musharakah mutanaqisahtransactions. Chart 3 shows the key risk exposures and risk management practices at the differentstages of a transaction in musharakah mutanaqisah, as well as additional risk mitigants that can beintroduced.

Musharakah mutanaqisah – A form of partnership in which one partnerpromises to gradually acquire the equity share of the other partner until theshare of ownership is completely transferred to the first partner.

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Chart 2 Dynamics of Musharakah Mutanaqisah Contract for Completed Property

Musharakah Mutanaqisah

The SAC in its 56th meeting held on 6 February 2006 has recognised the application of musharakah mutanaqisah as a permissible contract in Islamic muamalat which inculcates the element of sharing in terms of capital and liability between the financier and customer.

Shariah Advisory Council (SAC) Resolutions

TMTarikh Matang

n

% of share ownership of the banking institution in property

(100-x)%, where x = customer’s share

Periodic rental payment (Rental is calculated based on bankinginstitution’s prevailing share)

Lease rental & gradual transfer of banking institution’s ownership

Banking Institution

Customer

0%

TMTarikh MatangT0

Acquisition dateTn TM

Maturity date

T0-TM

Lease rental and gradual transfer of bank’s ownership.

T0

Acquisition of property by both parties.

STAGE OF TRANSACTION

KEY FEATURES

CONTRACTUAL RELATIONSHIP

Diminishing partnership and ijarah (lease).

Transfer of full ownership of the property to the customer.

TM

Full transfer of bank’s ownership to customer.

• Full settlement of the agreed rental.

• Allows early settlement by acquiring bank’s share of ownership.

Banking institution and customer enter into partnership contract to jointly purchase the property based on an agreed share ownership between them in the property.

They are partners/joint owners of the property based on the pre-agreed ratio, e.g. 10% will be paid by customer and the bank will pay the remaining 90%. The parties also agree on profit sharing ratios and the loss will be based on the proportion of each party’s capital contribution.

Under ijarah, customer pays the lease rental and gradually reduces the banking institution’s ownership (rental payment is inclusive of the use of asset and purchase of the banking institution’s share of the asset). The rental rate may be fixed or floating.

Tn – Prepayment / Withdrawals• Customer may opt to make partial prepayments

by acquiring a higher proportion of the banking institution’s ownership.

• Flexibility for customer to withdraw his share by selling off his ownership share to the banking institution.

Tn – Default Event In the event of customer default, the partnership will be terminated. • Without wa’d (purchase undertaking), the asset

will be sold and the proceeds will be divided according to the latest ownership shares of the banking institution and customer.

• With wa’d, the customer is obliged to acquire the banking institution’s remaining share. This creates a debt to be paid by the customer to the banking institution.

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Chart 3Management of Key Risks in Musharakah Mutanaqisah Contracts

TM: Full Transfer of Banking Institution’s Ownership to Customer

Risk ManagementProvide appropriate mechanism to compensate the bank’s loss of future income arising from early settlement.

Risk Management

RATE OF RETURN RISK Potential loss in future income arising from early settlement

T0: Acquisition of Property by Both Parties

1. Ensure comprehensive agreement to cover the rights and obligations under joint ownership.

2. Proper assessment of customer credit profile and valuation of the property.

LEGAL RISK

Enforceability of contract and recognition of beneficial ownership under the law

Pre-agreed rental price based on financial market indicators.e.g. BLR, KLIBOR

Risk Management

MARKET RISK

Arising from the fluctuation of market price (in the case of transactions without wa’d)

T0 – TM: Lease Rental & Transfer of Bank’s

Ownership

CREDIT RISK

Non-payment of rental by the customer1. Incorporation of

purchase undertaking (wa’d) as a risk mitigant (exit strategy) in the event of default. Refer to default scenario for wa’d in Chart 2.

Risk Management

Tn: Customer Default

2. To use security instruments (charge the underlying

property) against the non payment of rental.

The case of wa’d may give rise to arguments that it negates the essence of the partnership contract. However, there are Shariah views allowing the use of wa’d.

To consider other measures that will preserve the essence of the partnership and the virtue of sharing risk.

POSSIBLE ENHANCEMENT

To consider rental rate that is more indicative of the actual rental price while taking into account the competitiveness of the product.


To incorporate elements in the contract that would fully reflect the actual rights and obligations of the co-owners. e.g. maintenance cost and quit rent provisions/clauses.

To apply appropriate financial reporting standards that reflect the Shariah contract.


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Several jurisdictions have also applied specific regulatory requirements to ensure theappropriate management of risks associated with this type of contract. For example, in jurisdictionsadopting capital adequacy frameworks based on the Capital Adequacy Standard issued by theIslamic Financial Services Board, Islamic banking institutions are required to allocate sufficientregulatory capital to cover the exposures to both the price risk based on the proportion owned bythe banking institution in the underlying assets, as well as the credit risk arising from theoutstanding rental payable by the customer. In tandem with the banking institutions’ diminishingshare of ownership in the asset, the capital requirement for the price risk would gradually declineover the period of contract.

With its distinct features, and in-built checks and balances, the development of Islamic financeas a viable form of financial intermediation is expected to contribute towards enhancing financialstability. Moving forward, further product innovations in Islamic finance can be expected. Thisneeds to be supported by further in-depth research on Shariah issues relating to risk mitigation,liquidity management and hedging in order to ensure that the fundamental tenets of Shariahwhich underpin the stabilising factors inherent in Islamic financial transactions, are preserved.

Market Conduct and Enhancing Financial Capability

Promoting Fair and Equitable Market PracticesEnhancing Financial Capability of ConsumersStrengthening Avenues for Consumer RedressMarket Conduct Supervision and EnforcementRegulation of Insurance and Takaful IntermediariesMoving Forward

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The increasing diversity and complexity of thefinancial system has resulted in a morepronounced focus on fair market conduct andfinancial capability as important elements inensuring a sound framework for financial stability.In this regard, Bank Negara Malaysia’s objectivesare twofold: (i) fostering sound practices andcodes of conduct that will ensure fair treatment ofconsumers; and (ii) increasing financial literacylevels of Malaysian consumers.

In 2007, the following key trends anddevelopments in the current operatingenvironment that may affect Malaysian consumerswere identified:• the emergence of innovative and complex

financial products including structuredinvestment products and investment-linkedproducts, which offer potential for higherreturns but with greater investment risks, havegained greater popularity among consumers.Consumers need to fully understand the termsand conditions, the actual costs and theinvestment risks associated with theseproducts before investing in such products. Inthis context, effective internal controls tomitigate mis-selling practices and a greaterfocus by financial institutions on customersuitability assessments to ensure that financialproducts sold are appropriate to the needs ofcustomers have now become more important.Improved disclosure and product transparencywould not only bring benefits to consumersbut help to mitigate risks to consumers;

• the demographic trend towards an ageingpopulation and increased longevity, hasincreased the need for consumers to takegreater individual responsibility for financialplanning, including retirement planning. Thishas increased the importance of financialcapability to empower consumers to makesound financial decisions;

• the greater ease with which consumers canaccess credit in general and obtain credit cardshas increased the potential risk of over-indebtedness in the household sector.Financial incentives for consumers to obtaincredit, such as interest free periods andbalance transfers on credit cards as well asintroductory or teaser rates for mortgages canhave a similar effect. Greater financial literacy

can equip households to better manage theirfinancial exposures, while ensuring thatconsumer credit remains within prudentiallimits; and

• as part of strategies to improve efficiency andproductivity levels, financial service providersare gradually expanding their outsourcingarrangements to include marketing and debtcollection activities. Under such arrangements,there is a need to preserve the fair treatmentof consumers through ethical practices byboth financial institutions and theiroutsourcing partners.

Against this backdrop, the Bank intensifiedefforts to promote fair and equitable marketpractices, raise the level of financial capability withan increased focus on target groups and furtherenhance the efficacy of consumers’ access toredress avenues.

PROMOTING FAIR AND EQUITABLE MARKETPRACTICES

Measures undertaken by the Bank in 2007 wereprimarily directed towards further enhancingproduct transparency and disclosure andpromoting high standards of professionalismamong financial service providers, namely financialinstitutions and designated payment instrumentissuers, in their dealings with consumers.

During the year, the Bank developed a moreconsistent and comprehensive disclosureframework for retail financial products. Theframework is aimed at facilitating consumers’understanding of important product features, thusenabling consumers to make meaningfulcomparisons prior to making financial decisions.The disclosure framework will build on existingrequirements for banking institutions to disclosefees and charges imposed on banking productsand services, as well as minimum standards onproduct disclosure and transparency currentlyapplicable to the insurance sector. The newframework outlines general and product-specificdisclosure principles that should be observed byfinancial service providers and specifies differentdisclosure requirements at different stages ofentering into a financial contract (namely prior to,at the point of entering into, and during the term



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of, the contract) to enable consumers to makeinformed decisions when purchasing financialproducts. In developing the disclosure framework,the Bank has strived to balance between theneeds of ensuring an appropriate level oftransparency and disclosure to support informeddecisions by consumers, and avoiding excessiveregulatory costs on financial service providers.

and services offered to retail customers which didnot reasonably reflect the costs incurred by thefinancial institutions in providing such products orservices. Over time, the Bank expects that withincreased transparency and financial capability, theexercise of consumer preferences will furtherreinforce greater discipline on the financialinstitutions in this area.

Consistent with the efforts to promotebroader participation in financial services byconsumers, the Bank intensified efforts to increasepublic awareness of savings and current accountsbeing offered under the Basic Banking Services(BBS) Framework. First introduced to individuals in2005, these "no-frills" deposit products are aimedat meeting the general banking needs of retailcustomers and are offered at minimum cost. Apartfrom the on-going outreach programmes toincrease public awareness of the BBS, postersexplaining the features of BBS in four languageshave been printed and distributed nationwide in2007 for display in the premises of bankinginstitutions throughout the country. During theyear, the BBS framework was also extended tosmall and medium enterprises (SMEs). As at end2007, about 3.6 million consumers had basicsavings accounts, accounting for 13.7% of totalsavings accounts maintained in bankinginstitutions.

The use of credit cards as a paymentinstrument has continued to be increasinglypopular among the public with the number ofcredit cards in circulation rising by 12.1% to 9.9million credit cards in 2007. Despite the increase,most credit cardholders have been able to managetheir payment commitments. In 2007, the numberof credit card-related bankruptcies remained low,accounting for only 0.07% or 1,873 cases out ofthe 2.7 million principal cardholders. Nevertheless,there is a need to ensure that consumers fullyunderstand the responsibilities of card ownership,particularly with the intense competition and theadoption of aggressive marketing practices bycertain credit card issuers to pressure consumers tosign-up for multiple cards. As at end 2007, nearly2,500 individuals with credit card-related debtssought assistance under the Credit Counsellingand Debt Management Agency’s (CCDMA) debtmanagement programme. As aggressivemarketing practices can undermine efforts topromote responsible and prudent management ofhousehold debts, the Bank has issued minimum

The Bank has developed amore consistent andcomprehensive disclosureframework for retail financialproducts.

In addition to enhancing disclosures on feesand charges, the Bank remained vigilant inensuring that fees and charges imposed byfinancial institutions on products and servicesoffered to retail customers are reasonable, havingregard to the actual costs incurred by financialinstitutions in providing products and services toconsumers. Given the more competitiveenvironment, capital investments made byfinancial institutions have increased substantiallyto support product innovations andenhancements, and to improve services toconsumers. These investments have led to asignificantly broader range of products madeavailable to consumers, and increased convenienceand speed in the delivery of financial services.While corresponding adjustments to fee structureson financial products may be commerciallyjustified, the Bank expects such adjustments to becommensurate with the product quality or service,and cost of providing the product or service. Thecost considerations by financial institutions shouldalso be offset by the cost savings that are reapedfrom more efficient and automated processes.

Given the proliferation of diverse financialproducts and services that are also nowincreasingly more customised, the determinationof fees and charges is primarily a matter to bedecided by financial institutions. The Bank,however, has issued guiding principles on theimposition of fees and charges which financialinstitutions are required to observe to ensure thefair treatment of consumers. In enforcing theseprinciples, several banking institutions wererequired during the year to review or cease theimposition of certain fees and charges on products


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requirements for the sale, marketing andpromotion of credit cards aimed at curbing suchmarketing practices by credit card issuers. TheBank also introduced guidelines requiring cardissuers to adopt a tiered pricing structure for creditcards that incentivises prudent credit card usageby consumers. Under this structure, cardholderswould be tiered according to their repaymentbehaviour, with those demonstrating disciplineduse enjoying reduced charges which are capped at15% per annum, compared with the ceiling rateof 18% per annum applicable to othercardholders. The new structure will come into fulleffect on 1 July 2008.

During the year, the bankinginfo andinsuranceinfo websites were enhanced toincorporate tools such as financial calculators thatallow visitors to compute household budgets,motor insurance premiums and hire purchaseinstalments. Financial planning guides and newcomparative information on common financialproducts were also added to make it easier forconsumers to evaluate their financial requirementsand compare available solutions offered bydifferent financial institutions. There are currentlyeight comparative tables on banking products inthe bankinginfo website which provide keyinformation on common products presented in aconsistent manner for purposes of comparison,including financing and deposit rates as well asfees and charges. Three new information bookletsfor financial consumers were also published,bringing the total number of booklets publishedunder bankinginfo and insuranceinfo to 24 each.More than 360,000 of these booklets weredistributed to Malaysian consumers in 2007.

Outreach ActivitiesThe Bank’s outreach activities expanded in breadthin terms of people and segments reached, as wellas depth in terms of financial knowledgedisseminated. This was achieved by adopting amore targeted and collaborative approach whichenabled the Bank to focus its resources where thebiggest impact and multiplier effect could begained. In this regard, the Bank participated in atotal of 70 outreach activities during the year,including financial exhibitions as well as seminarsand briefings organised for consumers. At theseevents, the Bank focused on issues relating topersonal and household budgeting, basic bankingservices, the rights and responsibilities ofconsumers, financial scams and redress avenues.

The School Adoption Programme entered its10th year in 2007. The programme is acollaborative effort between the Bank, theMinistry of Education and financial institutionsaimed at eliminating financial illiteracy amongstschool children by raising awareness on theimportance of financial management. Since itsintroduction, more than 7,000 schools nationwidehave been adopted by financial institutions, withStudent Financial Clubs (SFCs) formed as part ofthe co-curricular activities in more than 2,000schools. The SFCs serve as an effective focal pointfor financial institutions’ outreach activities atschools by leveraging on the clubs’ activities to

The Bank has issued minimumrequirements for the sale,marketing and promotion ofcredit cards.

To prevent unethical practices by financialservice providers and their agents in the area ofdebt collection, the Bank has also issuedguidelines on fair debt collection practices. Whilethe Bank recognises that effective recovery ofdebts by financial service providers is an importantelement of good credit risk management, therecovery should be conducted in a manner that isfair to borrowers, including the protection of theborrowers’ privacy during the recovery process.

ENHANCING FINANCIAL CAPABILITY OFCONSUMERS

Bank Negara Malaysia’s financial capabilityinitiatives in 2007 continued to be directedtowards empowering consumers to take greaterresponsibility for their own personal financialmanagement. In particular, the Bank continued toexpand its outreach programmes by providinginformation to the public on the increasing arrayof financial products and services available tothem, and educating consumers on their rightsand responsibilities. In an effort to reach a widerdemographic, the Bank’s outreach efforts duringthe year were also specifically focused on targetgroups such as women, school children, collegeand university students, rural communities andretirees.

bankinginfo and insuranceinfobankinginfo and insuranceinfo remained the mainfocus of the Bank’s consumer education initiatives.


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increase the interest of students in financialmatters.

To increase awareness of the student pocketmoney book, Buku Wang Saku, and encourage itswider use among school children as part of effortsto inculcate good financial habits at an early age,the Bank, in collaboration with the Ministry ofEducation organised the National Buku WangSaku competition in July 2007. The event drewinterest from 3,200 students. More than 738,000copies of Buku Wang Saku were distributed toschool children all over the country in 2007. Todate, 5.9 million copies of Buku Wang Saku havebeen made available to students under the SchoolAdoption Programme.

The establishment of the Financial EducationWorking Committee (FEWC) in February 2007marked an important milestone in the Bank’scollaboration with other quasi-governmentalagencies such as the Credit Counselling and DebtManagement Agency (CCDMA), Financial MediationBureau (FMB) and the Malaysia Deposit InsuranceCorporation. The FEWC will serve as a platform tocoordinate financial education initiatives andfacilitate the more efficient allocation of resourcesbetween the agencies in achieving mutual goals.

personal financial management to be taught atpublic universities was developed by the agencywith the aim of preparing graduates to face thechallenges of managing their finances wisely atthe start of their careers.

STRENGTHENING AVENUES FOR CONSUMERREDRESS

In Malaysia, dedicated complaints units of financialinstitutions, BNMLINK (Bank Negara MalaysiaLaman Informasi Nasihat dan Khidmat) and theFMB have served as the primary avenues forredress to resolve consumer disputes.

Complaints received against bankinginstitutions during the year were mainly oncustomer service standards and credit cardrelated matters including unauthorisedtransactions and billing issues. In the insurancesector, complaints were mostly related todelays in processing insurance claims and theconduct of agents. All complaints received bythe Bank and FMB were promptly investigatedwith the financial institutions concernedaccording to the Bank’s and FMB’s respectiveclient charters. Investigations into complaintson unauthorised credit card transactions whichwere mainly due to card theft and negligenceof cardholders, did not reveal any concernsover inadequacies in the control functions ofcredit card issuers. Several financial institutionsalso took steps to introduce ConsumerAdvocates within their organisations to providean additional redress avenue for consumersdissatisfied with the resolution of theircomplaints by the institution’s complaint units.

In July 2007, the Bank launchedBNMTELELINK to complement existing channelsfor the general public to obtain information onfinancial services and seek assistance to resolverelated issues that they faced. Modelled afterBNMLINK which provides assistance to walk-invisitors on their complaints and queries, responseto the new channel which handles written andtelephone enquiries and complaints has beenencouraging, with a total of 25,012 queriesreceived in the first five months of its operations.Most queries related to requests from the publicfor credit reports generated from the CentralCredit Reference Information System (CCRIS)which is maintained by the Bank, and enquiriesregarding such information.

5,000 individuals with totaldebts of RM478 millionreceived assistance underCCDMA’s debt managementprogramme.

The CCDMA, which was established by theBank in 2006, opened three new branches inMalacca, Ipoh and Kuantan during the year, inaddition to the existing regional offices located atthe five Bank Negara Malaysia branches, therebyexpanding its services to a wider segment of theMalaysian population. As at end-2007, nearly50,000 customers had sought the services ofCCDMA. Of these, more than 5,000 individualswith total debts of RM478 million receivedassistance under its debt managementprogramme, with a low termination rate of 8.6%.In line with its mandate, the agency alsocontinued to contribute towards improvingfinancial education in Malaysia as a pre-emptivemeasure to promote prudent financialmanagement. During the year, a module on


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MARKET CONDUCT SUPERVISION ANDENFORCEMENT

Principles of fair market conduct and the role offinancial institutions in supporting nationalfinancial capability initiatives were reinforcedthrough the Bank’s market conduct supervisionand enforcement activities. The Bank supervisesthe practices of financial service providers byreviewing product-related information (includingfees and charges), conducting on-site reviews,telephone interviews, media surveillance as well asindustry and consumer surveys. These activitiesenable the Bank to identify and respond in atimely manner to emerging market practices thatundermine public confidence in the market forretail financial services.

In an effort to improve the service standardlevels of the financial services industry, the Bank’smarket conduct supervisory activities in 2007focused on assessing the practices of financialservice providers, in relation to public access tofinancial services and information, and assistanceto consumers. The relevant financial institutionshave taken corrective actions to address themarket conduct deficiencies identified by theBank, which had resulted in improvements in theindustry’s overall observance of fair marketconduct practices.

The Bank also reviews advertisements andspecial promotions by financial institutionspublished in major newspapers, websites andbrochures to ensure fair and transparent termsand conditions. As a result of these reviews, 11incidents of advertisements and promotions whichfailed to adequately disclose information on feesand charges as well as essential product featureswere modified or withdrawn by the financialinstitutions concerned at the Bank’s direction.

REGULATION OF INSURANCE AND TAKAFULINTERMEDIARIES

With nearly two-thirds of insurance and takafulbusiness distributed through intermediaries,including agents, the regulation of insurance andtakaful intermediaries remained an important partof efforts by the Bank to promote sound marketconduct practices in the insurance and takafulsectors. As at end-2007, a total of 82 insuranceand takaful intermediaries were regulated by BankNegara Malaysia.

During the year, initiatives to promote high standardsof market conduct and professionalism amonginsurance and takaful intermediaries were mainly ledby the industry associations with the support of theBank. To instil greater market discipline and improvecustomer service standards in the general insuranceindustry, the Malaysian Insurance and Takaful BrokersAssociation, the General Insurance Association ofMalaysia and the Malaysian Takaful Association havejointly developed the Best Practices Framework forbrokers, insurers and takaful operators. Theframework which came into effect in July 2007, is anindustry effort aimed at further improving thegeneral insurance premiums settlement practices byfacilitating the reconciliation of accounts as well aspayments of premiums and commissions betweenbrokers and insurers or takaful operators. It alsoprovides for the more effective enforcement ofpremium warranty conditions for certain non-motorclasses of insurance and takaful, thereby reducingrisks borne by insurers and takaful operators forpolicies on which premiums have not been received.

The proposed adoption of the Inter-TakafulOperators Agreement (ITA) by the takafuloperators will further enhance the level ofprofessionalism in the takaful industry. The ITAgoverns the conduct of takaful practitionersand intermediaries and provides for theestablishment of a centralised mechanism forthe registration of takaful intermediaries,enforcement mechanisms and a disciplinaryframework to ensure compliance by itsmembers. The implementation of the ITA willpromote orderly conduct and ensure moreconsistent market practices among takafuloperators while promoting a level playing fieldbetween insurance and takaful players in theindustry.

Table 5.1Insurance and Takaful Intermediaries as at end2007

Licensees Number of licensees

Insurance Act 1996Insurance brokers 34Adjusters 37Financial advisers 7

Takaful Act 1984Takaful brokers 301

Takaful adjusters 362

Reference1 Twenty six of these takaful brokers are also insurance brokers licensed under the

Insurance Act 1996.2 These takaful adjusters are also adjusters licensed under the Insurance Act 1996.


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also depend largely on the existence of a wellfunctioning and effective infrastructure forenforcement by the industry. This requires financialinstitutions, individually and collectively, to take alonger-term view of sustainable performance bybuilding confidence in, and a strong reputationfor, the industry, as opposed to focusing only onshorter-term gains (e.g. through excessive andunjustified fees and charges or mis-selling to meetannual revenue targets).

Greater convergence and efficiency in theregulatory framework for insurance intermediarieswas also achieved with the signing of aMemorandum of Understanding (MoU) betweenBank Negara Malaysia (which regulates financialadvisers) and the Securities Commission (whichregulates financial planners) in August 2007. Inaddition to providing for the mutual recognitionbetween both licensing regimes through theharmonisation of licensing requirements, the MoUalso introduces green-lane processes for financialadvisers and financial planners licensed under therespective regimes to apply for licences under theother regime. The streamlined processes willenable such intermediaries to provide a morecomplete suite of financial solutions to meetconsumer needs while minimising the regulatoryburden of complying with both regulatoryregimes.

MOVING FORWARD

The thrust of policy initiatives in 2008 will focus onstrengthening the legislative framework to supporta comprehensive and effective regulatory andsupervisory market conduct regime. Relevantpieces of legislation would be amended toempower the Bank to prescribe and enforcestandards of fair and equitable market practices inthe banking and insurance industry.

The Bank also envisions a greater role formarket discipline and self-regulation in ensuringsound market conduct practices in the industry inthe near future. In this regard, the Bank will beworking with the industry to consider possibleoptions to achieve a workable self-regulatoryregime. The Bank recognises that financialcapability of consumers is a key cornerstone ofsuch a regime, and that current investments andefforts undertaken by the Bank in this area areimportant to support the transition towards a self-regulation framework. The pace at which theindustry transitions toward such a framework will

The thrust of policy initiativesin 2008 will focus onstrengthening the legislativeframework to support acomprehensive and effectiveregulatory and supervisorymarket conduct regime.

A more efficient regulatory framework forintermediaries will also be considered to balancethe cost of regulation with the risks that they poseto financial stability. This will be accompanied bycontinued efforts to strengthen the consumerprotection framework with the introduction of anOmbudsman law that will provide consumers withan enhanced alternative avenue for redress in theirdealings with financial service providers. Inaddition, the Bank will continue to addressprinciples of fair market practices in all majoraspects of financial dealings, including ensuringthe protection of personal financial information,maintaining appropriate standards of disclosures,and ensuring that consumers receive the supportand information needed, through financialeducation and proper advice, to enable them tomake informed decisions. The Bank expects tointensify its market conduct surveillance activitiesin the coming year to ensure that these outcomesare achieved.

Managing Payment System Safety and StabilityPromoting Greater Efficiency in the Payment System

Payment and Settlement Systems

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The Bank’s oversight responsibilities for thepayment and settlement systems in the countryare drawn from the Payment Systems Act 2003(PSA). As payment systems are fundamental tothe functioning of the economy, the Bank’soversight activities are directed towards ensuringthe reliability of the major payment andsettlement systems and mitigating risks in thesesystems. While the Bank’s main focus is onsystemic risk reduction, promoting an efficientpayment and settlement infrastructure andefficiency in the provision of payment services areimportant considerations. Efforts to minimise riskare also balanced against considerations of costs,needs and practicality. This balance is importantin promoting cost-effective and efficient paymentservices that would encourage the wider use ofsafe payment alternatives. Although the Bank’smandate pursuant to the PSA is to promote thereliable, efficient and smooth operation of thenational payment and settlement systems, itsscope extends beyond its statutory mandate. TheBank also assumes a central role not only infostering payment innovations but also infacilitating and driving developments in thepayment landscape to enhance the safety,security and efficiency of the payment systems.This includes sustaining public confidence in theretail payment systems and the use of paymentinstruments, and steering the national agenda ofpromoting the migration to electronic payments(e-payments).


the payment infrastructure, fostering the adoptionof new technologies, and providing support tostakeholders in targeted sectors including theGovernment that has been identified as a primemover in the nation’s migration to e-payments.

MANAGING PAYMENT SYSTEM SAFETY ANDSTABILITY

The oversight activities undertaken by the Bank in2007 were centred on containing systemic risksand reducing overall risks in the payment system.Guided by this, the Bank focused its oversightresources on the Real-time Electronic Transfer ofFunds and Securities (RENTAS) system wherelarge values of payments are settled and wherethe occurrence of risks would have the greatestimpact on financial stability. More than 90% oftotal non-cash payments in 2007 valued atRM29.9 trillion were routed through RENTAS. Onaverage, RENTAS handled RM124.5 billion inpayment transactions daily in 2007, an increaseof 23.6% compared to 2006.

As the operator of RENTAS, the Bank placesgreat importance in ensuring its adherence tointernational best practices. In 2006, the ScriplessSecurities Trading System (SSTS) module of RENTASwas assessed against the Recommendations of theCommittee on Payment and Settlement Systems(CPSS) and the Technical Committee of theInternational Organisation of SecuritiesCommissions (IOSCO) for Securities SettlementSystems. The self-assessment concluded that theSSTS module of RENTAS achieved a high degree ofobservance of the Recommendations. Furtherdetails of this assessment are available in theFinancial Stability and Payment Systems Report2006. In 2007, a broader self-assessment wascarried out on RENTAS and its operations[comprising the Interbank Funds Transfer System(IFTS), SSTS and RENTAS-USD CHATS] against theBank for International Settlements (BIS) CorePrinciples for Systemically Important PaymentSystems (CPSIPS), together with an assessment ofthe responsibilities of the Bank in applying theCore Principles.

Benchmarking Against BIS CPSIPSThe BIS core principles are used by many centralbanks as a benchmark in ensuring reliable and

Oversight activities aredirected towards ensuring thereliability of the majorpayment and settlementsystems and mitigating risks inthese systems.

In 2007, the Bank focused its oversight effortson further addressing systemic risk in the majorpayment systems, sustaining public confidence inthe retail payment systems, and improving theoverall efficiency of the payment system.Continuing its efforts in promoting the migrationto e-payments, the Bank together with thepayment industry collaborated towards enhancing


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sound operations of systemically importantpayment systems (SIPS). The CPSIPS sets out tencore principles covering legal risks (Core PrincipleI), financial risks (Core Principle II to VI),operational risks (Core Principle VII), efficiency(Core Principle VIII), access criteria (Core PrincipleIX) and governance (Core Principle X). Overall, the

Core Principles and Central Bank Responsibilities for SIPS(RENTAS’ level of observance is indicated in parentheses)

CP I – Legal basis (fully observed)The system should have a well-founded legal basis under all relevant jurisdictions.

CP II – Understanding financial risks (broadly observed)The system’s rules and procedures should enable participants to have a clear understanding of thesystem’s impact on each of the financial risks they incur through participation in it.

CP III – Management of financial risks (fully observed)The system should have clearly defined procedures for the management of credit risks and liquidityrisks, which specify the respective responsibilities of the system operator and the participants andwhich provide appropriate incentives to manage and contain those risks.

CP IV – Prompt final settlement (fully observed)The system should provide prompt final settlement on the day of value, preferably during the dayand at a minimum, at the end of the day.

CP V – Settlement in multilateral netting systems (not applicable as RENTAS is a real timegross settlement system)A system in which multilateral netting takes place should, at a minimum, be capable of ensuring thetimely completion of daily settlements in the event of an inability to settle by the participant withthe largest single settlement obligation.

CP VI – Settlement assets (fully observed)Assets used for settlement should preferably be a claim on the central bank; where other assets areused, they should carry little or no credit risk and little or no liquidity risk.

CP VII – Security and operational reliability (broadly observed)The system should ensure a high degree of security and operational reliability and should havecontingency arrangements for timely completion of daily processing.

CP VIII – Efficiency (broadly observed)The system should provide a means of making payments which is practical for its users and efficientfor the economy.

CP IX – Access criteria (fully observed)The system should have objective and publicly disclosed criteria for participation, which permit fairand open access.

CP X – Governance (broadly observed)The system’s governance arrangements should be effective, accountable and transparent.

self-assessment conducted in 2007 concluded thatthe RENTAS system continued to exhibit a highlevel of robustness and came close to fullyobserving the international standards. A summaryof the CPSIPS requirements and RENTAS’observance of the principles is provided in thefollowing box.


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Responsibilities of the Central Bank in Applying the Core Principles

Responsibility A – Disclosure of objectives, role and major policies (broadly observed)The central bank should define clearly its payment system objectives and should disclose publicly itsrole and major policies with respect to systemically important payment systems.

Responsibility B – Compliance of central bank systems (broadly observed)The central bank should ensure that the systems it operates comply with the Core Principles.

Responsibility C – Oversight of non-central bank systems (not applicable)The central bank should oversee compliance with the Core Principles by systems it does not operateand it should have the ability to carry out this oversight.

Responsibility D – Cooperation with other authorities (fully observed)The central bank, in promoting payment system safety and efficiency through the Core Principles,should cooperate with other central banks and with any other relevant domestic or foreignauthorities.

Settlement RiskAnother focus of the Bank continues to be in thearea of settlement risk. The introduction of thePayment versus Payment (PvP) infrastructure for thesettlement of interbank ringgit/US dollar foreignexchange (FX) trades through RENTAS-USD CHATSin November 2006 has significantly reduced thesettlement risk of FX transactions. The PvP linkenables the simultaneous settlement of ringgit inMalaysia and US dollars in Hong Kong duringMalaysian business hours, thereby eliminating FXsettlement risk. In 2007, 59.8% of the totalringgit-US dollar FX trades and 61.6% of ringgit-USdollar transactions between participating memberswere settled through the link.

Leveraging on the PvP infrastructure, inOctober 2007, the Bank introduced the Deliveryversus Payment (DvP) settlement service for USdollar securities that are issued, deposited andtraded in Malaysia. With the implementation ofDvP, the delivery of the Malaysian-issued US dollarsecurities that are deposited with RENTAS will bemade simultaneously with its corresponding USdollar payment, thus eliminating the settlementrisk associated with the trading of such securitiesin Malaysia.

Cooperative Oversight with the Hong KongMonetary AuthorityTo mitigate systemic risk associated with thecross-border link between RENTAS and the USDCHATS in Hong Kong, a cooperative oversightarrangement between Bank Negara Malaysia, as

the overseer of RENTAS, and the Hong KongMonetary Authority (HKMA), as the overseer ofUSD CHATS, was established. Based on theprinciples of confidentiality and reciprocity forinformation exchanged between the Bank andthe HKMA, both regulatory agencies haveestablished points of contact and procedures forthe oversight activities of the link. Thiscooperative arrangement also includes businesscontinuity plans for the PvP and DvP links ofRENTAS-USD CHATS.

Operational Risk and Business ContinuityManagementThe RENTAS system did not encounter any majordisruptions during the year. Nonetheless, the Bankcontinued to ensure that operational risks inRENTAS are adequately addressed, therebypreventing systemic disruptions to the operations offinancial markets. In this respect, the Bank strives toensure that the design and operation of RENTASmeet an appropriately high standard of availabilityand resilience. As RENTAS is part of a complex ITinfrastructure with numerous interfaces,components and sub-systems interlinked with eachother, a glitch in any of the systems or sub-systemscould potentially adversely affect RENTASoperations. The likelihood and severity ofoperational problems will depend on the resilienceof the infrastructure for these systems and theadequacy of their back-up arrangements. The Bank,in its efforts to mitigate risk from key dependenciesof RENTAS on other systems, has enhanced furtherits business continuity management to ensure that


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there will be minimal disruption in the operationswhen faced with the wide range of contingencies.

new security threats and risks, thereby effectivelymaintaining the confidentiality, data integrity,authenticity and non-repudiation of daily RENTAStransactions. The new security system will also beadopted for the Cheque Truncation andConversion System.

Optimising Liquidity Management for theRENTAS SystemWhile the RENTAS system has achieved itsobjective of mitigating settlement risk by providingparticipants with a means of settling paymentobligations in real time with finality, the settlementof payment transactions on a gross basis imposesliquidity costs on participants.

The addition of new financial products settledthrough RENTAS, accompanied by a more activeinterbank bond market as well as growth ineconomic activities, have resulted in an increase inthe value of RENTAS transactions and thus, higherliquidity requirements. In 2007, the volume andvalue of RENTAS transactions rose by 19.5% and19.6% respectively. In addressing the associatedincrease in liquidity costs faced by RENTASparticipants, enhancements to improve theefficiency in liquidity management of the RENTASsystem will be undertaken. This will be achievedthrough the implementation of a combination ofgross, bilateral and multilateral netting settlementsthat leverages on the real time gross settlementsystem for making immediate payments, and thedeferred net settlement system for continuousbilateral and/or multilateral netting of payments.The availability of intraday credit facilitiesthroughout the operating hours of the system willalso be introduced. These enhancements willfacilitate the continuous settlement of interbanktransactions with lower liquidity requirements,hence enabling more efficient liquiditymanagement by RENTAS participants withoutincreasing settlement risk.

Preserving Public Confidence in RetailPayment Systems and Payment InstrumentsWhile the Bank’s oversight of payment systemsfocuses mainly on the operational performanceof RENTAS, ensuring the robustness of the retailpayment system is also important to promotepublic confidence. In this regard, initiatives andmeasures to ensure system availability, reliabilityand efficiency were instituted by MalaysianElectronic Payment System (1997) Sdn. Bhd.(MEPS), the major retail payment system

RENTAS did not encounter anymajor disruptions during theyear. The Bank’s efforts aredirected towards ensuring thatthe design and operation ofRENTAS meet an appropriatelyhigh standard of availabilityand resilience.

As part of the Bank’s continuous efforts toensure the reliability and uninterrupted availabilityof the RENTAS system, particularly at the RENTASDisaster Recovery Centre (DRC) sites, the Banksuccessfully conducted an industry-wide DisasterRecovery (DR) live run operation in June 2007.While RENTAS members are required to conductlive runs from their DR sites at least four times ayear to test the state of readiness of their DR sites,it is important that such testing should not only beconducted by members in isolation. Testing ofbusiness continuity arrangements on acoordinated basis involving the user communityserves to reinforce the robustness and resilience ofthe systemically important payment system. Inaddition, the Bank has introduced a second levelback-up facility to RENTAS members which may beactivated only in the event that both theirproduction and DRC sites are down.

Enterprise Public Key InfrastructurePublic Key Infrastructure (PKI) technology has beenemployed by the Bank since 1999 to ensure theconfidentiality and non-repudiation of RENTAStransactions, and to control access to the system.The Bank currently acts as the restrictedcertification authority for the issuance of digitalcertificates to RENTAS members. However, inkeeping with the technological developments andto meet business needs, the Bank had, in 2007,initiated work to replace the existing PKItechnology with a new system that will relieve theBank of its role as the restricted certificationauthority. When fully implemented in 2008,RENTAS members will obtain digital certificatesfrom the licensed public certification authorities inthe country. The implementation of the newsecurity system will contribute towards addressing


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operator and Rangkaian Segar Sdn. Bhd., thesystem operator and issuer of the Touch ’n Gocard. No major disruptions were experiencedduring the year.

In addition, as part of its business continuitymanagement, MEPS successfully conducted twoDR exercises on "live" run mode for three of itscore services, namely the Shared ATM Network,Electronic Debit at Point-of-Sale (e-Debit) andInterbank GIRO (IBG). The exercises also served tofamiliarise the MEPS Disaster Recovery team,financial institutions and related service providerswith the disaster recovery process. Such DRexercises will continue to take place on a routinebasis, thus minimising operational risk in theseretail payment systems.

Managing Fraud Risks in Retail PaymentsPromoting a safe and reliable paymentenvironment in the country has become morechallenging with the increasing sophistication offraud techniques, brought about by rapidtechnological advancements. Nevertheless,proactive measures undertaken in collaborationwith the industry and relevant authorities havesuccessfully mitigated these risks, hencesustaining public confidence in the use ofpayment instruments.

Payment CardsThe successful migration to the Europay-MasterCard-Visa (EMV) standard for credit cards in2005, led to a significant reduction in the numberof cases and amount of losses associated withcredit card fraud from counterfeiting activities(Chart 6.1). The EMV has also effectively disabledthe use of cloned domestic credit cards forpurchases in the country. However, other types ofcredit card fraud increased slightly in 2007, mainlyassociated with lost and stolen cards as well ascard-not-present (CNP) transactions that do notrequire the presence of physical cards, e.g. forpurchases made over the Internet or mail/telephone orders. Cases of the fraudulent use ofcounterfeited Malaysian cards in countries thathave yet to adopt the EMV standard alsocontributed to the increase. Nevertheless, creditcard fraud remained insignificant, accounting forless than 0.04% of total credit card transactionsduring the year.

To combat credit card fraud, the Bankconducts regular dialogues with the NationalCards Group, whose members consist of all

credit card issuers, and works closely with theindustry to consider new mitigation measures.During the year, more credit card issuersadopted the 3D secure scheme that requirescardholders to complete an additionalverification process when purchasing over theInternet to further minimise the risk of fraud.The Bank also continued to conduct awarenessprogrammes to educate cardholders on theimportance of safeguarding their credit cardsand credit card information.

The Malaysian Risk Management Task Force(MRMTF), whose members include credit andcharge card companies, issuers and acquirers, theRoyal Malaysia Police and Bank Negara Malaysia,continued to provide an important platform forcooperation among its members to prevent fraud.The MRMTF also participates in the South EastAsia (SEA) Cross-Border meetings, held annually todiscuss cross-border issues relating to credit cardfraud, and share information on fraud experiencesin individual countries as well as emerging fraudtrends and threats.

Internet BankingLosses emanating from Internet banking fraudhave been negligible, accounting for only0.0002% of the total value of Internet bankingtransactions in 2007. Social engineeringtechniques such as phishing remained the mostcommon method employed to conduct Internetbanking fraud. Phishing involves the sending offake e-mail messages purportedly from thefinancial institutions to lure recipients into

No. of cases RM million

Chart 6.1Credit Card Fraud

No. of cases Amount of losses (RHS)

120,000

100,000

80,000

60,000

40,000

20,000

0

80

70

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50

40

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02003 2004 2005 2006 2007


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divulging personal information such as personalidentification numbers (PINs) and passwords,resulting in identity theft. About 70% of theInternet banking fraud cases reported duringthe year involved phishing. Banking institutionshave therefore taken various measures tostrengthen the safety of Internet bankingservices, including extensive consumerawareness programmes. All banking institutionshave also implemented the two-factorauthentication for Internet banking transactionsas well as fraud warning systems to detect andreport suspicious transactions.

Notwithstanding the low incidence ofInternet banking fraud, the Bank continues toconstantly monitor trends and developments andundertake the necessary measures to mitigateany potential new risks, vulnerabilities andthreats that may emerge. In this regard, the Bankwill be issuing a guideline on electronic bankingwhich will outline the minimum requirements onrisk management for all forms of electronicbanking, whether conducted through theInternet, telephone, mobile phone or otherelectronic means.

PROMOTING GREATER EFFICIENCY IN THEPAYMENT SYSTEM

The Bank has a responsibility to promoteimprovements in the payment system to increasethe overall efficiency of the payment system aswell as to make payments more convenient andcost-effective for end-users. During the year,efforts by the Bank together with the paymentindustry were geared towards enhancing the

payment infrastructure to provide a wider arrayof payment channels and services, fostering theadoption of new technologies in promotingpayment innovations and providing support forthe migration to e-payments.

Efforts were geared towardsenhancing the paymentinfrastructure, fostering theadoption of new technologiesand providing support for themigration to e-payments.

Others19.5%

Forgedidentification

8.3%

Phishing72.2%

Chart 6.2Internet Banking Fraud Cases in 2007

Enhancing the Efficiency of Cheque Clearingand SettlementsAlthough the payment mode has shifted fromcheques to more e-payments over the recentfive years, in terms of transaction value, chequesstill account for a significant portion of non-cashretail transactions, at 93% in 2007 compared to97% in 2003. Hence, enhancing the efficiencyof cheque clearing is still an important area offocus for the Bank in efforts to lower the cost ofdoing business.

In modernising the way cheques areprocessed and to pave the way towards theelectronification of cheques, the Bank and thebanking industry embarked on a major initiativeto introduce a fully image-based chequeclearing process. The Cheque Truncation andConversion System (CTCS), better known aseSPICK, is scheduled for implementation in May2008, initially in Kuala Lumpur andneighbouring towns. It will thereafter beextended, in phases, to the rest of the countryby early-2009. eSPICK allows the clearing ofcheques to be done through truncation orconversion modes, hence eliminating thephysical movement of cheques once depositedat the collecting banks. In cheque truncation,both the image of the cheque and the magneticink character recognition (MICR) code line dataare captured and transmitted electronicallythroughout the cheque clearing process; whilein cheque conversion, only the MICR code linedata is captured and converted into a paymentinstruction to effect the transfer of funds fromthe drawer’s account into the drawee’s account.Both modes would reduce the risks and costsassociated with the physical handling of


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cheques and improve the efficiency of the entirecheque clearing process. The payment andreceipt of funds by customers would beexpedited with customers receiving funds on thenext business day, regardless of where thecheque is deposited, compared to between twoto eight business days currently.

While eSPICK may be perceived to beinconsistent with the agenda to activelypromote the migration to e-payments, theexperience in the United States has shown thatcheque conversion is a necessary prelude totransforming such paper-based payment modesinto e-payments. In 2006, almost 3 billioncheques issued by individuals, or 9.1% of totalcheques issued in the United States wereconverted and cleared as e-payments, aneightfold increase from 2003. More than 10%of the increase recorded in e-payments duringthe three-year period was attributed to chequeconversions. The conversion of these chequepayments into e-payments has translated intoconsiderable cost savings for businesses fromthe elimination of costs associated with thephysical handling and transportation ofcheques. Similarly in Malaysia, businesses thatreceive high volumes of cheque payments fromtheir customers such as utility andtelecommunication companies as well asinsurers, can utilise the cheque conversionfeature under eSPICK to collect payments.

Enhancing Product Delivery and Services overthe ATM NetworkLeveraging on the wide outreach of the ATMnetwork in providing convenient and efficientpayment services to its member institutions’growing customer base, MEPS enhanced its ATMnetwork in July 2007 to allow members to provide24-hour banking services to improve customerconvenience. Five members have since offered the24-hour ATM facility.

MEPS further enhanced the functionality of thedomestic shared ATM network to introduce facilitiesfor mobile phone users to top-up their prepaidaccounts with effect from January 2007. Thiscomplements existing Internet banking and mobilebanking channels offered by the banks that alsoprovide such facilities, thus increasing channeloptions for banking customers to perform mobileprepaid top-ups. The facility, which is now availableat over 1,000 ATMs of four participating banking

institutions, has recorded 62,687 transactionsvalued at RM1.1 million up to the end of 2007.

Following the encouraging response to theprovision of interbank funds transfer services viathe ATM network, three more bankinginstitutions have since offered the service. Thisbrings the total number of banking institutionsproviding this service to five, with about 4,000ATMs combined nationwide. There were151,242 interbank funds transfer transactionsamounting to RM125.2 million made via theATM channel in 2007.

With Malaysia receiving an increasing numberof tourists from China, MEPS entered into astrategic partnership with China UnionPay (CUP) inSeptember 2007 to enable CUP cardholders fromChina to benefit from the convenience ofperforming cash withdrawals at the ATMs inMalaysia. By end-2007, over 5,000 cash withdrawaltransactions valued at RM4 million were performedat the ATMs of the three participating banks inMalaysia. MEPS would be including more bankinginstitutions in 2008, while expanding the service toallow Malaysian ATM cardholders to perform cashwithdrawals in China. Similar strategic partnershipshave already been established by MEPS with ATMservice providers in Indonesia, Thailand andSingapore. Cash withdrawals made at MalaysianATMs in 2007 by cardholders from these threecountries increased eightfold from the previous yearto RM24.4 million.

Fostering Payment Innovation and Adoptionof New TechnologiesThe liberalised e-money and remittance accesspolicies coupled with the innovations in mobiletelephony, have also presented opportunities toenable e-money transfers over mobile networksas a new method for remittance. Given thepotential of mobile-based remittances due to thesizeable population of foreign workers and thehigh level of mobile phone penetration inMalaysia, several mobile remittance services wereintroduced during the year. This included theworld's first international mobile-to-mobilemoney transfer service between a Malaysianmobile operator and a Philippinestelecommunications operator that allowssubscribers in Malaysia to instantly remit up tothe value of RM500 per transaction at acompetitive rate of RM5.15 per transaction[including the short messaging service (SMS) cost


116

of 15 sen] to their beneficiaries in the Philippinesusing mobile phones. The Malaysian mobileoperator has since extended its reach toIndonesia, allowing its subscribers to send moneyvia SMS to Indonesian bank accounts. Thevolume and value of transactions made using thisservice for the seven months since it waslaunched in May 2007 was 355 transactionsvalued at RM69,075, comprising mainlyremittances to Indonesia.

strengthen their customer relationships, whileexpanding the reach of banking services to theunbanked segment over the mobile network.

Collaboration with the Government SectorDuring the year, the Bank continued with the activepartnership entered into with the Government infacilitating the further deployment of e-payments inthe economy. This included obtaining the supportof the Government to expedite the widespreaddeployment of high-speed and reliable broadbandInternet services which would spur further growthin Internet banking services and innovations thatleverage on Internet technology. Theannouncement of tax incentives relating tobroadband services and the formation of theCabinet Committee on Broadband in 2007 willprovide the impetus to achieve the two inter-relatedobjectives of increasing broadband penetration andthe use of the Internet for banking and paymentrelated activities.

As part of the Government’s ongoing effortsto improve its delivery of public services, themyGovernment portal was launched in December2005. The portal which enables the public to havedirect access to a comprehensive range of onlineservices, was enhanced to offer online paymentservices in April 2007. This includes theacceptance of credit cards as well as paymentsmade from banking accounts via the FinancialProcess Exchange (FPX) system. The onlinepayment facility is currently offered by theCompanies Commission of Malaysia for paymentsassociated with electronic lodgements of companyand business statutory documents, and by theNational Higher Education Fund Corporation forthe repayment of education loans. The InlandRevenue Board Malaysia has also offered FPX as anonline payment mode to the public to complementits e-filing services.

Apart from promoting more paymenttransactions via the Internet channel, the Bank isalso engaging the various Government agenciesthat receive substantial amounts of cash andcheque payments over-the-counter to acceptpayment cards. In this regard, several Governmentagencies namely the Immigration Department ofMalaysia, National Registration Department, RoadTransport Department (RTD) and the RoyalMalaysia Police, Government hospitals and somelocal councils have begun accepting credit cardand Bankcard. Another initiative underway is to

Liberalised policies facilitatedthe introduction of innovativeremittance products includingthe world's first internationalmobile-to-mobile moneytransfer service.

Another product launched during the yearwas a global mobile remittance service using themobile phone following a tie-up betweenanother Malaysian mobile operator and abanking institution which currently offersremittance services to Bangladesh, Indonesiaand the Philippines. Customers of the mobileoperator can remit up to RM5,000 pertransaction to the three countries via SMS orover-the-counter at the participating mobileoperator outlets. The services offer multiplepayment delivery options including thedepositing of funds into accounts of bankinginstitutions in the receiving country or thecollection of cash at designated agents in thethree countries.

The year also saw a non-bank launch aninternational prepaid card that offers remittances,person-to-person funds transfers, bill paymentsand mobile reloads. Customers would also be ableto use the card to withdraw cash from selectedATMs and make payments at more than 140,000merchant outlets nationwide.

These mobile international remittance services,leveraging on the familiarity with the use of SMS,provide a convenient platform for foreign workersin Malaysia to send money back home. Remittancescan be made at more affordable rates and at thespeed of a text message from any location at anytime. In addition, the emergence of these mobileremittance services has created a uniqueopportunity for the banking institutions to


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enhance the JPJ eINSURANS system implementedjointly by the insurance industry and the RTD inJanuary 2005 to incorporate e-payments. Thiswould build upon the successful adoption of theJPJ eINSURANS system, which facilitates the onlinetransmission of motor insurance details to the RTDfor the purpose of road tax renewal, thuseliminating the usage of physical cover notes.

In 2007, the Bank collaborated with theAccountant General’s Department and bankinginstitutions to put in place the necessary processesfor the reconciliation for payments and collectionsmade by the Government through the RENTASand IBG systems. Significant efficiency gains forthe Government and payment recipients areexpected to be derived from the adoption of thesee-payment systems, including enhancedoperational efficiency and productivity through thereduction or redeployment of resources, and costsavings from less cash handling and speedierpayments and receipts.

efforts undertaken during the year includedincorporating Bankcard as a payment option inthe credit card terminals. The number ofpayment terminals accepting Bankcard increasedfrom around 21,600 as at end-2006 to over34,000 terminals as at end-2007. By the end of2008, the number of terminals is expected toincrease further to 50,000. With theinfrastructure in place for the wider acceptanceof the Bankcard, focus was shifted towardsraising awareness of the Bankcard.Advertisements were placed in the media andmore coverage on the Bankcard was provided onthe websites of issuing banking institutions.

Bankcard offers an attractive value propositionto the merchants. Businesses and shops thatreceive cash payments have to incur high costssuch as security and insurance to address the risk

Significant efficiency gains forthe Government and paymentrecipients are expected to bederived from the adoption ofe-payment systems.

These efforts have resulted in the increaseduse of e-payments in place of cash and cheques.The volume of Government payments viaelectronic channels has increased ninefold from699,463 transactions in 2004 to 7,033,891transactions in 2007, while the value oftransactions increased almost threefold fromRM16.7 billion in 2004 to RM64.9 billion in 2007.

Positioning Bankcard to Accelerate Migrationto Electronic PaymentsMEPS and banking institutions are takingadvantage of the opportunities presented by thelarge number of 21.9 million Bankcards incirculation and payment terminals at merchantsin promoting cashless payments. Bankcard is theATM card issued by domestic banking institutionswhich also serves as a debit card. During the year,MEPS and banking institutions initiated steps toactively position the Bankcard as a convenientsubstitute for cash and as a more cost efficientpayment instrument. Building on the e-Debitapplication that MEPS had launched in 2003,

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Chart 6.3Trend of Government Payments by Volume

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Chart 6.4Trend of Government Payments by Value


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of theft, robbery and human error as well as timeinvolved in balancing cash registers and incollecting and delivering cash to the bankinginstitutions. With Bankcard, payments are crediteddirectly into the merchant’s account and thepayment for purchases is guaranteed as thecardholder’s account is verified for sufficient fundsbefore payment is authorised. In addition,merchants enjoy lower merchant fees for Bankcardcompared with credit cards. For consumers,Bankcard is as good as cash in the wallet, withadded security features such as PINs that provideprotection against theft and fraud.

Steps were taken to activelyposition the Bankcard as aconvenient substitute for cashand as a more cost efficientpayment instrument.

In 2008, greater attention would be directedat promoting the adoption of the Bankcard atGovernment counters as well as petrol stations.In developed economies such as Europe and theUnited States, debit cards are preferred overcredit cards and the reasons cited for thepreference include speed, convenience andsecurity. With the necessary infrastructure inplace and support from industry players, thepotential for Malaysia to move in the samedirection is enormous. The increasing preferencefor debit cards over credit cards would inculcategreater financial discipline as the expenditure ofdebit cardholders is limited to the amountavailable in their savings or current accounts.

Table 6.1Cash Holdings and Non-Cash Transactions

2003 2004 2005 2006 2007

CIC per capita (RM) 1,030.9 1,106.6 1,144.0 1,245.6 1,322.1

CIC-to-GDP (%) 6.2 6.0 5.8 5.9 5.7

Number of chequesissued per capita 7.7 7.7 7.6 7.5 7.7

Number of e-paymenttransactions per capita 13.8 17.6 21.6 28.0 32.5

Average value of ATMwithdrawals (RM) 400.1 407.2 428.1 460.9 463.3

Note: E-payment refers to credit card, charge card, debit card, e-money, IBG and FPX

2003 2007

Cheques35.9%

E-payments64.1%

Cheques19.2%

E-payments80.8%

Chart 6.5Share of Non-Cash Retail Payments by Volume

Trends in Migration to Electronic Payments

The role of cash in the economy exhibited a similartrend in 2007 with the cash in circulation (CIC)-to-GDP ratio declining while CIC per capita increasedslightly. ATM withdrawals were sustained at aboutthe same level. While cash is still viewed by manyconsumers as the cheapest and most convenientform of payment, the increasing availability anduse of payment alternatives have affected howpayments are being made. Many paymentstraditionally made by cash and cheques, are nowbeing made electronically with plastic cards orthrough electronic channels. This is demonstratedby the increase in the number of e-paymenttransactions made per capita to 32.5 transactionsin 2007 as compared to 13.8 in 2003.

Overall, the number of transactions for alle-payment channels and modes registeredincreases in 2007. The increase was most evidentin the usage of payment cards, mainly in the formof e-money. E-money accounted for nearly half ofthe e-payment transaction volume, which wasmainly attributable to the ease and convenience ofusing the Touch ‘n Go card for payments in the


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transportation sector. Following rapid growth inthe use of the Touch ‘n Go card and its popularityas a means to pay toll charges on the nation’shighways, the usage of the card is expected to beextended to the retail sector in the near future. In2007, there were 237.6 million credit cardtransactions valued at RM56.2 billion, an increaseof 13.8% and 18.2% respectively from theprevious year.

The contactless credit cards, Visa Wave andMasterCard PayPass, have also gained popularity in2007. There are currently eight issuers offering thesecontactless cards, which can be used at more than7,000 merchant outlets in the country. Debit cardsregistered an exponential growth of 114% and 81%in terms of volume and value respectively in 2007.The notable progress made in debit card transactionswas spurred by the growing acceptance of the publicand the increasing use of the debit card instead of

cash for payment of petrol purchases. The trend isexpected to continue with the intensified efforts bythe banking industry to deploy Bankcard terminals atmerchants as well as conduct awareness andpromotion programmes. Meanwhile, charge cardtransactions remained negligible accounting for only0.5% of non-cash transactions in 2007.

Notable growth was also recorded in othere-payment channels such as the IBG, FPX, Internetbanking and mobile banking during the year.• The IBG continued to grow at a rapid

double-digit rate, increasing by 42.6% interms of volume and 46.3% in terms ofvalue respectively. The increase was mainlyattributed to the participation of threeadditional banking institutions in 2007, itsencouraging usage in the Government sectorand the aggressive recruitment of corporateclients to adopt IBG.

2003 2007

Cheques97.0%

E-payments3.0%

Cheques93.0%

E-payments7.0%

Chart 6.6Share of Non-Cash Retail Payments by Value

100%

80%

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% share of total

2003 2004 2005 2006 2007

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Chart 6.7Trend of Non-Cash Retail Payments by Volume

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Cheques Payment instruments IBG

Chart 6.8Trend of Non-Cash Retail Payments by Value


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• Usage of the FPX in 2007 was also veryencouraging, attributed to active merchantrecruitment and recurring payments such asinsurance premiums and instalments. Thenumber of transactions made using the FPXduring the year was 71,220 compared to15,829 in 2006, while in terms of value,RM454.5 million was transacted against onlyRM25 million in the previous year.

• Internet banking continued to register stronggrowth in 2007. Internet banking subscribers-to-Internet subscriber penetration surged from67.8% as at end-2006 to 85.5% as atend-2007 reflecting the increasing popularityof Internet banking services among Internetusers. This also contributed to the increase involume and value of transactions by 45.3%and 70% respectively in 2007. The Internetbanking facilities have been used extensivelyfor salary and bill payments, third party fundstransfers and payment of credit card balancesby subscribers.

• Mobile banking subscribers increased by40.1% from the previous year, accountingfor 1.5% of mobile phone subscribers and1.3% of the population as at the end of2007. More than half (51.7%) of the totalvalue of transactions were to prepaidtop-ups, followed by bill payments via fundstransfers (24.2%) and own account fundtransfers (24.2%).

Roadmap for Migration to ElectronicPaymentsFollowing a consultative process with stakeholdersin the payment sector, comprising the bankinginstitutions and insurers, payment systemoperators and issuers, telecommunicationcompanies and relevant Government agencies aswell as views received from the NationalPayments Advisory Council members, the Bankfinalised the Roadmap for migration to e-paymentsin 2007. The Roadmap seeks to align thestrategies of key stakeholders, while investing theresources necessary to pursue the nationalagenda of accelerating migration to e-paymentsin a comprehensive and coordinated manner.Towards this end, the Roadmap seeks to bringtogether relevant stakeholders to remove thebarriers currently impeding the greater adoptionof e-payments.

Focusing on the main thrusts of safety,efficiency and public interest, the Roadmap seeks

to capitalise on the high number of bankingaccounts of over 40 million in the country and thesignificant investments made by the Governmentand the industry in expanding their services via theInternet and mobile channels. In encouraging thepayment industry to take advantage of theseopportunities to offer new payment instrumentsand improve existing products by offering moreconvenient and cheaper alternatives, efforts arealso being directed towards creating a conduciveenvironment that will foster innovation andexperimentation in payment systems. Towards thisend, the Bank will continue to enhance the policyframework in line with new developments andremove barriers impeding the entry of qualifiedplayers or introduction of products that wouldbring greater efficiency and innovation in themarket. This is to be achieved withoutcompromising the Bank’s primary objective ofmaintaining the overall safety and reliability of thepayment system. It is also in line with the Bank’smove towards placing greater reliance on marketdiscipline to complement supervisory oversight.

The Roadmap calls for further improvementsto be made in the retail payment systems that arecrucial to reduce the use of cash and cheques.There is considerable scope for these systems towiden their access to the general public, therebyaccelerating the migration to e-payments andachieving greater financial inclusion. The Roadmapcontains action plans that would encourage orfacilitate the transition to e-payments, such as

6.0

5.0

4.0

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90.080.070.060.050.040.030.020.010.0-

No. of subscribers (million) % penetration

No. of Internet banking subscribers (million)

No. of Internet subscribers, which includes number of broadbandsubscribers (million)

Penetration of Internet banking subscribers to population (%) (RHS)

Penetration of Internet banking subscribers to Internet subscribers(%) (RHS)

7.87.0 9.6 11.816.5

60.459.0 57.9

67.8

85.5

2003 2004 2005 2006 2007

Chart 6.9Internet Banking Growth and Penetration


121

developing enabling solutions for users, anddefining necessary common standards as well asthose that have a direct bearing on the growth ine-payments. This includes encouraging morebusinesses to engage in electronic commerce orelectronic banking.

Achievement of greaterefficiency gains in thepayment system will reducethe cost of doing business,thereby improving thecompetitiveness of theeconomy.

The Roadmap also addresses important issuessuch as the need to build consumer confidence,increase consumer awareness of e-payments andhave in place adequate redress mechanisms. Usersneed to be able to make better-informed choicesin adopting the most efficient or cost-effectivemeans for payments. In this regard, bankinginstitutions and payment providers need tocollaborate and design pricing structures thatwould motivate payment behaviours in the desired

direction. The achievement of greater efficiencygains in the payment system serves not only theinterest of the participants in the paymentindustry, but also the general public as a whole byreducing the cost of doing business, therebyimproving the competitiveness of the economy.

Periodic dialogues between the Bank and therelevant stakeholders will continue to be held toidentify and address issues of efficiency and costeffectiveness in a balanced and strategic manner.The potential economic and efficiency gains fromreducing the use of paper-based payments arelarge and could lead to significant and meaningfulgains in enhancing Malaysia’s competitiveness.

While the transition to e-payments will begradual and may span several years, the shift isimportant given the significant pay-offs derived forboth the providers as well as users of e-payments,and for the overall economy. Efforts would beintensified to encourage the public to use e-paymentmethods, with more initiatives to be undertaken inthe years to come in tandem with advancements intechnology. Further efforts will also be made toleverage on the Internet and mobile phone aspowerful and low-cost delivery channels for bankingand payment services.

Annex

14th divider - Annex


C 15M 95Y 100K 10

C 75M 15

C 10Y 50

Annex

Contents

Key Financial and Payment Systems Statistics

Banking SystemA.1 Sources and Uses of Funds of the Financial System P 1A.2 Banking System: Income and Expenditure P 2A.3 Commercial Banks: Income and Expenditure P 3A.4 Investment Banks: Income and Expenditure P 4A.5 Islamic Banking System: Income and Expenditure P 5A.6 Banking System: Key Data P 6A.7 Commercial Banks: Commitments and Contingencies P 7A.8 Investment Banks: Commitments and Contingencies P 7

Insurance SectorLife Insurance Business

A.9 Life Insurance: Income and Outgo P 8

General Insurance BusinesA.10 General Insurance: Underwriting and Operating Results P 8

Takaful SectorFamily Takaful Business

A.11 Family Takaful: Income and Outgo P 9

General Takaful BusinessA.12 General Takaful: Underwriting and Operating Results P 9

Development Financial InstitutionsA.13 Development Financial Institutions: Sources and Uses of Funds P 10A.14 Development Financial Institutions under DFIA: Sources and Uses of Funds P 11A.15 Development Financial Institutions: Direction of Lending P 12A.16 Development Financial Institutions under DFIA: Direction of Lending P 13A.17 Development Financial Institutions under DFIA: Non-performing Loans and

Loan Loss Provisions P 13A.18 Bank Pembangunan Malaysia Berhad P 14A.19 Bank Perusahaan Kecil & Sederhana Malaysia Berhad (SME Bank) P 14A.20 Export-Import Bank of Malaysia Berhad P 15A.21 Bank Kerjasama Rakyat Malaysia Berhad P 16A.22 Bank Simpanan Nasional P 17A.23 Bank Pertanian Malaysia P 18A.24 Development Financial Institutions: Selected Data P 19

Household SectorA.25 Household Sector: Selected Indicators P 19


Payment and Settlement SystemsA.26 Basic Payments Indicator P 20A.27 Usage of Various Cashless Payments: Volume of Transactions P 21A.28 Usage of Various Cashless Payments: Value of Transactions P 21A.29 Payment and Securities Transfer Instructions Handled by RENTAS: Volume of Transactions P 22A.30 Payment and Securities Transfer Instructions Handled by RENTAS: Value of Transactions P 22A.31 Number of Payment Machines and EFTPOS Terminals P 23A.32 Number of Users/Subscribers of Payment Instruments P 23A.33 Usage of Internet Banking P 23A.34 Usage of Mobile Banking P 23A.35 Number of Participants and Instrument Issuers P 24

Annex

P 1

Table A.1Sources and Uses of Funds of the Financial System

2003 2004 2005 2006

RM million

2007p

1 Equals savings, fixed and other (NIF, LPHT, etc.) deposits + NIDs + repos2 Includes statutory reserves of banking institutions3 Effective 2006, portions of 'Other assets' have been re-classifiedp PreliminaryNote: Numbers may not necessarily add up due to rounding

Sources of FundsCapital, reserves and profit 148,901.8 167,017.9 180,639.1 215,542.9 227,579.9Currency 29,445.4 32,353.9 34,396.7 37,896.0 42,192.7Demand deposits 92,117.8 124,333.4 135,944.1 141,864.3 166,070.3Other deposits1 (of which) 617,286.6 711,307.5 787,169.3 936,089.0 981,070.5 Banking and financial institutions 161,311.5 197,022.6 227,173.6 319,550.6 310,807.0 Public sector 40,563.0 38,809.9 44,415.0 34,176.8 37,810.1 Private sector 406,049.3 462,149.5 501,873.3 570,274.9 616,290.3 Foreign 9,362.8 13,325.4 13,707.4 12,086.7 16,163.1Borrowings 48,715.3 52,607.9 55,955.8 93,936.0 112,763.4Funds from other financial institutions 87,571.5 71,717.6 84,238.8 79,121.0 122,726.0 Domestic2 61,837.8 33,762.8 43,150.4 46,638.0 68,413.4 Foreign 25,733.6 37,954.7 41,088.4 32,483.0 54,312.6Insurance, provident and pension funds 305,657.0 337,937.6 373,645.1 425,637.3 486,219.2Other liabilities 233,384.8 267,579.3 260,673.7 226,539.4 337,236.8

Total Liabilities 1,563,080.0 1,764,855.0 1,912,662.6 2,156,625.9 2,475,858.7

Uses of FundsCurrency 5,573.8 5,058.3 6,057.3 6,531.3 8,980.1Deposits with other financial institutions 226,303.7 247,947.3 259,429.4 347,383.6 468,844.4 Domestic 211,075.6 214,355.2 232,385.7 299,065.4 379,938.9 Foreign 15,228.0 33,592.0 27,043.7 48,318.2 88,905.5Loans and advances 599,285.5 655,668.4 721,642.3 784,457.1 861,353.0 Banking and financial institutions 24,295.3 24,382.2 22,449.5 55,863.5 61,555.2 Public sector 7,799.2 7,950.3 5,446.5 12,054.8 11,989.2 Private sector 564,850.9 620,712.1 691,258.2 713,482.6 781,751.7 Foreign 2,340.0 2,623.8 2,488.1 3,056.3 6,056.8Securities 409,488.6 433,071.0 472,883.8 599,508.3 661,178.1 Treasury bills 3,539.4 445.2 1,698.4 1,687.1 1,969.8 Commercial bills 13,468.4 8,403.7 7,078.7 6,250.2 10,912.4 Malaysian Government Securities (MGS) 125,165.0 139,488.3 153,654.3 174,424.5 201,950.7 Corporate 254,197.9 271,630.7 291,606.4 297,301.0 355,849.7 Private Debt Securities (PDS) 122,237.8 130,213.0 140,405.4 135,384.5 175,065.1 Equities 131,960.1 141,417.7 151,201.0 161,916.5 180,784.6 Foreign 3,429.0 4,578.6 6,677.9 7,399.2 5,222.6 Others 9,688.7 8,524.5 12,168.0 112,446.3 85,273.0Gold and forex reserves 163,499.1 247,786.6 263,235.6 288,921.8 334,410.9Other assets3 158,929.3 175,323.5 189,414.3 129,823.7 141,092.3

Total Assets 1,563,080.0 1,764,855.0 1,912,662.6 2,156,625.9 2,475,858.7

P 2


43,659.622,034.8

52,134.527,809.1

21,624.84,721.26,280.07,057.8

24,325.45,167.97,509.58,211.3

13,008.25,558.7

13,772.56,538.3

7,449.64,932.2

7,234.25,715.0

12,381.8 12,949.2

1.416.8

130.340.061.7

112.465.3

1.316.2

131.842.064.6

109.374.8

59,742.232,816.0

26,926.26,890.38,503.89,515.2

15,797.45,342.6

10,454.97,204.5

17,659.4

1.519.7

168.140.866.9

111.977.5

Table A.2Banking System1: Income and Expenditure

For the calendar year

2005 2006

Interest incomeLess: Interest expense

Net interest incomeAdd: Fee-based incomeLess: Staff cost

Overheads

Gross operating profitLess: Loan loss and other provisions

Gross operating profit after provisionAdd: Other income

Pre-tax profit

Pre-tax profit/Average assets (%)Pre-tax profit/Average shareholders' funds (%)Pre-tax profit/Average employee (RM'000)Cost incurred per ringgit of revenue earned (sen)Cost incurred per ringgit of net interest income (sen)Overheads to staff cost (%)Staff cost per employee (RM'000)

2007p

RM million

1 Includes Islamic banksp PreliminaryNote: Numbers may not necessarily add up due to rounding

Annex

P 3

Table A.3Commercial Banks1: Income and Expenditure


2005 2006 2007p

RM million



Overheads



Pre-tax profit


1 Includes fi nance companies and Islamic banks

p PreliminaryNote: Numbers may not necessarily add up due to rounding

41,960.920,768.9

50,396.026,486.7

56,842.830,587.7

21,192.04,367.05,932.46,876.9

23,909.34,885.77,088.57,926.3

26,255.15,592.87,742.18,560.7

12,749.85,444.7

13,780.26,339.3

15,545.15,495.9

7,305.03,790.3

7,440.94,642.2

10,049.25,600.5

11,095.3 12,083.1 15,649.7

1.316.2

120.140.960.4

115.963.5

1.216.4

126.942.262.8

111.873.2

1.419.2

157.440.462.1

110.675.9

P 4


2.923.2

484.125.6

122.1

1,698.71,265.9

432.8354.2347.6180.9

258.5113.9

144.51,141.9

1,286.5

52.0132.4

1,738.51,322.4

416.0282.2421.0285.0

-7.7199.0

-206.71,072.8

866.2

1.513.8

281.837.6

169.767.7

119.5

Table A.4Investment Banks: Income and Expenditure


2005 2006 2007p

RM million



Overheads



Pre-tax profit



2,899.52,228.3

671.11,297.4

761.7954.6

252.3-153.4

405.71,604.0

2,009.7

2.724.7

357.544.9

255.7125.398.6

Annex

P 5

7,670.4

3,506.3

4,164.1

461.2

798.1

1,320.6

2,506.7

1,104.8

1,401.9

414.5

1,816.4

4,183.1

1,639.8

2,543.3

232.7

282.7

468.5

2,024.8

652.5

1,372.3

170.3

1,542.6

1.9

24.0

195.0

18.0

29.5

165.7

32.9

5,271.2

2,418.9

2,852.3

297.7

346.8

812.7

1,990.4

575.3

1,415.1

197.2

1,612.3

1.6

18.7

198.8

22.0

40.7

234.3

45.5

Table A.5Islamic Banking System: Income and Expenditure


20051 20061 2007p

RM million

Income net of income-in-suspense

Less: Expense

Net income

Add: Fee income

Less: Staff cost

Overheads

Gross operating profit

Less: Financing loss and other provisions

Gross operating profit after provision

Add: Other income

Pre-tax profit

Pre-tax profit/Average assets (%)

Pre-tax profit/Average shareholders' funds (%)

Pre-tax profit/Average employee (RM'000)2

Cost incurred per ringgit of revenue earned (sen)

Cost incurred per ringgit of net income (sen)

Overheads to staff cost (%)

Staff cost per employee (RM'000)2

1 Excluding one Islamic bank that made exceptional loss2 Number of employees is estimated based on the percentage of institution's Islamic assetp PreliminaryNote: Numbers may not necessarily add up due to rounding

1.4

16.6

192.1

27.6

50.9

165.5

70.7

P 6


Table A.6Banking System: Key Data

As at end

20072003 2004 2005 2006

1 Includes finance companies2 Includes Islamic bank branches that are shared with conventional bank branches

Number of institutionsCommercial banks1

Investment banksIslamic banks

Office networkCommercial banks1

Investment banksIslamic banks2

ATM networkCommercial banks1

Islamic banks

Number of banks with Internet services

Number of employeesCommercial banks1

Investment banksIslamic banks

4634102

2,5632,414

17132

4,3964,184

212

12

90,84485,0922,4293,323

4129102

2,4292,276

17136

4,7084,428

280

13

93,94887,2222,6904,036

4327106

2,2442,072

19766

4,8924,584

308

13

96,10689,047

2,6254,434

42221010

2,1391,952

191,167

5,2384,869

369

13

100,41491,741

3,5225,151

47221411

2,2451,968

1201,271

6,2105,797

413

15

109,69996,145

7,7215,833

Annex

P 7

2003 2004 2005

As at end

2006

RM million

Table A.7Commercial Banks1: Commitments and Contingencies

1 Includes finance companies and Islamic banksp PreliminaryNote: Numbers may not necessarily add up due to rounding

Total

Assets sold with recourse and commitments with drawdown

Direct credit substitutes

Credit extension commitments

Interest rate related contracts

Foreign exchange related contracts

Trade-related contingencies

Transaction-related contingencies

Others

Underwriting obligations

502,704.2

26,124.6

14,795.5

180,149.3

124,496.6

101,477.0

20,507.2

21,621.3

11,664.3

1,868.4

643,803.0

24,728.9

14,713.9

204,293.3

163,101.1

175,269.0

23,851.7

21,685.4

14,636.8

1,522.9

745,357.7

21,693.4

16,026.4

228,723.2

252,488.9

161,030.2

21,049.1

23,529.3

19,211.5

1,605.7

1,142,883.7

21,052.0

16,404.2

258,026.1

552,340.1

212,377.6

20,767.3

26,245.3

34,360.7

1,310.4

2007p

1,447,540.5

19,574.6

19,424.7

303,862.7

642,812.1

368,769.5

17,756.9

29,031.1

44,026.3

2,282.7

2003 2004 2005

As at end

2006

RM million

Table A.8Investment Banks: Commitments and Contingencies


Total

Assets sold with recourse and commitments with drawdown

Direct credit substitutes

Credit extension commitments

Interest rate related contracts

Foreign exchange related contracts

Trade-related contingencies

Transaction-related contingencies

Others

Underwriting obligations

124,172.6

1,595.2

1,226.8

2,545.9

115,332.1

1,459.9

0.0

818.2

55.4

1,139.0

179,825.0

2,493.7

1,126.2

2,387.6

169,189.1

2,877.6

0.0

676.6

44.6

1,029.6

128,371.5

2,418.3

1,312.4

2,847.3

112,409.4

4,976.9

0.0

1,794.5

506.2

2,106.5

63,039.2

2,968.0

855.5

1,681.3

38,010.1

5,669.7

0.0

1,304.5

7,950.4

4,599.8

2007p

85,575.0

2,049.9

1,165.9

4,128.8

44,180.0

2,812.3

1.1

806.7

26,943.7

3,486.7

P 8


9,653.92,566.6

1,387.3

915.0

14,522.8

13,884.4

18,898.94,572.7

4,935.6

28,407.2

34.0 9.04.9

3.2

51.1

48.9

100.0

66.516.1

17.4

Table A.9Life Insurance: Income and Outgo

16,002.1 3,660.8

1,257.1

20,920.0

6,268.7 2,504.6 1,071.7

1,158.9

11,003.9

9,916.1

Item 2005 2006 2007p

RM million % RM million % RM million %

IncomePremium incomeNet investment incomeProfit on sale of assets and miscellaneous income

Total

OutgoNet policy benefitsAgency remuneration Management expenses1

Loss on disposal of assets and other outgo

Total

Excess of income over outgo

100.0

76.517.5

6.0

30.0 12.0 5.1

5.5

52.6

47.4

100.0

72.116.8

11.1

30.8 10.3

5.3

4.5

50.9

49.1

17,120.23,994.0

2,624.5

23,738.7

7,311.12,453.7

1,249.6

1,063.8

12,078.2

11,660.5


1 Inclusive of net bad and doubtful debtsp PreliminaryNote: Numbers may not necessarily add up due to rounding

-48.5

8.8

71.4

142.7

-1.3

-41.0

-6.3

39.2

758.6

577.9

108.0

13.8

124.7

1,345.2

-92.0

8.7

216.0

-59.1

-84.0

10.5

-6.5

Table A.10General Insurance: Underwriting and Operating Results

Item 2005 2006 2007p

RM million % change RM million % change RM million % change

Underwriting profit

Investment income

Capital gains

Other income

Capital losses

Other outgo

Operating profit

956.9

641.2

106.7

108.9

87.6

191.1

1,535.0

106.0

8.0

-43.5

45.1

365.5

53.4

30.2

492.4

697.8

182.9

264.3

86.5

112.8

1,438.1



Annex

P 9

Table A.11Family Takaful: Income and Outgo

Item 2005 2006


2007p

RM million % RM million % RM million %

IncomeNet contributionsNet investment incomeProfit on sale of assets and miscellaneous income

Total

OutgoNet certificate benefitsNet commissionsManagement expenses1

Loss on disposal of assets and other outgo

Total

1 Inclusive of net bad and doubtful debtsp PreliminaryNote: Numbers may not necessarily add up due to rounding

977.1192.3

57.7

1,277.0

347.293.046.360.3

546.8

79.615.7

4.7

100.0

28.37.63.84.9

44.6

1,242.3232.0

126.5

1,600.9

400.8129.497.5

100.7

728.5

77.614.5

7.9

25.08.16.16.3

45.5

100.0

1,975.8284.5

104.3

2,364.6

534.2186.6161.658.6

941.0

1,423.6

83.612.0

4.4

100.0

22.67.96.82.5

39.8

60.2Excess of income over outgo 680.3 55.4 872.4 54.5

Table A.12General Takaful: Underwriting and Operating Results

2006


2007p

RM million % change RM million % change RM million % change

Underwriting profit1

Investment income

Capital gains

Other income

Capital losses

Other outgo

Operating profit

-25.4

44.6

10.3

8.6

0.7

11.0

26.3

-157.9

38.3

171.3

-55.3

-92.8

11.8

-67.0

-74.1

64.2

18.1

228.9

113.7

-29.0

-55.7

43.9

32.3

3.8

19.2

9.5

9.9

79.8

50.1

33.2

52.0

94.3

282.6

-14.3

55.9

169.6

19.6

3.2

5.8

4.5

13.9

179.9

Item 2005

1 Figures have been adjusted to reflect actual expenses borne by general takaful funds p PreliminaryNote: Numbers may not necessarily add up due to rounding

P 10


Table A.13Development Financial Institutions1: Sources and Uses of Funds

As at end

20072003 2004 2005 2006

RM million

Sources:

Shareholders’ fundsPaid-up capitalReservesRetained earnings

Deposits accepted

BorrowingsGovernmentMultilateral/International agenciesOthers

Others

Total

Uses:

Deposits placed

Investmentsof which:

Government securitiesShares

QuotedUnquoted

Loans and advances

Fixed assets

Others

Total

Contingencies:

Guarantee

Export credit insurance

Total1 Refers to Bank Pembangunan Malaysia Berhad, Bank Kerjasama Rakyat Malaysia Berhad, Bank Simpanan Nasional, Export-Import Bank of Malaysia Berhad, Bank Pertanian Malaysia, Bank Perusahaan Kecil & Sederhana Malaysia Berhad (SME Bank), Malaysian Industrial Development Finance Berhad, Sabah Development Bank Berhad, Borneo Development Corporation (Sabah) Sendirian Berhad, Borneo Development Corporation (Sarawak) Sendirian Berhad, Credit Guarantee Corporation Malaysia Berhad, Sabah Credit Corporation and Lembaga Tabung Haji. Prior to 1 October 2005, data include Bank Industri & Teknologi Malaysia Berhad and Malaysia Export Credit Insurance Berhad and exclude SME Bank

15,091.110,296.7

3,006.01,788.4

60,402.0

23,239.114,823.7

4,050.74,364.7

14,829.9

113,562.1

18,831.3

28,819.7

4,617.78,005.67,561.4

444.2

55,527.8

4,449.7

5,933.6

113,562.1

5,365.7

348.8

5,714.5

9,424.1 10,543.8 12,744.07,192.3 7,862.3 8,563.41,599.6 2,051.3 2,221.5

632.2 630.2 1,959.1

42,403.3 49,878.0 54,084.7

16,576.8 18,730.9 20,672.511,730.2 13,050.1 13,386.2

3,158.5 4,044.2 4,103.21,688.1 1,636.6 3,183.1

10,686.2 12,297.2 12,366.7

79,090.4 91,449.9 99,867.9

16,244.7 18,908.0 13,964.4

21,229.5 25,557.0 28,034.6

2,950.8 2,629.3 4,489.26,778.1 8,256.0 8,370.55,200.9 6,369.1 7,030.11,577.2 1,886.9 1,340.4

32,354.8 37,747.1 47,495.9

3,707.5 4,057.7 4,205.3

5,553.9 5,180.1 6,167.7

79,090.4 91,449.9 99,867.9

3,661.6 3,949.0 4,341.0

123.3 308.6 380.5

3,784.9 4,257.6 4,721.5

17,297.310,341.8

3,121.03,834.5

67,067.9

24,851.617,359.8

2,755.44,736.4

19,117.4

128,334.2

20,075.1

32,657.0

4,759.06,825.06,458.9

366.1

65,206.4

4,726.4

5,669.3

128,334.2

5,952.6

659.4

6,612.0

Annex

P 11

11,278.67,194.92,322.61,761.1

50,450.3

19,948.416,079.7

2,571.01,297.7

15,207.6

96,884.9

11,150.8

20,829.5

4,726.4644.2569.0

75.2

60,402.2

2,196.0

2,306.4

96,884.9

561.5

659.4

1,220.9

Table A.14 Development Financial Institutions1 under DFIA2 : Sources and Uses of Funds

As at end

20072003 2004 2005 2006

RM million

Sources:

Shareholders’ fundsPaid-up capitalReservesRetained earnings

Deposits accepted

BorrowingsGovernmentMultilateral/International agenciesOthers

Others

Total

Uses:

Deposits placed

Investmentsof which:

Government securitiesShares

QuotedUnquoted

Loans and advances

Fixed assets

Others

Total

Contingencies:

Guarantee

Export credit insurance

Total

1 Refers to Bank Pembangunan Malaysia Berhad, Bank Kerjasama Rakyat Malaysia Berhad, Bank Simpanan Nasional, Export-Import Bank of Malaysia Berhad, Bank Pertanian Malaysia and Bank Perusahaan Kecil & Sederhana Malaysia Berhad (SME Bank). Prior to 1 October 2005, data include Bank Industri & Teknologi Malaysia Berhad and Malaysia Export Credit Insurance Berhad and exclude SME Bank2 Development Financial Institutions Act 2002

10,484.27,171.52,207.71,105.0

45,098.7

18,729.113,758.7

3,869.81,100.6

11,343.1

85,655.1

12,713.4

17,500.6

4,560.11,429.51,325.5

104.1

50,961.4

1,994.9

2,484.8

85,655.1

524.7

348.8

873.5

5,359.4 6,178.1 8,398.14,167.5 4,811.1 5,503.6

964.1 1,339.4 1,479.9227.8 27.6 1,414.6

30,762.7 37,278.5 40,225.5

12,347.7 14,586.9 16,437.29,039.8 10,438.2 12,201.1

2,933.9 3,846.3 3,927.4374.0 302.4 308.7

8,403.7 9,730.3 9,550.1

56,873.5 67,773.8 74,610.9

11,383.5 12,949.5 8,204.7

12,970.7 15,868.1 18,634.9

2,736.5 2,549.8 4,446.21,778.5 1,705.8 1,742.31,664.7 1,616.7 1,625.7

113.8 89.1 116.6

28,072.3 33,472.5 43,374.9

1,550.3 1,786.1 1,843.0

2,896.7 3,697.6 2,553.4

56,873.5 67,773.8 74,610.9

549.1 533.3 613.5

123.3 308.6 380.5

672.4 841.9 994.0

P 12


65,206.4

1,037.81,834.5

3,021.6

3,477.85,698.0

20.23,968.5

1,030.916,383.17,548.67,391.2

614.0829.3

5,509.1

23,158.9

2,375.886.766.0

799.0

55,527.8

877.4

2,797.1

2,920.94,655.7

41.63,575.7

761.215,192.47,057.16,868.0

545.8721.5

6,281.1

17,435.8

2,168.850.4

189.9

Maritime

Table A.15Development Financial Institutions1: Direction of Lending

As at end

20072003 2004 2005 2006

RM million

Import and export, wholesale and retail

of which:

Total

1 Refers to Bank Pembangunan Malaysia Berhad, Bank Kerjasama Rakyat Malaysia Berhad, Bank Simpanan Nasional, Export-Import Bank of Malaysia Berhad, Bank Pertanian Malaysia, Bank Perusahaan Kecil & Sederhana Malaysia Berhad (SME Bank), Malaysian Industrial Development Finance Berhad, Sabah Development Bank Berhad, Borneo Development Corporation (Sabah) Sendirian Berhad, Borneo Development Corporation (Sarawak) Sendirian Berhad, Credit Guarantee Corporation Malaysia Berhad, Sabah Credit Corporation and Lembaga Tabung Haji. Prior to 1 October 2005, data include Bank Industri & Teknologi Malaysia Berhad and exclude SME Bank

Finance, insurance and business services

Others

Electricity, gas and water supplyManufacturingMining and quarryingAgriculture, forestry and fishery

trade, restaurants and hotelsBroad property sector

ConstructionPurchase of residential propertyPurchase of non-residential propertyReal estate

Transport, storage and communication

Consumption credit

Purchase of motor vehiclesCredit card


474.4

37,747.1

984.2

2,156.7

1,228.94,126.2

66.83,261.3

698.810,084.74,186.64,078.1

463.91,356.14,665.2

9,896.5

1,104.824.3

103.4

473.1

32,354.8

1,694.7

1,405.3

617.13,952.0

75.22,874.0

250.48,376.64,009.42,927.9

441.1998.2

4,433.7

8,066.5

800.223.7

136.2

47,495.9

766.1681.5

3,347.1

2,253.04,474.3

56.63,359.1

643.311,789.45,246.65,475.5

429.6637.7

5,837.1

14,074.3

1,508.232.6

214.1

Annex

P 13

General provisions

Interest-in-suspense

Speci fic provisions

Non-performing loans

Gross NPL ratio

Net NPL ratio

Total provisions/NPL

1,126.5

828.6

1,735.4

4,919.1

10.0

5.0

75.0

1,286.6

960.0

2,499.5

5,137.8

8.8

3.1

92.4

Table A.17Development Financial Institutions1 under DFIA2 : Non-performing Loans and Loan Loss Provisions

As at end

20072006

RM million

Percent (%)

1 Refers to Bank Pembangunan Malaysia Berhad, Bank Perusahaan Kecil & Sederhana Malaysia Berhad (SME Bank), Bank Kerjasama Rakyat Malaysia Berhad, Bank Simpanan Nasional, Export-Import Bank of Malaysia Berhad and Bank Pertanian Malaysia2 Development Financial Institutions Act 2002

3,865.014.2

4,486.13,476.8

780.914,800.8

7,036.17,119.8

561.383.6

5,433.81,834.5

940.222,433.5

2,315.686.766.0

2,270.4

60,402.2

Table A.16Development Financial Institutions1 under DFIA2: Direction of Lending

As at end

20072003 2004 2005 2006

RM million

Total

Agriculture, forestry and fisheryMining and quarryingManufacturingElectricity, gas and water supplyImport and export, wholesale and retail

trade, restaurants and hotelsBroad property sector

ConstructionPurchase of residential propertyPurchase of non-residential propertyReal estate

Transport, storage and communicationMaritimeFinance, insurance and business servicesConsumption creditof which:

Purchase of motor vehiclesCredit card

Purchase of securitiesOthers

1 Refers to Bank Pembangunan Malaysia Berhad, Bank Kerjasama Rakyat Malaysia Berhad, Bank Simpanan Nasional, Export-Import Bank of Malaysia Berhad, Bank Pertanian Malaysia and Bank Perusahaan Kecil & Sederhana Malaysia Berhad (SME Bank). Prior to 1 October 2005, data include Bank Industri & Teknologi Malaysia Berhad and exclude SME Bank2 Development Financial Institutions Act 2002

3,513.719.9

3,422.12,919.7

502.213,709.2

6,566.46,582.3

480.879.7

6,200.0799.0763.1

16,926.8

2,095.450.464.9

2,120.8

50,961.4

2,749.158.8

2,675.3617.1

151.57,371.43,842.02,629.3

438.8461.3

4,390.0473.1896.0

7,812.8

800.223.7

136.2741.0

28,072.3

3,148.349.1

2,872.21,228.9

260.78,933.13,973.73,797.0

461.2701.2

4,615.0474.4827.4

9,571.1

1,104.824.3

103.41,388.9

33,472.5

3,239.535.5

3,254.52,251.6

356.810,580.9

4,908.85,195.4

429.147.6

5,778.3681.5657.0

13,679.5

1,508.232.688.2

2,771.6

43,374.9

P 14


Table A.18Bank Pembangunan Malaysia Berhad

Year of establishment 1973

ObjectivesTo provide medium and long-term fi nancing for infrastructure projects, maritime,capital intensive and high technology industries in manufacturing sector and otherselected sectors in line with the national development policy.

Sector

Loans Outstanding Loans Approved Loans Disbursed

As at end During the year During the year

2006 2007 2006 2007 2006 2007

RM million

InfrastructureGovernment programmes

Private programmes

MaritimeShipping industryShipyard industryMarine-related services

Manufacturingof which: High technologyOthers

Total

Source: Bank Pembangunan Malaysia Berhad

18,123.1 4,230.6 4,297.016,693.7 6,834.7 3,890.0

2,540.21,660.6

879.6

1,358.7480.0826.1

52.6

391.86.3

3,240.2636.2

2,604.0

262.4128.2

16.8117.4

382.05.4

2,549.41,355.6

1,193.8

539.0338.6200.4

0.0

1,139.13.1

3,170.9373.6

2,797.3

1,802.8640.8942.0220.0

1,854.76.3

15,286.512,572.5

2,714.0

1,834.5776.4868.9189.2

942.459.7

15,294.212,843.7

2,450.5

799.1437.0182.8179.3

542.757.7

797.6 1,802.8 57.1

Table A.19Bank Perusahaan Kecil & Sederhana Malaysia Berhad (SME Bank)

Year of establishment October 2005

ObjectivesTo provide financing and advisory services to SMEs involve in manufacturing,services and construction sectors, particularly Bumiputera entrepreneurs.

Sector

Loans Outstanding Loans Approved Loans Disbursed


2006 2007 2006 2007 2006 2007

RM million

SMEsMicroSmallMedium

Others

Total

Source: Bank Perusahaan Kecil & Sederhana Malaysia Berhad

2,135.698.9

463.41,573.3

0.0

2,135.6

992.0102.2558.3331.5

233.0

1,225.0

1,742.7204.1753.2785.4

122.1

1,864.8

3,051.9221.7806.6

2,023.6

0.0

3,051.9

2,204.7255.6

1,115.3833.8

439.3

2,644.0

1,504.5175.4795.1534.0

413.6

1,918.1

Annex

P 15

Table A.20Export-Import Bank of Malaysia Berhad


Objectives

To provide credit facilities to finance and support the exports and imports ofgoods, services and overseas project financing with concentration to thenon-traditional markets, as well as to provide export credit insurance services,export financing insurance, overseas investment insurance and guaranteefacilities, as well as other services which are normally offered by theexport-import financial institutions and credit insurance financial institutions.

Loans Facility

Loans Outstanding(RM million)

Loans Approved(RM million)

Loans Disbursed(RM million)

As at end-2007

2006

Buyer credit facility

Overseas investment credit facility

Supplier credit facility

Export credit refi nancing

Total

108.3

215.2

594.0

8,245.8

9,163.3

521.7

347.6

723.9

8,428.9

10,022.1

Guarantee and Insurance Policy

Contingent Liabilities(RM million)

Business Coverage(RM million)

Short-term Policies

Comprehensive policies

Bank letter of credit policy

Speci fic policies

Others

Sub-total

Medium and Long-term Policies

Speci fic policies

Buyer credit guarantee

Bond indemnity support

Overseas investment insurance

Others

Sub-total

Total

420.0

601.7

236.2

1,585.3

2,843.2

319.0

56.3

17.0

54.2

446.5

1.9

202.3

0.0

10.8

212.0

427.0

873.5

639.6

808.8

290.3

1,955.0

3,693.7

573.0

33.9

0.9

33.1

640.9

80.0

270.0

64.0

3.1

162.9

580.0

1,220.9

826.6

695.2

1,633.4

8,245.8

11,401.0

1,759.0

175.0

24.0

99.0

2,057.0

2.0

168.0

0.0

12.0

0.0

182.0

2,239.0

169.0

429.1

850.1

8,428.9

9,877.1

2,518.0

116.7

1.0

57.2

2,692.9

84.0

225.0

71.0

3.5

0.0

383.5

3,076.4

Source: Export-Import Bank of Malaysia Berhad

As at end-2006

As at end-2007

As at end-2006

2007

2006 2007

2006 2007

P 16


Table A.21Bank Kerjasama Rakyat Malaysia Berhad


ObjectivesBank Kerjasama Rakyat Malaysia Berhad mobilises savings and provides financingservices to its members as well as non-members.

Deposits accepted

Deposits Accepted (RM million)

As at end-2006 As at end-2007

Members Non-

membersTotal Members

Non-members

Total

903.4 21,781.4

Direction of Financing

Sector

Financing Outstanding (RM million)


Members Non-members

Total Members Non-members

Total

Agriculture

Purchase of residental property

Purchase of non-residental property

General commerce


Purchase of motor vehicles

Consumption credit

Manufacturing

Others

Total

Source: Bank Kerjasama Rakyat Malaysia Berhad

937.8 26,320.5 27,258.322,684.8

51.7

4,474.7

494.9

787.8

59.1

25.0

18,169.3

71.7

598.6

24,732.8

12.7

1,374.4

396.3

751.2

51.6

25.0

5,625.4

71.7

598.6

8,906.9

39.0

3,100.3

98.6

36.6

7.5

0.0

12,543.9

0.0

0.0

15,825.9

43.7 13.2 56.9

3,061.3 1,248.4 4,309.7

83.2 348.0 431.2

53.3 598.4 651.7

5.5 50.2 55.7

0.0 25.6 25.6

10,705.6 3,392.5 14,098.1

0.0 689.0 689.0

0.0 92.3 92.3

13,952.6 6,457.6 20,410.2

Annex

P 17

Table A.22Bank Simpanan Nasional


Bank Simpanan Nasional is a savings bank, incorporatedunder the National Savings Bank Act 1974 and focuses onretail banking and personal finance especially for smallsavers.

Objectives

Deposits facilityRM million


Savings deposits

Fixed deposits

GIRO deposits

Islamic deposits

Premium savings certificates

Others

Total

InvestmentsRM million


Quoted shares

Government Securitiesof which: Malaysian Government Securities

Private debt securities

Subsidiary companies

Associate companies

Total

Direction of LendingRM million



Purchase of residental property

Purchase of non-residental property

Consumption credit

Others

Total

Source: Bank Simpanan Nasional

190.0

6,210.0

4,745.1

1,276.9

899.9

103.1

13,425.0

360.2

7,496.1

4,572.0

472.6

838.4

81.0

13,820.3

214.4

4,668.2

1,121.2

467.8

231.8

7,334.9

908.9

5,135.1

889.2

3,347.53,525.1

467.5

231.8

8,208.7

6.9

2,645.1

66.5

4,264.1

420.7

7,403.3

9.2

2,272.6

49.7

2,828.8

493.8

Others 631.5576.2

5,654.1

P 18


Table A.23Bank Pertanian Malaysia


Objectives

Bank Pertanian Malaysia was established to promote sound agriculturaldevelopment in the country, through the provision of loans and advances. The main function of the bank is to co-ordinate and supervise the granting ofcredit facilities for agricultural purposes and mobilise savings, particularly fromthe agriculture sector and community.

Agriculture, Forestry & Fishery

Loans Outstanding(RM million)

Loans Approved(RM million)

Loans Disbursed(RM million)


2006 2007 2006 2007 2006 2007

Sub-sector

Oil palm

Food crops

Livestock

Fishery

Forestry

Tobacco

Rubber

Others

Total

Source: Bank Pertanian Malaysia

198.4

151.5

137.1

110.2

2.1

4.8

20.6

618.1

1,242.8

465.3

193.6

263.8

135.9

41.5

0.6

34.3

654.7

1,789.7

851.2

443.3

477.2

369.0

42.4

19.8

56.0

1,546.5

3,805.4

801.2 304.3 169.8

419.6 145.8 131.4

423.6 191.6 101.8

317.8 108.5 56.2

63.5 47.2 18.4

36.2 1.0 5.3

51.8 22.9 23.5

1,328.3 417.4 417.8

3,442.0 1,238.7 924.2

Annex

P 19

Table A.25Household Sector: Selected Indicators

2003 2004 2005 2006 2007p

RM million

Household debt1

Household financial assets2

%

Household debt to GDP ratioHousehold financial assets to household debt ratioHousehold banking system NPL ratio

275,176595,573

65.7216.4

8.7

312,754664,334

66.0212.4

8.0

359,777723,736

69.3201.2

7.7

396,604809,799

69.3204.2

7.1

427,912 931,872

66.7217.8

5.3

1 Comprises household loans outstanding in banking system, Bank Simpanan Nasional, Bank Kerjasama Rakyat Malaysia Berhad, insurance companies and Treasury Housing Loans Division

2 Comprises household deposits held in banking system, Bank Simpanan Nasional, Bank Kerjasama Rakyat Malaysia Berhad, total assets of life insurance funds, Employees Provident Fund contributions and net asset value of unit trust funds

p Preliminary

Source: Treasury Housing Loans Division, Securities Commission, Employees Provident Fund and Bank Negara Malaysia

Table A.24 Development Financial Institutions: Selected Data

As at end

2006 2007

DFIs under DFIA1: Branch ATM Staff Branch ATM Staff

Bank Pembangunan Malaysia Berhad Bank Kerjasama Rakyat Malaysia BerhadBank Simpanan NasionalExport-Import Bank of Malaysia BerhadBank Pertanian Malaysia

Sub-total

Other DFIs:

Malaysian Industrial Development Finance BerhadSabah Development Bank BerhadBorneo Development Corporation (Sabah) Sendirian BerhadBorneo Development Corporation (Sarawak) Sendirian BerhadCredit Guarantee Corporation Malaysia BerhadSabah Credit CorporationLembaga Tabung Haji

Sub-total

Total

Bank Perusahaan Kecil & Sederhana Malaysia Berhad

1 Development Financial Institutions Act 2002

– – 499112 165 3,239375 626 4,865

– – 205172 148 2,683

18 – 908

677 939 12,399

8 – 425 – – 83

– – 13

– – 35

10 20116 – 415

–123 – 1,936

157 – 3,108

834 939 15,507

– – 465109 135 3,078379 620 4,918

– – 180172 146 2,657

16 – 792

676 901 12,090

8 – 352– – 84

– – 13

– – 351610

– 393– 208

124 – 1,612

158 – 2,697

834 901 14,787

P 20


Table A.26Basic Payments Indicator

2003 2004 2005 2006 2007

Population (million) 25.3 25.9 26.4 26.9 27.5GDP (RM million) 418,769 474,048 519,451 572,555 641,499Cash in circulation (CIC) (RM million) 26,101.4 28,616.9 30,177.6 33,519.4 36,290.8

Volume of transactions (unit)

Per capita:

Cheque 7.7 7.7 7.6 7.5 7.7

E-paymentsCredit cardCharge cardDebit card

13.85.80.3…

17.66.40.30.1

21.67.00.20.1

28.07.80.20.2

32.58.70.20.3

E-moneyInterbank GIROFPX1

ATM2

7.60.1

10.80.1

13.90.4

19.20.7

22.3

– … … … …1.0

Internet banking3

Mobile banking3

0.3

n.a.

0.5

n.a.

0.7

...

1.0

...

1.5n.a. … 0.1 0.1 0.1

...


9.47.00.5…

10.97.40.4…

13.67.90.40.1

17.08.30.40.1

20.18.80.30.2


ATM2

0.11.8

0.23.0

0.25.1

0.28.0

0.3

– … … … 0.110.4

Internet bankingMobile banking

2.4n.a.

3.0n.a.

3.6...

5.0...

7.6n.a. … 0.7 0.4 0.7

...


1,554.81,159.6

74.93.5

2,006.81,348.6

78.86.4

2,674.01,550.3

78.79.9

3,621.71,767.2

82.024.1

4,686.92,047.3

81.742.9


ATM2

22.4294.5

28.4544.5

37.3997.3

47.31,700.2

59.2

– 0.1 0.5 0.9 16.62,439.2

Internet bankingMobile banking

403.9n.a.

552.7n.a.

705.10.2

1,059.40.3

1,765.2n.a. 6.2 145.1 79.8 161.4

0.3

Value of transactions (RM)

Per capita:

CIC 1,030.9 1,106.6 1,144.0 1,245.6 1,322.1

Cheque 49,855.1 52,841.7 51,467.1 53,584.9 62,443.1

Percentage of GDP (%):

CIC 6.2 6.0 5.8 5.9 5.7

Cheque 301.4 288.3 261.4 251.8 267.2

1 Financial Process Exchange, an Internet-based payment, launched in October 20042 ATM transactions comprise bill payments, payments for electronic share application and loading transactions for MEPS Cash and Touch 'n Go3 Refer to transactional hits i.e. transactions with valuen.a. Not available... NegligibleNote: Numbers may not necessarily add up due to rounding

Annex

P 21

Table A.28Usage of Various Cashless Payments: Value of Transactions

System/Instrument2003 2004 2005 2006 2007

RM billion

RENTAS1 13,370.6 17,872.7 19,314.6 24,974.6 29,880.6

IFTS SSTS

12,691.7678.9

16,545.51,327.1

17,606.21,708.5

22,804.62,169.9

27,909.71,970.9

Cheque 1,262.3 1,366.5 1,357.7 1,442.0 1,714.1

Payment instruments:

Credit cardCharge cardDebit cardE-money

29.41.90.10.6

34.92.00.20.7

40.92.10.31.0

47.62.20.61.3

56.22.21.21.6

Other systems:

Interbank GIROFPXATM2

7.5-

n.a.

14.1...

0.2

26.3...

3.8

45.8...

2.1

67.00.54.4

1 Real time gross settlement system - with two subsystems i.e. Interbank Funds Transfer System (IFTS), and Scripless Securities Trading System (SSTS)2 ATM transactions comprise bill payments, payments for electronic share application and loading transactions for MEPS Cash and Touch 'n Go n.a. Not available... NegligibleNote: Numbers may not necessarily add up due to rounding

Table A.27Usage of Various Cashless Payments: Volume of Transactions

System/Instrument2003 2004 2005 2006 2007

Million

RENTAS1

IFTS SSTS

1.81.70.1

1.91.80.1

2.01.90.2

2.22.10.2

2.72.50.1

Cheque 195.1 200.2 199.9 201.2 211.7

Payment instruments:

Credit cardCharge cardDebit cardE-money

146.37.51.2

192.4

164.56.61.6

279.4

184.66.22.1

365.6

208.85.94.2

516.8

237.65.59.1

612.0

Other systems:

Interbank GIROFPXATM2

1.3-

n.a.

3.7...

0.3

10.4...

3.6

18.7...

1.8

26.60.13.4

1 Real time gross settlement system - with two subsystems i.e. Interbank Funds Transfer System (IFTS), and Scripless Securities Trading System (SSTS)

2 ATM transactions comprise bill payments, payments for electronic share application and loading transactions for MEPS Cash and Touch 'n Go

n.a. Not available... NegligibleNote: Numbers may not necessarily add up due to rounding

P 22


Table A.29Payment and Securities Transfer Instructions Handled by RENTAS: Volume of Transactions

2003 2004 2005 2006 2007

'000

IFTS1 1,728.9 1,797.0 1,881.3 2,065.8 2,548.4

Money market operations 93.9 101.3 93.1 103.2 108.3

Foreign exchange settlement 13.3 15.7 20.2 32.9 47.7

Government payment2 n.a. n.a. n.a. 0.2 36.8

Custom duty payment 103.3 91.0 82.8 68.262.4

Third party payment2 n.a. n.a. n.a. 106.2 1,462.0

Others 1,518.3 1,589.0 1,685.2 1,761.0 825.5

SSTS3 103.4 123.9 158.0 160.4 111.31 Interbank Funds Transfer System

2 Data were collected since November 2006. Third party payment refers to IFTS transaction with a minimum amount of RM10,000, where the beneficiary

or ordering party is a non-RENTAS member3 Scripless Securities Trading System, for Malaysian Government Securities, Treasury bills, and scripless public debt securities

n.a. Not availableNote: Numbers may not necessarily add up due to rounding

Table A.30Payment and Securities Transfer Instructions Handled by RENTAS: Value of Transactions

2003 2004 2005 2006 2007

RM billion

IFTS1 12,691.7 16,545.5 17,606.2 22,804.6 27,909.7

Money market operations 4,955.8 6,912.8 7,354.4 10,576.4 12,261.8

Foreign exchange settlement 441.0 920.2 1,262.4 1,531.4 2,179.0

Government payment2 n.a. n.a. n.a. 3.5 39.9

Custom duty payment 2.6 2.2 2.6 2.62.3

Third party payment2 n.a. n.a. n.a. 458.6 5,813.4

Others 7,292.3 8,710.3 8,986.8 10,232.5 7,613.0

SSTS3 678.9 1,327.1 1,708.5 2,169.9 1,970.91 Interbank Funds Transfer System

2 Data were collected since November 2006. Third party payment refers to IFTS transaction with a minimum amount of RM10,000, where the beneficiary

or ordering party is a non-RENTAS member3 Scripless Securities Trading System, for Malaysian Government Securities, Treasury bills, and scripless public debt securitiesn.a. Not availableNote: Numbers may not necessarily add up due to rounding

Annex

P 23

Table A.34Usage of Mobile Banking1

Items 2003 2004 2005 2006 2007

No. of subscribers ('000) n.a. 25.7 127.6 246.7 345.7

Volume of transactional hits ('000)2 n.a. n.a. 391.8 237.8 341.4

Value of transactions (RM'000) n.a. n.a. 4,455.5 7,509.9 8,077.91 Individual subscribers only

2 Refer to transactions with value

n.a. Not available

Table A.33Usage of Internet Banking1

Items 2003 2004 2005 2006 2007

No. of subscribers (million) 1.7 2.0 2.5 3.2 4.5

Volume of transactional hits (million)2 8.9 12.6 18.6 27.7 40.3

Value of transactions (RM million) 10,225.7 14,292.4 18,600.5 28,507.9 48,456.01 Individual subscribers only

2 Refer to transactions with value

Table A.32Number of Users/Subscribers of Payment Instruments

2003 2004 2005 2006 2007

'000

Credit card 5,098.1 6,583.0 7,815.5 8,833.0 9,899.3

Charge card 305.6 283.6 241.4 268.3 240.6

Debit card1 3,152.9 10,237.2 15,676.7 18,861.4 21,887.3

E-money 22,844.3 34,174.1 44,034.7 46,802.2 53,012.31 Include International brand debit card and e-Debit

Table A.31Number of Payment Machines and EFTPOS Terminals

Terminals2003 2004 2005 2006 2007

Unit

ATM1 4,396 5,568 5,777 6,147 7,156

CDM2 1,584 1,657 2,535 2,971 4,092

EFTPOS terminals:

Credit cardDebit card (Bankcard)3

E-money

n.a.n.a.

13,314

n.a.n.a.

16,642

84,75120,05218,198

102,87121,59228,115

133,57434,75428,771

1 Include non-banks' ATM in 20072 Include cash and cheque deposit machines3 e-Debit onlyn.a. Not available

P 24


1 Include international brand prepaid card

Table A.35 Number of Participants and Instrument Issuers

2003 2004 2005 2006 2007

Unit

RENTAS 54 52 55 53 54

Banks Non-banks

531

484

505

485

513

Credit card 19 18 19 18 18

BanksNon-banks

181

171

172

162

162

Debit Card

Banks 9 13 13 13 14

Charge card 5 5 5 6 6

BanksNon-banks

14

14

14

33

33

BanksNon-banks 4 5 7 11

4 5 8 13 15

– – 1 2 411

E-money1

Internet banking

Banks 13 14 14 16 18

Mobile banking

Banks 3 4 5 6 7

FPX

Banks - 4 5 11 11

Interbank GIRO

Banks 14 13 16 16 19

Documents

C01 Letter of Transmittal EN - Bank Negara Malaysia...which are incorporated into this Financial Stability and Payment Systems Report 2007. Respectfully submitted, Zeti Akhtar Aziz