Module Foundation of Banking

FOUNDATION OF BANKING

MD NAZRI MD NOR
NORZIHAN BINTI MOHAMAD

RATNA HAFIZA REDZUAN

POLITEKNIK UNGKU OMAR

Cetakan Pertama /First Printing, Disember 2018
Cetakan Kedua/Second Printing Jun 2019
Cetakan Ketiga/Third Printing Disember 2019
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ABOUT THE AUTHORS

MD NAZRI MD NOR is a lecturer in Finance and Banking
programme in Ungku Omar Polytechnic (PUO), Perak. His
education background is in Banking and Finance area. He expert in
Malaysian Capital Market area as he had passed the examination for
Capital Market Services Representatives License (CMSRL)
conducted by Securities Commission of Malaysia (SC). He also
passed for professional certificate in Islamic Finanacial Planning
conducted by Financial Planning Association of Malaysia (FPAM)
and Islamic Banking and Finance Institute of Malaysia (IBFIM). He
has been teaching in polytechnic for almost 10 years.

NORZIHAN BINTI MOHAMAD is a lecturer in Finance and
Banking programme in Politeknik Ungku Omar (PUO), Perak. Her
education background is in Banking and Finance area. She holds a
Master Science of Banking and Bachelor of Finance from Universiti
Utara Malaysia (UUM). She has been teaching in polytechnic for
almost 10 years.

RATNA HAFIZA REDZUAN is a lecturer in Finance and Banking
programme in Ungku Omar Polytechnic (PUO), Perak. Her education
background is in Banking and Finance area. She received her Master
of Business Administration and her Bachelor of Business
Administartion (HONS) (finance) from Universiti Teknologi Mara
(UiTM). She has been teaching in polytechnic for almost 10 years.

PREFACE

Foundation of Banking is written to introduce the students regarding the characteristics, functions and
structures of the financial system in Malaysia. This book gives an overview of financial institutions and
the structure of Malaysian financial system as discussed in Chapter 1 and Chapter 2 focuses on the
functions of the regulatory authority Bank Negara Malaysia (BNM). Chapter 3 discusses the roles and
responsibilities of the commercial banks and services provided in commercial banks which include
deposits, money remittances and other types of services. Chapter 4 focuses on introduction and roles of
finance companies and investment banks, services provided in finance companies - deposits, loans, hire
purchase, leasing, unit trusts, services provided by investment banks - activities that are based on fees and
funds. Chapter 5 discusses the roles of non-bank financial intermediaries – Development Finance
companies, Savings institutions, Employees Provident and Pension Fund, and Insurance Companies, and
other financial intermediaries – Factoring companies, Leasing companies, Unit Trusts, and Cagamas. The
book also examines the features of main financial market, financial market participants, treasury
functions, roles of Bank Negara Malaysia (BNM) in financial markets. Chapter 9 which is the final
chapter then examines the Islamic banking concept and the need for Islamic banking, Islamic financial
instruments, comparison between the Islamic banking system and the conventional banking system and
implementation of Islamic foundation of banking.

Md Nazri Bin Md Nor
Jabatan Perdagangan
Politeknik Ungku Omar
[email protected]

Norzihan Binti Mohamad
Jabatan Perdagangan
Politeknik Ungku Omar
[email protected]

Ratna Hafiza Binti Redzuan
Jabatan Perdagangan
Politeknik Ungku Omar
[email protected]

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TABLE OF CONTENT

CHAPTER 1: FINANCIAL STRUCTURE 2 – 28
CHAPTER 2: CENTRAL BANK 29 – 44
CHAPTER 3: COMMERCIAL BANK 45 - 58
CHAPTER 4: INVESTMENT BANK 59 – 66
CHAPTER 5: NON BANK FINANCIAL INTERMEDIARIES 67 – 77
CHAPTER 6: FINANCIAL MARKET ENVIRONMENT 78 – 91
CHAPTER 7: ISLAMIC BANKING OPERATION 92 – 101
REFERENCES 102
REVISION QUESTIONS 103 – 113

CHAPTER 1

1.0 FINANCIAL STRUCTURE

1.1 Explain the roles and structures of the financial system in Malaysia
1.1.1 Explain the roles of the financial system
a. Financial Intermediation
b. Payment systems
1.1.2 Illustrate the structures of the financial system in Malaysia which consist
the following
a. Financial Institutions
b. Financial Markets

1.2 Explain the laws regulating financial institutions
a. Financial Services Act (FSA) 2013
b. Islamic Financial Services Act (IFSA) 2013

1.3 Explain the characteristics, roles and objectives of Labuan International Business and
Financial Centre (Labuan IBFC)

1.4 Explain the roles and responsibilities of the regulatory and supervisory body.
a. Securities Commission (SC)
b. Bursa Malaysia
c. Malaysian International Islamic Financial Centre (MIFC)

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EXPLAIN THE ROLES AND STRUCTURES OF THE FINANCIAL SYSTEM IN MALAYSIA

OVERVIEW OF THE MALAYSIAN FINANCIAL SYSTEM

The Malaysian financial system has played an important catalytic role in facilitating the economic
transformation and growth of the Malaysian economy through the various phases of economic
development. This strategic role of the Malaysian financial sector will increase in importance in
the years ahead as Malaysia becomes even more integrated with the international financial
system and the global economy. The rapid changes in the global economic and financial
environment will also contribute towards transforming the operating landscape of the Malaysian
financial system. At the same time, a more integrated and globalized environment, greater
regionalization, and the more sophisticated and diverse investment and financing needs of the
domestic economy will require a financial system that is more progressive and dynamic to advance
the nation’s vision towards the attainment of a high value-added, high-income economy.

This 10-year Blueprint is a strategic plan that charts the future direction of the financial system as
Malaysia transitions towards becoming a high value added, high-income economy. To achieve this
and to leverage on the opportunities going forward, consideration is made on the global trends
and domestic economic forces of change that will affect the operating environment. The progress
made in the financial system over the recent decade provides a foundation for the future growth
and development of the financial system in the next ten years. This chapter discusses the global
and domestic landscape that is likely to evolve over this decade and the financial system that will
be developed during the course of the decade to 2020, as the Malaysian financial sector matures
and advances to become more effective in performing its intermediation function in tandem with
Malaysia becoming a developed economy.

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EXPLAIN THE ROLES OF THE FINANCIAL SYSTEM

a) Financial Intermediation

Malaysia has a modern and comprehensive financial system that continues to evolve in response
to changing domestic and international conditions. A financial structure consists of two major
components; financial institutions and financial markets. Principally, the financial system aims to
facilitate the effective use of funds.

The financial institution acts as an intermediary for the savers called the surplus units and
borrower’s called the deficit units. Many deposit products have been developed to meet the
surplus units’ varying needs. Likewise, many loan products have been developed to meet
the deficit units’ varying needs.

In simple terms, the intermediation process involves mobilizing funds from the economy’s surplus
units to its deficit units to aid in enhancing economic development. In this regard, the financial
system’s intermediation function has strong linkages with savings and investment decisions
that can influence the pace of economic growth.

Ask yourself as an individual – would you like to be a surplus or deficit unit? The response
is most likely to be a surplus unit. Then, if countered by asking, that would you only save to
buy a house costing, say – RM100,000? If so, how long would it take to save that much? By the
time that much was saved, would the price of the house be the same? Wouldn’t it have gone up
due to inflation? Therefore, the better idea would be to borrow, wouldn’t it?

Having understood the rationale, one would immediately like to be a deficit unit. Now to
view it from both perspectives, when one opens a savings account, one becomes a surplus
unit. When the same person takes a housing loan, then he becomes a deficit unit. Therefore
in reality, a person could be the surplus and deficit unit at the same time or could be either
one if he only deposits or borrows.

For this very important process of financial intermediation,
financial intermediaries must be efficiently equipped with a
well-functioning payment system. It is crucial for the efficient
operation of the financial market as well as to support the
Malaysian economy.

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How The Financial Intermediation Works?

Situation 1

Imagine a household that has a regular income of RM 10,000. They spend RM5,000 on food,
clothing, rent, school fees, etc, and are left with RM5,000. This is extra money that they plan to
save for a bigger expenditure later some time. They can store this money at home as cash. But
what if they could store it in a form which is safer than cash and also earns them some return on
it?

Situation 2

On the other hand, there is a young man with a great business idea. But he needs money to
actually execute the idea. Money that he doesn't have. Should he drop the idea and live in poverty
forever? Maybe the folks with extra money could give to our entrepreneur for some time so he
can do the business, make some money, keep some for himself, and return the money (with
interest) to the households.

Then should our entrepreneur go door to door asking for money? Or should these households look
for entrepreneurs who are willing to pay them some extra interest for their savings? If yes, how
would the households know whether the entrepreneur actually has a decent business idea or not?
How do they make sure that the entrepreneur doesn't run away with their money?

This is where a bank would come into picture. There are millions of households with savings, or
extra cash that they want to store, and many entrepreneurs who could use this cash and make a
profitable business out of it. A bank acts as an intermediary between those who have extra money
(households) and those who can use the money profitably in a business (investors). This function
is called Financial Intermediation. This way banks serve a very important function in an economy.

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b) Payment System

Under the Bank for International Settlements (BIS) definition, a payment system consists of
instruments, banking procedures, and typically interbank funds transfer systems that ensure and
facilitate the circulation of money. In essence, it facilitates corporations, businesses and
consumers to transfer funds to one another.

Payment system is defined as any system or arrangement for the transfer, clearing or settlement
of funds or securities in the Central Bank of Malaysia Act 2009. In essence, it facilitates
corporations, businesses and consumers to transfer funds to one another.

The Importance of Payment System

Payment systems are a vital Safe and efficient payment systems
part of the financial are fundamental to promote financial

infrastructure of a country. stability. (Facilitating Bank Negara
(RENTAS enables the transfer Malaysia in the conduct of its
and settlement of high-value
monetary policy by allowing greater
interbank payments and use of market-based instruments to
securities.)
achieve its objectives)

Role of BNM in Malaysian Payment System

Bank Negara Malaysia plays its role as overseer in ensuring the safety, reliability, and efficiency of
payment systems infrastructure, and to safeguard the public’s interest.

As an overseer, Bank Negara Malaysia formulates regulatory framework and conducts oversight
on both large value and retail payment systems. The oversight activities are focused on containing
systemic risks and reducing the overall risks in the payment systems in ensuring the reliability of
the major payment and settlement systems.

Bank Negara Malaysia also facilitates improvements in payment services and market
developments by fostering payment innovations and ensuring public confidence in the retail
payment systems and the use of payment instruments. The Bank undertakes active consultation
and cooperation with market players and stakeholders.

Given the importance of e-payments in enhancing economic efficiency, accelerating the migration
to electronic payments become one of the nine focus areas under the Financial Sector Blueprint
2011-2020 released by the Bank Negara in Dec 2011.

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FIGURE 1.2: THE MALAYSIAN PAYMENT SYSYTEM (MPS)
 Large Value Payment System (SIPS)
A Systemically Important Payment System (SIPS) or Large Value Payment System (LVPS)
typically processes high-value and time-critical payments. It is an essential payment system to
ensure the smooth functioning of the economy, financial systems and financial markets, and
its failure could trigger disruptions or transmit shocks within the economy and the financial
market, both at the domestic and potentially at the cross-border level. Real Time Electronics
Transfer of Funds and Securities (RENTAS) is the only LVPS for Malaysia and it is operated
under Real Time Gross Settlement (RTGS) basis.
 Retail Payment System (RPS)
In general, the retail payments in Malaysia can be divided into three - Retail Payment Systems,
Retail Payment Instruments and Retail Payment Channels.

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c) Monetary Policy Transmission Channel

In addition to its contribution to the development of the economy, a well-functioning and efficient
financial system is vital for the effective conduct of monetary policy. This is because monetary
policy is transmitted primarily through the banking system. On the other hand, an inefficient
banking system, usually characterized by financially weak banking institutions and inefficient
market mechanism may render monetary policy less effectively in achieving its objectives. In an
environment of emerging inflationary pressure, the ability of a central bank to raise interest rates
would be constrained if the financial institutions are weak. This is because higher interest rates
would weaken the health of the corporate sector and lead to the deterioration in the asset quality
of the banking institutions.

THE FINANCIAL SYSTEM STRUCTURES IN MALAYSIA

In Malaysia, the financial system structure consists of the financial institution and the financial
markets. Financial markets are places where investors buy or sell financial assets, for instance
stock, bond, and commodity. The participants in financial markets, transfer the funds by
purchasing or selling financial assets through organized exchange or over-the-counter
transactions.

Meanwhile, financial institutions are the financial intermediaries who play an important role of
financial intermediation by facilitating the flow of funds through the investment and financing
activities by the surplus units and deficit units in the economy. They may also the parties who
operate in the financial markets by providing financial products and services to their customers.

Banking system consists of Bank Negara Malaysia, Commercial Banks, Investment Banks, Islamic
Banks and foreign banks representative offices. Non-Bank financial intermediaries comprises
Provident and Pensions Funds, Insurance Companies, Development Financial Institutions, Saving
Institutions and others intermediaries.

The first commercial bank to be established in the country was a branch of a British
exchange bank called The Chartered Mercantile Bank of India, London and China (later renamed
as the Mercantile Bank) in Penang in 1859. This was followed by The Chartered Bank
establishing a branch in Penang in 1875. The first domestic bank to be incorporated in Kuala
Lumpur was the Kwong Yik (Selangor) Banking Corporation in July 1913.

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In 1955 following the World Bank Mission, which reviewed the country’s economic situation and
potential for development, a recommendation was made to form a Central Bank. This lead to the
establishment of the Central Bank of Malaya called Bank Negara Malaysia under the Central Bank of
Malaya Ordinance, 1958 on January 26, 1959.
Under the Financial Sector Master Plan (FSMP), the financial industry is now going through a
phases of consolidation. Commercial banks are merging with their finance companies. This is to
enable financial institutions to become one-stop financial centres to be more competitive and
to be better prepared for the impending liberalisation of the financial services sector, which
is expected to come on board from 2007 onwards.

As mentioned before, the Malaysian financial system are structured into two major categories,
Financial Institutions and Financial Market. The Financial Institutions comprises Banking System
and Non-bank Financial Intermediaries while the Financial Market in Malaysia comprises four
major markets namely: Money & Foreign Exchange Market, Capital Market, Derivatives Market,
and Offshore Market.

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FINANCIAL INSTITUTIONS
A. Banking System
The banking system consists of Bank Negara Malaysia (Central Bank of Malaysia), banking
institutions (commercial banks, finance companies, merchant banks and Islamic banks) and a
miscellaneous group (discount houses and representative offices of foreign banks). The banking
system is the largest component of the financial system, accounting for about 67% of the total
assets of the financial system.

The summary background information and functions of the institutions mentioned above are set
out as follows:-

i) Bank Negara Malaysia (BNM)
Bank Negara Malaysia (the Central Bank of Malaysia) was established on 26 January 1959, under
the Central Bank of Malaya Ordinance 1958. The objectives of BNM are as follows:

 To issue currency and keep reserves to safeguard the value of the currency;
 To act as a banker and financial advisor to the Government;
 To promote monetary stability and a sound financial structure; and
 To influence the credit situation to the advantage of Malaysia.

The introduction of the Banking and Financial Institutions Act 1989 (BAFIA) on 1 October 1989
extended BNM’s power for the supervision and regulation of financial institutions and deposit-
taking institutions who are also engaged in the provision of finance and credit.

We will discuss further in Chapter 2 or you guys can view BNM websites for further insights.
http://www.bnm.gov.my/index.php

Logo and Bank Negara Malaysia building
Source: website BNM

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ii) Commercial Banks

The commercial banks are the largest and most significant providers of funds in the banking
system. There are currently 27 commercial banks (excluding Islamic banks) of which 19 are locally
incorporated foreign banks. The main functions of commercial banks are to provide:

 Retail banking services such
as the acceptance of deposit,
granting of loans and
advances, and financial
guarantees;

 Trade financing facilities such
as letters of credit,
discounting of trade bills,
shipping guarantees, trust
receipts and Banker’s
Acceptances;

 Treasury services;
 Cross border payment services; and
 Custody services such as safe deposits and share custody.
 Commercial banks are also authorised to deal in foreign exchange and are the only financial

institutions allowed to provide current account facilities.

We will discuss further about Commercial banks in Chapter 3.
For the list of Commercial banks incorporated in Malaysia you can view it in the provided links.
http://www.bnm.gov.my/index.php?ch=li&cat=banking&type=CB&fund=0&cu=0

iii) Investment Banks

Investment banks emerged in the Malaysian banking scene in the 1970s, making an important
milestone in the development of the financial system alongside the corporate development of the
country. They play a role in the short-term money market and capital raising activities including
financing, specialising in syndication, corporate finance and management advisory services,
arranging for the issue and listing of shares, as well as investment portfolio management. There
are currently 11 Investment banks in Malaysia.

For the list of Investment Banks incorporated in Malaysia you can view it in the provided links.
http://www.bnm.gov.my/index.php?ch=li&cat=banking&type=MB&fund=0&cu=0

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iv) Islamic Banking
Islamic banking refers to a system of banking that complies with Islamic law also known as Shariah
law. The underlying principles that govern Islamic banking are mutual risk and profit sharing
between parties, the assurance of fairness for all and that transactions are based on an underlying
business activity or asset.
These principles are supported by Islamic banking's core values whereby activities that cultivate
entrepreneurship, trade and commerce and bring societal development or benefit is encouraged.
Activities that involve interest (riba), gambling (maisir) and speculative trading (gharar) are
prohibited. Through the use of various Islamic finance concepts such as ijarah (leasing),
mudharabah (profit sharing), musyarakah (partnership), financial institutions have a great deal of
flexibility, creativity and choice in the creation of Islamic finance products.
Currently, Malaysia has a significant number of full-fledged Islamic banks including several foreign
owned entities; conventional institutions who have established Islamic subsidiaries and also
entities who are conducting foreign currency business. All financial institutions are given
permission to conduct both ringgit and non-ringgit businesses. Malaysia continues to progress and
to build on the industry by inviting foreign financial institutions to establish international Islamic
banking business in Malaysia to conduct foreign currency business.
For the list of Islamic Banks incorporated in Malaysia you can view it in the provided links.
http://www.bnm.gov.my/index.php?ch=li&cat=islamic&type=IB&fund=0&cu=0

v) Representative Offices of Foreign Banks in Malaysia
There are 17 foreign banks that have established representative offices in Malaysia, with all
concentrated in Kuala Lumpur. Most of the banks originated from Europe and Japan.
Representative office is merely a liaison office and does not offer banking products directly to the
Malaysian market.
For the list of foreign banks representative offices in Malaysia you can view it in the provided links.
http://www.bnm.gov.my/index.php?ch=fs&pg=fs_mfs_repoffice&ac=598&lang=en

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B. Non-Bank Financial Intermediaries

Non-Bank Financial Intermediaries mainly comprised of Insurance Companies, Provident and
Pension Funds and Development Finance Institutions. Summary background information and
functions of these institutions are appended below:-

i) Provident and Pension Funds

Provident and Pension Funds (PPFs) are a group of financial schemes designed to provide
members and their dependents with a measure of social security in the form of retirement,
medical, death or disability benefits. The major PPFs in Malaysia comprise the Employees
Provident Fund (EPF), the Social Security Organisation (SOCSO), the Armed Forces Fund and the
Teachers Provident Funds. The PPFs funds serve as important mobilizes of long term savings in the
economy for rechanneling into both the public and private sectors to finance long-term
investment. The PPFs are the second largest group of financial institutions in the country in terms
of aggregate assets, next to banking institutions.

ii) Development Financial Institutions

Development Financial Institutions (DFIs) are established by the Government to promote the
development of certain identified priority sectors and sub-sectors of the economy, such as
agriculture, infrastructure development and international trade. DFIs generally specialise in the
provision of medium and long term financing of projects that may carry higher credit or market
risk. It is envisaged that in the next decade, DFIs will continue to progress and assume a more
significant role in pursuing the Government policy goals for strategic, social and economic
development. The following are the main DFIs in Malaysia:-

Bank Pertanian Malaysia
Bank Industri & Technologi Malaysia
Bank Pembangunan & Infrastruktur Malaysia Berhad
EXIM Bank
Malaysian Industrial Development Finance (MIDF)
These are specialised financial institutions, established by the Government to promote
investments in the manufacturing and agriculture sectors. Their emergence, as in most
developing countries, are to fill the gap in the supply of financial services, which are not
usually covered by the established financial institutions. The prime objective of development
finance institutions in Malaysia is to provide long-term funds tailored to the need of
borrowers. Both Federal and State Governments provide funding in the form of equity
participation and low interest loans. As the name suggests, development finance institutions are
to develop specific sectors in the economy.

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The Development Finance Institutions Act 2002, (DFIA) was enacted and made effective on
15th February 2002 to provide a comprehensive regulatory and supervisory framework to
ensure safe and sound financial management of the DFIs.

Six institutions now come under the purview of Bank Negara Malaysia. They are Bank
Pembangunan dan Infrastruktur Malaysia Berhad, Bank Industri & Teknologi Malaysia Berhad,
Malaysia Export Credit Insurance Berhad, Export-Import Bank of Malaysia Berhad, Bank
Kerjasama Rakyat Malaysia Berhad and Bank Simpanan Nasional which have been gazetted
as “prescribed institutions” under subsection 2(1) of the DFIA.

iii) Savings institutions

Savings institutions exist in the country to complement the commercial banks and finance
companies as the major deposit taking institutions. The main savings institutions are the
National Savings Bank and the co- operative societies. These savings institutions promote
savings among middle and lower income groups in the rural areas that are not adequately
served by the commercial banks and finance companies.

Bank Simpanan Nasional

The National Savings Bank (NSB) was established through the National Savings Bank Act
1974, through a reorganisation of the former Post Office Savings Bank system. The National
Savings Bank’s principal activity is to carry out the functions of a national savings bank,
namely to accept deposits and to provide retail loans to small borrowers. The Government
guarantees all deposits. Funds raised through the premiums savings certificates are unique to
this bank. Attractive prizes for lucky draw winners and payment of dividends contributed to the
growth of these deposits. Other deposit products are savings deposits, fixed deposits and Giro
deposits and save-as-you-earn deposits. The Giro savings scheme is attractive due to its
features, which enables depositors to remit funds and make payments while earning an interest.
Lending is channeled to housing, credit cards, hire- purchase and corporate loans.

Co- operatives Societies

The co-operative movement was first introduced in the country in 1922. In the same year, the
Department of Co-operative Development was also established. Co-operatives are
organisations of consumers or producers who voluntarily pool their resources together to
meet common objectives. The Co- operative Societies Ordinance 1948 defines a co-operative
society as “society which has its objective of promotion of economic interest of its members
in accordance with co-operative principles”.

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Therefore, the aim is to provide opportunities for its members to save, invest and participate
in economic interests. Collectively, members can be a force to be reckoned with as they have a
better bargaining power. Co-operatives can be classified as single purpose or multi-purpose.
Comprehensive guidelines under the National Co-operative Policy are a framework and guide
to eradicate poverty, create jobs and business and to improve quality of life. To date, there are
4,330 co - operatives with a membership of 5 million members.

Bank Kerjasama Rakyat Malaysia Berhad was established in 1954, under the Co-operative
Ordinance 1948. On 6 January 1973, its name was changed to Bank Kerjasama Rakyat Malaysia
Berhad following a broadening of its scope of activity. As a co-operative, the main objectives
of Bank Kerjasama Rakyat Malaysia Berhad are to improve the standard of living through the
provision of financing and financial and advisory services in the commercial, industrial,
agricultural and other sectors, and to encourage savings among its members. The principal
activities of Bank Kerjasama Rakyat Malaysia Berhad are providing personal, property,
education and other financing, including pawn broking to members of the public and co-
operatives. Since 1997, all banking facilities offered by Bank Kerjasama Rakyat Malaysia
Berhad are based on the Syariah principles.

iv) Unit trusts

Unit trusts serve as a medium through which small individual investors can acquire a share
in a diversified portfolio of corporate securities. It is a trust established by a trust deed. There
are three parties to a trust deed namely, the managers, investors and trustees. Unit trusts come
under the purview of the Securities Commission. The size of a unit trust shall not exceed 500
million units. To exceed this limit, an application must be made to the Securities Commission
who will be mindful of the fund manager’s experience and resources. Unit trusts play an
important role in the development of the private capital market as funds are mobilised
from small savings for active participation in the corporate securities market. Returns will depend
on the risk assumed by the investor. The higher the risk, the greater the potential return.

v) Cagamas Berhad

The national mortgage corporation, Cagamas Berhad, was established in December 1986, to
ensure a steady flow of funds to the housing industry as well as to develop a secondary mortgage
market. Cagamas issues notes and bonds to raise funds. Notes are short term, with maturity dates
being less than one year. Bonds are long term, having maturity dates of more than one year.
Financial institutions invest in these notes and bonds. Having raised these funds, they are mainly
used in two areas.

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vi) Leasing companies

Leasing companies constitute a relatively small but growing sub-sector of the Malaysian financial
sector. Under the third schedule of the BAFIA 1989, leasing business is a scheduled business,
whereby the Central Bank has the power to regulate and supervise the businesses. Leasing
companies source their funds from shareholder funds, borrowings from financial institutions and
intercompany borrowing. Leasing companies, from which 70% of their business is in leasing, can
be called “PURE-LEASING” companies. Leasing finance of the pure leasing companies is channeled
mainly to the manufacturing, transport and storage, finance, insurance and business services,
general commerce and agriculture sectors.

vii) Insurance Companies

Insurance companies are incorporated under the Companies Act 1965, engaged in the
business of insurance services. They design financial schemes to provide members and their
dependants with a measure of security in the form of retirement, medical, death or disability
benefits. The insurance industry forms part of the financial industry. It is the government’s
objective to promote the growth of domestic insurers to establish a national insurance industry
to cater to Malaysian needs. There are two main types of insurance companies namely life and
general.

a. Life insurance companies

Life insurance business is concerned with the insurance of individuals’ lives. As a reward for
taking risks, insurance companies receive income in the form of premiums. In a life insurance
contract, the policyholder pays a periodic premium in return for a lump sum payment in
the event of death, permanent disability or major illness or on maturity of the policy.

b. General insurance companies

General insurance covers all risks except risk of life. It operates on the principle of pooling of risks
by bringing together a sufficiently large number of people, who seek protection from any
common risk of loss of property or income, arising from accidents, burglaries, fires or
unexpected events. In the event of a loss, the insured will be compensated for loss.

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THE LAWS REGULATING FINANCIAL INSTITUTIONS

The regulatory and supervisory framework of Malaysia enters a new stage of its development as
the Financial Services Act 2013 (FSA) and Islamic Financial Services Act 2013 (IFSA) come into force
on 30 June 2013.

The FSA and IFSA is the culmination of efforts to modernize the laws that govern the conduct and
supervision of financial institutions in Malaysia to ensure that these laws continue to be relevant
and effective to maintain financial stability, support inclusive growth in the financial system and
the economy, as well as to provide adequate protection for consumers. The laws also provide
Bank Negara Malaysia with the necessary regulatory and supervisory oversight powers to fulfil its
broad mandate within a more complex and interconnected environment, given the regional and
international nature of financial developments. This includes an increased focus on preemptive
measures to address issues of concern within financial institutions that may affect the interests of
depositors and policyholders, and the effective and efficient functioning of financial
intermediation.

The FSA, which has the aim of promoting financial stability, is an extensive legislation which
consolidates the various legislations pertaining to banking, investment banking, insurance and
payment systems businesses and the oversight of the money market and foreign exchange
administration in Malaysia. Thus, the Banking and Financial Institutions Act 1989, the Insurance
Act 1996, the Exchange Control Act 1953 and the Payment Systems Act 2003 are all repealed by
the FSA although licences which were issued and approvals which were granted under the
repealed legislations are deemed to have been issued under the FSA and continue to apply.

It is important that Malaysia’s regulatory and supervisory system is adequately equipped to
respond effectively to new and emerging risks so that confidence in the financial system is
preserved and that the critical financial intermediation activities which are vital to the economy
are not disrupted. The FSA and IFSA amalgamate several separate laws to govern the financial
sector under a single legislative framework for the conventional and Islamic financial sectors
respectively, namely, the Banking and Financial Institutions Act 1989 (BAFIA), Islamic Banking Act
1983, Insurance Act 1996 (IA), Takaful Act 1984, Payment Systems Act 2003 and Exchange Control
Act 1953 which are repealed on the same date.

17

Key features of the new legislation include:

 Greater clarity and transparency in the implementation and administration of the law.
This includes clearly defined regulatory objectives and accountability of Bank Negara
Malaysia in pursuing its principal object to safeguard financial stability, transparent triggers
for the exercise of Bank Negara Malaysia’s powers and functions under the law, and
transparent assessment criteria for authorizing institutions to carry on regulated financial
business, and for shareholder suitability;

 A clear focus on Shariah compliance and governance in the Islamic financial sector. In
particular, the IFSA provides a comprehensive legal framework that is fully consistent with
Shariah in all aspects of regulation and supervision, from licensing to the winding-up of an
institution;

 Provisions for differentiated regulatory requirements that reflect the nature of financial
intermediation activities and their risks to the overall financial system;

 Provisions to regulate financial holding companies and non-regulated entities to take
account of systemic risks that can emerge from the interaction between regulated and
unregulated institutions, activities and markets. The Minister of Finance may subject an
institution that engages in financial intermediation activities to ongoing regulation and
supervision by Bank Negara Malaysia if it poses or is likely to pose a risk to overall financial
stability;

 Strengthened business conduct and consumer protection requirements to promote
consumer confidence in the use of financial services and products;

 Strengthened provisions for effective and early enforcement and supervisory intervention

The new laws will place Malaysia’s financial sector, encompassing the banking system, the
insurance/takaful sector, the financial markets and payment systems and other financial
intermediaries, on a platform for advancing forward as a sound, responsible and progressive
financial system. This is especially important to enable the financial system to meet the new
demands for financing associated with Malaysia’s economic transformation programme both
during and beyond the next decade, the changing demographics of our population, and the
increasing integration of the Malaysian economy with the region and the world.

Copies of the FSA and IFSA are available on Bank Negara Malaysia’s website.

http://www.bnm.gov.my/index.php?ch=en_legislation

18

THE CHARACTERISTICS, ROLES AND OBJECTIVES OF LABUAN INTERNATIONAL BUSINESS
FINANCIAL CENTRE (LIBFC)

Labuan, situated a few miles off the northern coast of Borneo in Malaysia and just 60-odd square
miles in size, is one of the newer additions to the list of the world’s offshore jurisdictions. But the
jurisdiction has quickly risen to prominence as one of the preferred platforms for investment into
the region’s emerging economies.
HISTORY OF LABUAN INTERNATIONAL BUSINESS FINANCIAL CENTRE

Situated in the heart of the fast growing South Eastern Asian region, and close to a number of
major cities and economic hubs such as Singapore, Hong Kong, Kuala Lumpur and Jakarta, Labuan
is currently home to a population of around 85,000, benefits from a benign income tax regime, a
well-regulated financial regime, a deep water port and a well-developed supporting infrastructure,
including internet communications.
Used by the British as a coaling station in the days of empire, Labuan’s economic existence has
traditionally depended on its port and position at the confluence of Eastern Asian’s trade routes.
Latterly, oil and gas exploration and their supporting industries were the main contributors to the
island’s economy. However, these are fast being superseded by financial services, and tourism is
also a growing industry as the island’s year-round tropical climate, coral reefs and sandy beaches
become more well-known. Given the jurisdiction’s current growth trajectory, it could well soon be
giving other more established financial jurisdictions a run for their money, particularly in the field
of Islamic finance.
THE LABUAN INTERNATIONAL BUSINESS AND FINANCE CENTRE (LIBFC)

Labuan was declared as an International Offshore Financial Centre (IOFC) in October 1990 to
complement the activities of the domestic financial market in Kuala Lumpur, strengthen the
contribution of financial services to Gross National Products of Malaysia as well as develop the
island and areas within its vicinity.

The financial services industry in Labuan has taken root thanks to the creation of the Labuan
International Offshore Financial Centre in 1990, along with the passing of a batch of offshore laws
and the creation of LOFSA (Labuan Offshore Financial Services Authority).

With the passage of new laws to govern its business environment in 2010, LOFSA has since re-
branded itself as Labuan FSA (Labuan Financial Services Authority), and the centre itself as the
LIBFC (Labuan International Business and Finance Centre).

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1990 2010

LIOFC LIBFC

REBRANDED

1990 2010

LOFSA LFSA

REBRANDED

Despite the challenging global economic environment, the Labuan IBFC has recorded healthy
growth over the past few years, and the island has quickly grown as a major conduit for Foreign
Direct Investment into a number of local countries, particularly South Korea and Malaysia itself.

Releasing its 2012 Annual Report in June 2013, the Labuan FSA said that 2012 saw a continuation
in growth trajectory across the key business sectors in the LIBFC, including the banking, insurance
and reinsurance, and leasing sectors. Its achievements last year were mainly attributed to its
strategic focus towards the emerging economies, particularly in Asia.

The LIBFC is now home to 59 banks, 203 insurance and insurance-related companies, 257 leasing
companies and 37 trust companies. Of notable achievement, it was said, has been the expansion
of Labuan foundations, the number of which increased by 62.5 percent, to 65 foundations from
40 the year before.

In October 2013, the Labuan FSA announced that the Labuan IBFC achieved a major milestone by
surpassing the 10,000 companies mark during the third quarter of this year. As of August 31, 2013,
a total of 10,003 companies had a presence in Labuan IBFC comprising 641 licensed entities and
9,362 normal Labuan companies, of which 4,660 are operating.

More than 70 percent of the Labuan companies originated from the Asian region. This reflects
Labuan IBFC's aim to foster regional financial integration in facilitating cross-border trade and
investment in the regional emerging market. Nonetheless, the jurisdiction has also witnessed
sustainable interest from investors in Europe and America, as well as the Middle Eastern region.

20

Another milestone was achieved during the year with the acceptance of the LIBFC as a recognized
jurisdiction by the Stock Exchange of Hong Kong for Labuan-incorporated companies to obtain
listing in Hong Kong.

THE OBJECTIVES OF LABUAN IBFC

Labuan IBFC is Malaysia’s very own integrated financial centre, providing a wide range of
corporate, trust and company secretarial services. It was made a Federal Territory directly under
the administration of the Federal Government of Malaysia in 1984. The development of Labuan
as an international financial centre only began in October 1990. The statutory body responsible
for the development of Labuan IBFC is the Labuan Financial Services Authority (LFSA). Beginning
January 2008, Labuan IOFC has been repositioned as Asia’s most connected, convenient and cost-
efficient International Business and Financial Centre, with a specific focus on business
incorporations.

In summary, the objectives of establishing Labuan IBFC are as follows:

 To enhance the attractiveness of Malaysia as an investment centre.
 To supplement the onshore financial system centre in Kuala Lumpur by tapping the

growing demand for tailored financial and related services.
 To strengthen the contribution of broad financial sector to the progress of diversified

economic growth.
 To form part of the broad national strategy to spread out and diversify the growth

opportunities of the nation, focusing attention on the further development of East
Malaysia in terms of industrial and services (including tourism) development.

THE CHARACTERISTICS OF LABUAN IBFC

 LIBFC is basically a small territory or jurisdiction that imposes low or no taxes on income,
profit, dividend and interest earned carried out by offshore Multinational Corporation in
or from those jurisdictions.

 Does not have any exchange control or limitation or transboundary movement of funds
into and out of the jurisdiction by the offshore company.

 No stamp death, inheritance or estate duties.
 No value added tax

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 Maintains a high degree of secrecy through or beneficial ownership and management
of the business, financial or other affairs of the company other than in compliance with
the law.

 LIBFC is developed holistically to support the development of the island, and plays an
effective complementary role to the domestic financial market.

 These include enhancing the Islamic banking business with the establishment of an
international Islamic financial market as well as developing the banking and insurance
sectors to become a significant regional hub while taking the lead in retakaful business.

FINANCIAL SERVICES OFFERED BY LABUAN IBFC

The diverse selection of Labuan IBFC’s financial products and services brings to investors a wealth
of business opportunities, covering the areas of banking, insurance, trust company business,
capital market, wealth management and other Labuan financial businesses.

BANKING

As much as half of the world’s capital is estimated to flow through international business and
financial centres, making banking the most important activity in these centres. Labuan IBFC offers
a wholesale platform for banks and financial intermediaries looking to establish their operations
and take advantage of the numerous associated opportunities in the region. Labuan IBFC is also
bound by an effective regulatory regime that subscribes to internationally-recognised standards
and best practices in financial services and prudential regulation.

Labuan banks and investment banks operating out of Labuan IBFC provide a host of services,
conventional as well as Islamic to cater to the growing demand from investors both domestic and
international.

INSURANCE

Labuan IBFC’s insurance industry is a thriving one, as evidenced by its vibrant growth in the past
few years. Comprising not just reinsurers and direct insurers, Labuan IBFC also provides unique
underwriting vehicles in the form of captives. This is an increasingly popular risk solution sought
by many corporates that prefer to have the flexibility of managing their own perils as part of their
own risk management. Aside from conventional (re)insurance services, Labuan IBFC also offers
Islamic (re)insurance, better known as (re)takaful, for those seeking Shariah-compliant protection.
Insurance brokers, underwriting managers as well as insurance managers complete the supply
chain by offering the needed services within the sector.

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The industry is set on a positive trajectory and will continue to expand to provide the needed
reinsurance capacity and insurance products in order to meet sophisticated clientele needs and
expectations. Business flexibilities in tandem with an orderly set of regulations provide a stable
business environment for prospective investors and clients alike.

LEASING

The leasing industry in Labuan IBFC has recorded tremendous growth in recent years. In tandem
with the region’s economic growth, demand for capital equipment, especially in the shipping,
aviation, and oil and gas industries, have shown no signs of abating. Its innovative leasing
structures and close proximity to emerging economies such as China and India attract both local
and foreign corporations, opening up a variety of investment opportunities in the region.

Leasing companies in Labuan IBFC enjoy an ideal balance of fiscal neutrality and certainty. The
ease through which leasing transactions can be structured in the jurisdiction, along with an
efficient tax framework, have also allowed for effective management of their operational cost.

A normal leasing transaction includes earning rental income for the lessor, and the lessee
benefiting from the leased asset, for example in providing short-term capital and facilitating
business operations.

FACTORING

Labuan factoring is defined as the business of acquiring debts to any person or institution at a
discount or such other business as approved by Labuan FSA.

MONEY BROKING

Money broking business is defined as the business of arranging transactions between a buyer and
a seller in the money markets, with a broker acting as an intermediary for consideration of
brokerage fees paid. However, this does not include the buying or selling of foreign currencies by
the said broker as principal in such markets.

COMMODITY TRADING

As part of the strategy to encourage oil and gas trading companies to expand into Malaysia,
Labuan IBFC introduced the Global Incentives for Trading (GIFT) programme in 2011. The GIFT
programme is a framework of incentives designed to attract traders of specified commodities to
use Malaysia as their international or regional trading base.

23

Under the GIFT programme, a Labuan International Commodity Trading Company (LITC) can be
set up to facilitate the trading of physical and related derivative instruments in any currency other
than the Malaysian Ringgit in the following commodities: petroleum and petroleum-related
products (including liquefied natural gas (LNG)), agriculture products, refined raw materials,
chemicals, base minerals, carbon credits and any other commodities as may be approved by
Labuan FSA. The programme’s ultimate aim is to position Malaysia as a regional trading and
storage hub for oil and gas.

CREDIT TOKEN BUSINESS

A credit token business is defined as any business where a token, being a cheque, card, voucher,
stamp, booklet, coupon, form or other document or thing is given or issued to a person (referred
to as "customer") by the person carrying on the business (referred to as "issuer").

COMPANY MANAGEMENT BUSINESS

Company management business means the provision of treasury processing services and such
other services, and to such persons, as may be permitted by Labuan FSA. The permissible activities
of company management firms are described as follows:

 Treasury processing activities comprising back and middle office processing functions
which include processing and confirming deals, preparing accounting records and reports,
maintaining registers and files and custodial services.

 Islamic advisory services and processing functions which include launching, administering,
and backroom processing of collective investment schemes; consultancy, advisory and
support services; and developing Islamic trusts.

MALAYSIA INTERNATIONAL SHIP REGISTRY

Labuan IBFC’s strategic location enables investors to foster long-lasting business relationships with
Asia’s emerging economies such as China and India. In addition, it lies in close proximity to major
shipping routes and boasts excellent shipping support services and facilities.

The Malaysian International Ship Registry (MISR), introduced to attract individual or foreign
shipping companies to register their ships through Labuan IBFC thereby bypassing the
requirements for a Malaysian majority shareholder, is expected to further enhance the
jurisdiction’s shipping operations. Shipping operations include the transportation of passengers
or cargo by sea or the letting or charter of ships on a voyage or time charter basis.

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CAPITAL MARKETS

Labuan IBFC is committed to developing its capital market in line with internationally-recognised
standards and best practices. To foster investors’ confidence, Labuan IBFC subscribes to the
International Organisation of Securities Commissions’ (IOSCO) core principles of securities
regulation. In addition, Labuan IBFC’s legal and regulatory framework provides a sound business
environment with adequate protection and stability for the industry.

The capital market industry in Labuan IBFC is further boosted by the presence of the Labuan
International Financial Exchange (LFX), which was established as a cost-effective and practical
alternative to existing exchanges in the region. Wholly owned by Bursa Malaysia, LFX plays a
complementary role with respect to its parent company, in attracting international investors to
the country. Investors may establish mutual funds or issue securities out of Labuan IBFC as a
platform to raise funding in the international market. The jurisdiction also offers fund
management licence for entities that are interested to provide management, administrative and
advisory services for the purposes of investment related activities. In addition, securities licences
are also available for companies that would like to deal in securities and provide securities advice
and administration services for investment purposes.

WEALTH MANAGEMENT

Labuan IBFC is now at the forefront of international wealth planning, providing investors the
flexibility to choose the ideal wealth creation and wealth preservation structure, either
conventional or Islamic, that best suits their needs. This is in line with the interest in wealth
management solutions which has grown in tandem with Asia’s growing economy. High-net-worth
individuals and the affluent population will find a comprehensive stable of private wealth
management vehicles on offer in Labuan IBFC, such as trusts and foundations. These can be
structured for a wide array of wealth management needs and are especially suitable for family
offices and wealth managers in facilitating dynamic wealth transfer, dynastic planning and
inheritance management.

In wealth asset planning, consideration has to be given to the laws of the trust / foundation
jurisdiction together with other jurisdictions on the location of the settlors, founders, beneficiaries
and endowed properties.

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The key considerations for choosing Labuan IBFC as the jurisdiction of choice for wealth
management include the following:

 Legal foundation - comprehensive legal system, ie sufficiency of law to render legal
protection, clarity of Shariah rulings and the implementation of a well-regulated
framework

 Stability - the presence of a strong government in fostering political, economic and
financial stability; and

 Ease of doing business - cost efficient and easy procedures in setting up entities, with
the assistance professional intermediaries and authorities.

THE FACTORS THAT CONTRIBUTED TO THE SUCCESSFUL OF LABUAN IBFC

There are many factors that contribute to the successful of Labuan IBFC:-

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Explain the roles and responsibilities of the regulatory and supervisory body.

a) Securities Commission (SC)
The Securities Commission Malaysia (SC), a statutory body reporting to the Minister of Finance, was
established under the Securities Commission Act 1993. It is the sole regulatory agency for the regulation
and development of capital markets. The SC has direct responsibility for supervising and monitoring the
activities of market institutions, including the exchanges and clearing houses, and regulating all persons
licensed under the Capital Markets and Services Act 2007. The SC’s many regulatory functions include:

 Supervising exchanges, clearing houses and central depositories;
 Registering authority for prospectuses of corporations other than unlisted recreational clubs;
 Approving authority for corporate bond issues;
 Regulating all matters relating to securities and futures contracts;
 Regulating the take-over and mergers of companies
 Regulating all matters relating to unit trust schemes;
 Licensing and supervising all licensed persons;
 Encouraging self-regulation; and
 Ensuring proper conduct of market institutions and licensed persons.
Responsibilities of Securities Commission:
 Developing the overall capital market and its market segments such as the equity market, bond

and sukuk market, Islamic capital market, fund management, derivatives and other market-based
platforms and services;
 Facilitating innovation and digital services through the capital market;
 Creating avenues for a sustainable financing ecosystem;
 Ensuring proper conduct of all market participants through our supervisory, surveillance and
enforcement work;
 Championing good corporate governance practices; and
 Facilitating greater cross-border regulatory co-operation and thought leadership.
 Bursa Malaysia
 Malaysian International Islamic Financial Centre (MIFC)
The SC administers the following acts:
a) Securities Commission Act 1993;
b) Capital Markets and Services Act 2007; and
c) Securities Industry (Central Depositories) Act 1991.

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b) Bursa Malaysia
Based in Kuala Lumpur, Bursa Malaysia is the country’s stock exchange and operates as a platform which
offers a range of exchange-related products and services for companies, groups and governments to sell
securities to the public. The range of products offered by Bursa Malaysia include bonds, derivatives,
equities, trading, settle, clearing and depository services. It also offers Shariah-compliant securities which
are in accordance with the Shariah investment guidelines. The stock exchange is among the one of the
largest in the Asian region, and part of its central function includes ensuring that the price information
for the trading of securities is disseminated in an efficient manner to ensure that trading is carried out in
a fair and orderly manner.

The role of Bursa Malaysia is to give companies, governments and other groups a platform to sell
securities to the investing public by offering a range of exchange-related services and products. These
include trading, clearing, settlement and depository services, along with products such as bonds, equities
and derivatives. Among Bursa Malaysia’s central functions are ensuring that price information for
securities trading on the exchange is disseminated efficiently and that trading is fair and orderly. As one
of the largest exchanges in Asia, it also operates in the Islamic capital market, offering Shariah-compliant
securities according to Shariah investment guides.

The exchange’s regulatory powers are derived from rules and listing requirements. It enforces regulations
by imposing fines and reprimands, supervising stock broking and listed companies, approving listings and
security quotations, regulating disclosures by listed companies, and controlling admission to the
exchange’s membership. Bursa Malaysia maintains a website containing information on the Malaysian
capital market, including online stock prices, the profiles of listed companies, announcements, trading
and settlement procedures, and details of participating companies. The website also posts publications,
media releases, initial public offerings and investor education programs.

In summary, Bursa Malaysia provides facilities and infrastructure for capital raising and investment, and
enforces rules and regulations to ensure an efficient, fair, cost-effective and orderly market that
encourages investor confidence. Bursa Malaysia’s website contains all the necessary and pertinent
information regarding the Malaysian capital markets. The website serves as the first point of contact for
information regarding the profiles of the companies listed on the stock exchange, online stock prices,
latest announcements, details of participating companies as well as procedures relating to trade and
settlement. Additionally, there are publications, initial public offerings, media releases and other investor
education programs available on the website.

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c) Malaysia International Islamic Financial Centre (MIFC)
The Malaysia International Islamic Financial Centre (MIFC) is an initiative of Malaysia’s financial market
regulators and relevant government agencies dedicated to developing Malaysia’s Islamic finance market
by engaging with industry and government. The initiative was launched in 2006 and is based in Kuala
Lumpur, Malaysia. The MIFC Community is a network of the country’s financial sector regulators,
including Bank Negara Malaysia (Central Bank of Malaysia), Securities Commission Malaysia, Labuan
Financial Services Authority and Bursa Malaysia (Kuala Lumpur Stock Exchange), Government ministries
and agencies, industry players from the Islamic banking, takaful, re-takaful and Islamic capital market
industries, human capital development institutions as well as professional ancillary services companies
ranging from legal firms and Shariah advisories to tax and audit firms and research companies.

In its role to develop and promote Malaysia as an international marketplace for Islamic finance, MIFC is
tasked to bring together the key stakeholders in an increasingly important international Islamic finance
ecosystem. These key stakeholders include government ministries and agencies, financial and market
regulators including Malaysia's Central Bank, its Securities Commission, the Malaysian stock exchange
and Labuan Financial Services Authority; as well as the many financial institutions, human capital
development organisations and other professional services companies, and unite them under a common
banner, to establish Malaysia as the world’s Islamic Finance Marketplace. Our key value proposition is an
end-to-end Shariah-compliant business environment. This environment is the result of a long history of
developing Islamic finance together with thought leaders and talent who understand the Shariah
framework and how it affects finance.

The integral sectors established within the MIFC initiative work seamlessly to allow new business
partnerships to benefit from Malaysia’s track record of innovation, pool of expertise, attractive
incentives, and robust and comprehensive. Malaysia’s Islamic financial industry is market-driven with
strong and continual government commitment. The MIFC Executive Committee (ExCo) provides high-
level strategic direction through an ongoing consultative process between the public and private sectors
of Malaysia’s Islamic financial industry. The MIFC ExCo is tasked to ensure the effective and efficient
implementation of the MIFC initiative. This high-level commitment contributes to an increasingly
business-friendly and liberalised environment for the globalisation of Islamic finance by the MIFC
community.

CHAPTER 2

2.0 CENTRAL BANK

2.1 Identify the establishment of Bank Negara Malaysia (BNM)
2.2 Explain the objectives of Bank Negara Malaysia (BNM)

2.2.1 Describe the objectives of Bank Negara Malaysia (BNM)
2.3 Illustrate the organizational structure of Bank Negara Malaysia (BNM) related to

international institutions
2.3.1 Describe the organizational structure of BNM
2.3.2 Explain the function of each department in BNM

2.4 Show the BNM techniques to influence the supply of funds, credit and interest rates
using financial regulatory instruments and industry reforms
a. Statutory Reserve Requirements (SRR)
b. Monetary Liquidity Requirements (MLR)
c. Control of interest rates
d. Open market operations
e. Discount operations
f. Moral persuasion

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ESTABLISHMENT OF BANK NEGARA MALAYSIA (BNM)

The Central Bank of Malaya Ordinance 1958 (CBO) (Central Bank of Malaya until the formation
of Malaysia in 1963) was enacted on 23 October 1958, while the Central Bank of Malaysia was
established on 24 January 1959. At the same time, the Banking Ordinance, 1958, which
provided for the licensing and regulation of the business of banking in the Federation of
Malaya also came into force. The CBO was revised in 1994 and is now the Central Bank of
Malaysia Act 1958 (CBA). Bank Negara Malaysia is governed by the Central Bank of Malaysia
Act 2009. The role of Bank Negara Malaysia is to promote monetary and financial stability.
This is aimed at providing a conducive environment for the sustainable growth of the
Malaysian economy.

Bank Negara Malaysia’s monetary policy stance is to maintain price stability while remaining
supportive of growth. Bank Negara Malaysia is also responsible for financial system stability.
This is achieved by developing a sound, resilient, progressive and diversified financial sector
which serves to support the sectors of the real economy. It also plays an important function
in implementing initiatives to deepen and strengthen the financial markets, including the
foreign exchange market.

Bank Negara Malaysia has played a significant developmental role in developing the financial
system infrastructure in advancing the financial inclusion agenda. This is to ensure all
economic sectors and segments of the society have access to financial services. In addition,
Bank Negara Malaysia also oversees the nation’s payment systems infrastructure which
emphasize on the efficiency and security of the financial systems.

As the banker and adviser to the Government, Bank Negara Malaysia provides advice on
macroeconomic policies and the management of public debt. Bank Negara Malaysia is also
the sole authority in issuing the national currency and in managing the country's international
reserves.

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ROLES AND OBJECTIVES OF BNM

Under the banking ordinance 1958, BNM has full power to supervise the orderly licensing,
conduct and regulating of the business and activities of the banking institutions, including the
opening and location of branches throughout the country. The banking ordinance underwent
a series of amendments, consistent and in line with the changing banking, financial and
economic environment, and this ordinance was subsequently repealed by the enhanced and
updated Banking Act 1973 and the Central Banking of Malaysia and Banking (Amendment)
Act 1982. To further strengthen the financial infrastructure, the banking and financial
institutions Act 1989 (BAFIA) was promulgated to supersede the Banking Act 1973 and also
the Finance Companies Act 1969. BAFIA 1989 became effective on 1 October 1989. BAFIA
1989 was replaced by Financial Services Act (FSA) 2013 and Islamic Financial Services Act
(IFSA) 2013.

ROLES OF BNM

Among the major role of the Bank Negara Malaysia are:-

 The prudent conduct of monetary policy, which has seen generally low and stable
inflation for decades and thereby, preserving the purchasing power of the ringgit.

 The Bank is also responsible for bringing about financial system stability and fostering a
sound and progressive financial sector. There is now in place a well-diversified,
comprehensive and resilient financial sector, that is able to meet the increasingly
sophisticated needs of consumers and businesses, and which has become a growth driver in
the economy.

 The Bank also plays a significant developmental role, including development of financial
system infrastructure with major emphasis placed on building the nations efficient and
secured payment systems as well as the necessary institutions (Securities Commission, Bursa
Malaysia and Credit Guarantee Corporation) which are important towards building a
comprehensive, robust and resilient financial system.

 The Bank actively promotes financial inclusion, which has led to improved access to financial
services for all economic sectors and segments of society, thereby supporting balanced
economic growth.

 Other important roles of the Bank are being a banker and adviser to the Government,
playing an active role in advising on macroeconomic policies and managing the public
debt. It is also the sole authority in issuing currency as well as managing the country's
international reserves.

The roles of the Bank are supported by 39 departments/units covering the following seven
functional areas.

 Economics and Monetary Policy  Organisational development
 Communication
 Investment and Operations
 Regulations
 Payment systems
 Supervision

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OBJECTIVES OF BNM

The objectives of Bank Negara Malaysia as outlined in the CBA are:

• To promote monetary stability and a sound financial structure
• To act as a banker and financial adviser to the Government
• To issue currency and keep reserves safeguarding the value of the currency
• To influence the credit situation to the advantage of the country

Over the years, the roles and responsibilities of Bank Negara Malaysia have evolved and
expanded. Today, Bank Negara Malaysia focuses on the three pillars of central banking,
namely monetary stability, financial stability and the payments system. In addition,
importance is given to the developmental role of Bank Negara Malaysia, in respect to
economic management, institutional building and the development of the financial system.

MONETARY STABILITY

As the country's monetary authority, Bank Negara Malaysia is responsible to maintain
monetary stability. Monetary stability refers to the stability of the value of the Malaysian
currency, the ringgit. The best way to ensure that the value of the ringgit is preserved is by
ensuring price stability, that is, to ensure that inflation in the country remains low and stable.
By maintaining monetary stability through appropriate changes in monetary policy, Bank
Negara Malaysia ensures that inflation is kept low and that the purchasing power of the ringgit
is not diminished.

FINANCIAL STABILITY

Financial stability refers to an environment where institutions in a financial system are strong
and can continue to meet their contractual obligations without interruption or without any
external assistance. Market participants can also confidently enter into transactions at prices
that do not change substantially over short periods when there has not been any changes in
market fundamentals.

DEVELOPMENTAL ROLE

As a central bank in an emerging economy, Bank Negara Malaysia has an important
developmental role. This role ranges from developing the necessary institutions and market
infrastructure for the development of a modern and strong financial system to contributing to the
strengthening of the foundation of the economy. In strengthening the financial market
infrastructure, Bank Negara Malaysia has built a strong payment systems. These systems are
regularly "upgraded" to address the impact of technology on the banking system.

To promote a good credit culture among banking institutions, Bank Negara Malaysia also
operates the Central Credit Reference Information System. The first of its kind in this region,
this system collects and disseminates credit information on all borrowers. This allows banking
institutions to make informed decisions on loan applications.

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PAYMENTS SYSTEM

The payments system is an important part of the financial system. It provides a means of
transferring funds between parties and for commercial transactions to be conducted
effectively and efficiently. Bank Negara Malaysia is entrusted with the role of ensuring that
the payments system of the country is stable and operates smoothly.

OTHER RESPONSIBILITIES OF BANK NEGARA MALAYSIA

Bank Negara Malaysia serves as the economic and financial adviser to the Government and also
participates in international meetings to strengthen co-operation with other countries as well as
to discuss the important issues from the perspective of emerging market economies.

 Role of economic adviser

In its role as the economic and financial adviser to the Government, Bank Negara
Malaysia analyses and assesses the developments in the international and domestic
economy and highlights the areas that need to be addressed.

 Role of financial adviser

Bank Negara Malaysia does not provide financing to the Government. However, as the
financial adviser to the Government, Bank Negara Malaysia gives regular advice to the
Government on the management of its domestic and external debts and the terms
and timing of Government loan programmes.

 International Relations

Bank Negara Malaysia also participates in a number of international meetings.
Amongst them are the meetings of the South-East Asian Nations (ASEAN), ASEAN +3
(which includes China, Korea and Japan), South-East Asian Central Banks (SEACEN),
Executive Meeting of East Asia and Pacific (EMEAP), the Asia-Pacific Economic Co-
operation (APEC) and the international agencies including the Bank for International
Settlements.

FUNCTIONS OF BNM

 Bank For Currency Issues

BNM commenced to issue its own currency on June 12th, 1967, thereby replacing the
Currency Board as the sole currency issuing authority in Malaysia. Under the
Malaysian Currency (Ringgit) Act 1978, the Malaysian dollar and cent were renamed
“ringgit” and “Sen” respectively. Thus, BNM shall:-

a) Arrange for the printing of currency notes and the minting of coins.
b) Issue, re-issue and exchange notes and coins at its office and at such agencies

as it may, from time to time and establish or appoint.
c) Arrange for the safe custody of unissued stocks of currency and for the

preparation, safe custody and destruction of plates paper for the printing of
notes and of dies for the minting of coins.

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 Keeper of International Reserves

The country’s official external reserves are held and maintained by BNM. Such holding
are generally held in the form of gold, reserves position in the International Monetary
Fund (IMF), Special Drawing Rights (SDR) and a well-managed and diversified portfolio
of foreign exchange assets and investments denominated in the major international
currencies, such as bank balances, Treasury Bills, Bonds and other appropriate term
securities to secure the best result and returns/ benefits for the country. Throughout
the years, gold and foreign exchanges have been the major components of external
reserves held by BNM.

 Government Banker and Financial advisor

BNM acts as a banker to the government, state governments and statutory bodies.
Management of Government Accounts
It provides cheque facilities, accepts funds and makes payments on behalf of the
government and undertakes the foreign exchange business of the government.
Source of Funds to Government
BNM ordinance 1958 empowers the BNM to provide temporary advances to the
Government to cover any deficit in the budget revenue. However, there are legal
limitations to the amount and the duration of loans that BNM can make available to
the government.
Management of National Debt
BNM manages the public debt and is responsible for the floatation of government
loans, both in Malaysia and abroad. It advises the government on its loan
programmes, including terms and timing of loans and the issue of new types of
securities.

 cTooupnrtormy.ote monetary stability and influence the credit situation to the advantages of the
BNM is responsible to the government for promoting monetary stability and sound
financial structure, and for influencing the credit situations to help achieve the
nation’s overall economic objectives.
BNM is obliged to ensure that the supply of money and the volume of credit are
sufficiently elastic to the demands in the domestic economy without creating undue
pressure on resources.

 Banker to the bank

i. Promote a sound financial structure

BNM’s relationship with the commercial banks, investment banks, and Islamic bank
has its legal foundation in three pieces of legislation, namely:-

a) The Central Bank Ordinance 1958
b) Financial Services Acts (FSA) 2013
c) Islamic Financial Services Acts (IFSA) 2013

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BNM cooperates closely with the financial institutions to promote and maintain a
range of banking and other services for the public, enhance efficiency and strengthen
the institution’s prudential standards, discipline and moral fibre. BNM maintains
special accounts for the major financial institutions, inspects them regularly and
performs the functions of the lender of the last resort.

ii. Licensing of banks and non-banks

Activities which require a banking licence under the Financial Services Acts 2013
(FSA) are banking and investment banking business which are defined as follows:-

“Banking Business” is:

The business of: Accepting deposits
Paying or collecting cheques
 Providing finance





Other prescribe business:

“Investment banking” business is:

The business of:
 Accepting deposits on deposits account and

 Providing finance

Any regulated activity carried on pursuant to a Capital Markets Services

Licence under the Capital Market Services Act 2007 (CMSA). Other business prescribed by
Bank Negara Malaysia (BNM) with approval of the Minister.

iii. Banking relationship
All banking institutions maintain two types of deposits accounts with BNM; statutory
reserves accounts (SRA) and current account. SRA is require for the purposes of
monetary control. The current account constitutes the normal current account and a
clearing account:

 Normal current account

Mainly records cash transactions between the banking institutions and BNM including
cash withdrawals when the institutions need to replenish their supply of money.

 Clearing account

Is maintained by the banks for interbank settlements, after the daily clearing of
cheques is made in BNM which provides the clearing house facilities as one of its
services to the banking system.

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iv. Currency distributions
BNM is responsible for the provision of cash required by the commercial banks and

investment banks and for the acceptance of cash of them. When the institutions

needs to replenish their supply, they will order currencies from BNM and the cost is

charged into their current accounts.

v. Inspections and investigation of banks and non-banks.

Under the Financial Services Acts 2013 (FSA) and the Islamic Financial Services Acts
2013 (IFSA), an overseas supervisory authority can, with the approval of BNM,
examine the books, accounts, and transactions of a (section 152 FSA, section 164
IFSA):
 Representative’s office in Malaysia of a foreign institutions.
 Bank or financial holding company in Malaysia which is a subsidiary of a foreign
institute.
 Bank which is a branch of a foreign institution.

BNM can also request by the relevant supervisory authority of a country, territoryor
place outside of Malaysia, provide documents or information on matters relating to:

 The affairs of a bank or financial holding company which is a subsidiary or associate
of a foreign institution.

 Any office of a bank or financial holding company;
 Any bank or financial holding company for the purpose of assessing aproposed

establishment of any office by the bank or financial holding company.
vi. Lender of the last resort

The BNM is ready to provide lender of last resort facilities to the licensed institutions.
The main forms of assistance given by BNM are the rediscounting of eligible bills (such
as T-bills, Government Securities and investment certificates, trade bills, and
commercial papers.)

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THE ORGANISATION OF BANK NEGARA MALAYSIA
Bank Negara Malaysia is a statutory body which is wholly owned by the Federal Government.
It started operations in 1959 with a paid-up capital of RM20 million which has since increased
to its present level of RM100 million in 1977. The constitution, functions, duties and powers
of Bank Negara Malaysia are set out in the CBA. The administration of Bank Negara Malaysia
is organised to meet its principal objectives, with clear lines of responsibility. The Governor
of Bank Negara Malaysia is also the chief executive officer and the Governor is assisted by
two Deputy Governors and five Assistant Governors. The CBA provides that the Governor shall
be appointed by the Yang di-Pertuan Agong and the Deputy Governors by the Minister of
Finance.

Bank Negara Malaysia is required to have a Board of Directors under the CBA. Like any other
board of directors of a private organisation, the Board is entrusted with the responsibilities
of setting the policy direction of Bank Negara Malaysia and the general administration of the
affairs of the Bank. The CBA requires the Board of Directors to inform the Minister of Finance
of the monetary and banking policies pursued or intended to be pursued by it. There are eight
members on the Board of Directors. The ex-officio members of the Board are the Governor,
the Deputy Governors and the Secretary-General to the Treasury. The other directors are
persons of standing and experience in banking and economic affairs. All members except the
Deputy Governors are appointed by His Majesty, the Yang di-Pertuan Agong and hold office
for a maximum term of three years but are eligible for reappointment. The Governor is the
chairman of the Board and the Board is required to meet at least once a month

ECONOMICS & .
MONETARY
POLICY INVESTMENT &
OPERATIONS
COMMUNICATION

ORGANIZATIONAL BNM
DEVELOPMENT
DEPARTMENTS/
AREAS

REGULATIONS

SUPERVISION PAYMENT
SYSTEMS

37

38

ORGANIZATIONAL STRUCTURES OF BNM

FUNCTION OF DEPARTMENTS / AREAS IN BNM

The roles of the Bank are supported by 39 departments/units covering the following seven
functional areas.

 Economics and Monetary Policy

Primarily provides good technical and research support on growth-related issues to enhance
formulation of monetary and credit policies in promoting monetary stability and ensuring the
availability of adequate credit to finance economic growth.

 Investment and Operations

Manage domestic liquidity and exchange rates to ensure that monetary policy targets are achieved as
well as managing external reserves to safeguard its value and optimise its returns. It also has the
responsibility of providing advice and assistance to the Government in the area of debt and fund
management and contributing to domestic financial market development.

 Regulations

Promote financial sector stability through the progressive development of sustainable, robust and
sound financial institutions and financial infrastructure, thus enabling a competitive local financial
industry to be resilient against the changing future environment as well as leads initiatives to enhance
access to financing. It also formulates and implements policies and strategies towards building and
positioning Malaysia as a premier integrated Islamic Financial Centre and enhance the financial
capability of consumers.

 Payment systems

Develop policies and strategies to promote reliable, secure and efficient clearing, settlement and
payment systems in the country.

 Supervision

Develop, enhance and implement an effective surveillance framework to ensure safety and
soundness of financial institutions and to enforce sound practices in them.

 Organisational development

Spearhead the Bank's strategic management, organisational-performance management and
programme management functions to drive its performance-improvement processes and
strengthening the capacity building of the Bank. It also leads and drives human resources initiatives
and other strategic activities to ensure that the overall Human Capital Management framework is
implemented effectively.

 Communications

The communications function has assumed increasing importance in response to the heightened
demands of the various stakeholders, seeking greater transparency and disclosure.

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BNM TECHNIQUES TO INFLUENCE THE ECONOMIC SITUATION

Bank Negara Malaysia (BNM) can impose prudential standards on a bank relating to liquidity
under the FSA 2013 and IFSA 2013 to ensure the safety and soundness of the bank or the
integrity, professionalism and expertise in the conduct of its business.

As the country's monetary authority, Bank Negara Quantitatives

Malaysia is responsible to maintain a sound and Qualitatives
Instruments
conducive financial stability. This can be achieve by Instruments
using several tools or techniques to influence the Selectives Credit

supply of funds, credit and interest rates. These Moral Suasions

techniques is also known as monetary policy Statutory Reserves
instruments. There are two categories of monetary Requirements

policy instruments:- (SRR)

STATUTORY RESERVES REQUIREMENTS (SRR) Liquidity Coverage
Ratio (LCR) or
The Statutory Reserve Requirement (SRR) is an Liquidity
instrument to manage liquidity. Banking institutions are
required to maintain balances in their Statutory Reserve Requirement (LR)
Accounts (SRA) equivalent to a certain proportion of
their eligible liabilities (EL), this proportion being the Money Market
SRR rate. Operations (MMO)

The SRR may be raised to manage the significant build- Discount
up of liquidity, which may result in financial imbalances Operations
and create risks to financial stability. Conversely, the
Bank may lower the SRR if necessary to support the Interest Rate
transmission of monetary policy rates to retail rates. Management
However, it is important to note that changes to SRR
should not be construed as a signal on the stance of

monetary policy, whereby the OPR is the sole indicator.

Under section 37(1)(c) of the Central Bank Ordinance, the banking institutions are required
to maintain a certain percentage of their reserves with BNM. SRR known as a banks’ eligible
liabilities (EL) which comprises of deposits (including NCDs and REPOs). Any increment in SRR
will reduce the level of funds available to the banking institutions and decrease the lending
ability of the banking institutions and vice versa. Separately, banks must maintain balances in
their statutory reserve accounts that are at least equal to the prescribed ratio. With effect
from 1st February 2016, the statutory reserve requirement for banking institutions is
currently set at 3.5% of total EL pursuant to the SRR guidelines issued by BNM.

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LIQUIDITY COVERAGE RATIO (LCR)

The Liquidity Coverage Ratio (LCR) is a quantitative requirement which seeks to ensure that
banking institutions hold sufficient high-quality liquid assets (HQLA) to withstand an acute
liquidity stress scenario over a 30-day period at both the entity and consolidated level. Briefly, the
method of calculating the LCR is by taking the stock of HQLA and dividing it by the total net cash
outflows over the next 30 calendar days. The Liquidity Coverage Ratio contain a list of assets
(including the type and quality of such assets) that can be included in the stock of HQLA. Such
guidelines also provide that a banking institutions is required to hold, at all times, an adequate
stock of HQLA such that it maintains the following minimum LCR levels:

 From 1 June 2015: 60%

 From 1 January 2016: 70%
 From 1 January 2017: 80%
 From 1 January 2018: 90%
 From 1 January 2019:100%

The ratio is also expressed as a percentage of the EL based on the banking institutions.

Statutory liquid assets are immobilised in the bank and they yield a return though not

necessarily at the highest rate in the market. The current definition of liquid assets are:

 Cash  Cagamas Bond
 Clearing balances with the Central Bank  Bill discounted or purchases
 Money at call  Bank Negara Bills
 Treasury bills  Bank Negara Certificates
 Government securities  State Government Securities
 Government Investment Certificates

LCR credit facilities and
lending ability
increase.

credit facilities and LCR
lending ability
reduced.

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INTEREST RATE MANAGEMENT (IRM)

An important instrument which BNM can control including the Bank’s liquidity and cost of
bank credit through the interest rates charged on bank loans as well as the rates of interest
offered for deposits.

IRM increase the cost of funds for
banks loans and decrease the
demand for bank loans.

decreased the cost of funds IRM
for banks loans and increase

the demand for bank loans.

Effective
2 January

to 2
January 2015 will continue to be
referenced against the Base
Lending Rate (BLR) or Base
Financing Rate (BFR) until their
maturities.

The move to BR does not affect Effective Lending
Rates

Applicable to floating rate loans / financing facilities offered to individuals.

For more information about the transition of BLR to BR please get it from this
link. http://www.bnm.gov.my/index.php?ch=en_press&pg=en_press&ac=555
For more information about the latest BR rates can get from this link.
https://loanstreet.com.my/latest-base-rate-blr-interest-rates

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MONEY MARKET OPERATION (MMO)

Money market operations (MMO) are operations conducted by BNM to influence the
liquidity situation in the system. MMO can be conducted by the following:

 OGopveenrmnmareknettpoappeerrastioorns (MMO) are mainly transacted via the sales and purchase of

 The borrowing or lending by BNM in the interbank market.

During tight monetary policy stance, BNM will contract liquidity by borrowing and issuing
BNM papers or selling Government papers to market participants. These operation have an
immediate impact on the availability of funds in the systems hence, limiting the bank’s ability
to create money.

i. Open Market Operations (OMO)
OMO involves the sales and purchase of Government papers by BNM in open
organised markets with the intention to directly affect banks reserves, the flow of bank
credit and money. The OMO is based on the logic that the sales of securities causes
credit supply to shrink, while the purchase of securities causes credit supply to expand.
When BNM sells securities in the open market, it receives payment in cash (paid in the
form of commercial bank cheques). Consequently, the cash balances of the banks will
decrease and this will force them to reduce their lending activities. This results in the
reduction of credit available. When BNM buys securities, it pays cash to the banks and
this will increase the bank’s cash balances and enable them to increase credit for their
customers.

ii. Direct Borrowing or Lending
MMO can also be conducted through directed borrowing and lending in the interbank
market. Direct borrowing or lending were normally undertaken in short-term maturity
periods of one to three months. The main advantage of this instrument is its flexibility,
which is the term (maturity, rate of interest structure and amount) can be varied according
to the needs of BNM to influence the liquidity situation.

DISCOUNT OPERATIONS (DO)

The discount operations is defined as deliberate measures by BNM to influence the interest rate
and liquidity situations via various terms and conditions under which the commercial banks and
money market may have temporary access to BNM’s credit facilities. BNM is normally prepared
to lend to banks for short periods of up two weeks. In Malaysia, the commercial banks and other
eligible institutions such as investment bank may borrow from BNM which is a lender of last resort
by way of discounting or advance. That’s mean that they may rediscount Treasury bills and eligible
short-term commercial papers and other bills with resources for the borrowing banks or if they
would prefer, seek and advance secured by paper

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eligible for rediscounting by Government securities. Both of these types of borrowing are
referred to as rediscounting and the rate of interest charged is the discount rate.

DO increase the reserves banks

increase the credit available to the customers
increase the supply of money in the market

decrease the reserves banks DO

reduced the credit available to the customers
decrease the supply of money in the market

MORAL SUASION (MS)

Moral Suasion is a traditional ways of method which BNM will informally induces a voluntary
response from the financial system to its policy initiatives. Moral Suasion has been used
frequently in Malaysia since the decades. Some of the initiatives are:

 Discouraging financial institutions to lend excessively for speculation activity

 Encouraging them to extend longer-term financing, to be granted on the basis of
vreiaqbuiilriteymeonfts.projects rather than purely dependent on meeting collateral

 Commercial banks were aenndcosumraalglemdetdoiustmepenutpetrhperiisrel.ending priority areas such as the
Bumiputera community

 The banking institutions were also urged to limit lending secured mbyasrhkeatr.es to protect the
banking systems from over exposure to the volatility of the stock

44

How Bank Negara Malaysia’s Monetary Policy Affects the Economy and Inflation