## _cr1352 ## Source details **Canonical URL:** [_cr1352](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1352.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1352.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1352.pdf.json) --- ### Executive overview and reform background - Malaysia experienced significant macro/financial distress in the late 1990s; subsequent reforms included a ten-year Financial Sector Masterplan (2001–2010) led by Bank Negara Malaysia (BNM) and a Capital Market Masterplan (CMP) led by the Securities Commission (SC). - The Financial Sector Blueprint (2011–2020), CMP2 (2011–2020), and a Corporate Governance Blueprint (2011–2015) aim to: - Support transition to a high value-added, high-income economy by 2020. - Intensify regional integration and internationalisation of Islamic finance. - Progressively reduce direct state roles in financial markets and further liberalize markets. ### I. Macrofinancial setting and recent performance - Growth and inflation: - Malaysian economy grew strongly in the first three quarters of 2012; headline inflation fell to 1.3 percent in September 2012. - Capital flows and exchange rate management: - Capital inflows were volatile through 2011; inflows robust in H1 2011 then reversed in H2 2011. - BNM foreign exchange intervention described as limited to smoothing excessive volatility and facilitating orderly exchange rate adjustment. - Policy responses to global financial crisis: - BNM measures included reductions in the Policy Rate, extension of access to BNM’s standing facility to insurance companies, temporary Reserve Requirement reduction, and extension of a Government Deposit Guarantee (GDG) on all RM and foreign currency deposits (GDG lifted in 2011 as scheduled; deposit insurance coverage increased from RM 60,000 to RM 250,000). ### II. Financial system structure and size - Aggregate size: - Overall financial sector assets close to 400 percent of GDP as of end-2011. - Asset-share composition (by asset share): - Banking Institutions: 50.6% - DFI: 5.8% - Labuan IBFC: 7.2% - Insurance Cos.: 5.6% - Pensions & Provident Fund: 16.0% - Fund Management: 12.0% - NBFIs: 2.8% - Banking consolidation: - Number of domestic commercial banking groups reduced from 22 in 1986 to 8 currently. - Consolidation led to cost rationalization and increased competitiveness. ### III. Banking sector soundness and vulnerabilities - Strengths: - Banking institutions are well capitalized; asset quality improved significantly over the last five years; banks are profitable. - Stress tests indicate the banking system is resilient to economic and market shocks overall. - Vulnerabilities: - Some smaller banks are more vulnerable in stress scenarios. - Liquidity is a potential vulnerability given banks’ reliance on demand deposits. - Recent rapid loan growth and strong household debt: - Household debt has risen strongly and is one of the highest in the region. - House prices in urban areas have risen fast. - Overseas credit operations for some Malaysian banks have reached significant levels, posing new supervisory and risk-management challenges. ### IV. Regulatory and supervisory framework assessment - Overall assessment: - Regulatory and supervisory regimes for banking, insurance, and securities are well developed with high compliance with international standards. - Authorities have initiated actions to address most remaining shortcomings; a draft law (passed in December) set to eliminate key gaps in the framework for banking and insurance supervision. - Identified gaps and needed enhancements: - Banking supervision: - Gaps relate to formal powers to include financial holding companies (FHCs) in consolidated supervision; certain legal provisions that could compromise independence; lack of clarity in definition of connected lending. - Insurance supervision: - Need to strengthen regulation of financial guarantee business and enhance transparency (e.g., licensing and acquisitions approval criteria). - Securities regulation: - Enhancements needed to legal underpinning of SC’s operational independence and disclosure deadlines for issuers and substantial shareholders. - Proposed legislative and supervisory actions: - Implement proposed new FSA and IFSA at an early date; strengthen legal and regulatory requirements for Islamic banks. - Strengthen framework for consolidated supervision to address FHCs (consolidated capital standards and risk management expectations). - Ground operational independence of SC by changing legal provisions on removal of commission members and protections for Commission members and staff. - Strengthen the definition of connected lending. ### V. Labuan International Business and Financial Center (IBFC) - Current issues: - Regulatory and supervisory framework for Labuan IBFC needs considerable strengthening. - Recommended actions: - Impose prudential and regulatory requirements on Labuan financial institutions in line with international standards and best practice (including adopting BNM prudential and conduct-of-business requirements used in mainland Malaysia). - Define Labuan IBFC business model more clearly and focus on comparative advantages. - LFSA to undertake more proactive engagement and effective communication with home supervisors and external auditors to continue reliance on their work. ### VI. AML/CFT, deposit insurance, payment systems, and crisis management - AML/CFT: - Malaysia has made significant progress; the criminal framework is comprehensive; the financial sector appears subject to generally adequate AML/CFT obligations and supervision. - Deposit insurance: - Framework broadly conforms to best international practice. - Current reserve level for conventional deposits is sufficient only for payouts in smaller banks—highlighting the need to introduce a back-up funding agreement with the Ministry of Finance (MoF). - Payment system: - National payment system is well-developed with clear demarcation of oversight between SC and BNM. - Assessment concluded Malaysia complied at a significantly high level with the new FMI Principles. - Crisis management: - Building blocks for a crisis management framework are in place. - Important enhancement recommended: formalize an apex monitoring and crisis coordination committee involving BNM, SC, PIDM, and the fiscal authority for ongoing systemic risk monitoring, information sharing, and crisis action. ### VII. Government ownership and Islamic finance - Government involvement: - Government ownership in the financial sector, through direct and indirect holdings, is extensive. - All banks and insurance companies are subject to the same regulations and governance regardless of ownership. - Authorities’ development plans recognize the need for greater private-sector leadership in achieving high-income goals. - Islamic finance: - Malaysia is a global centre for Islamic finance with a facilitative regulatory framework and targeted incentives. - Further development of domestic Islamic financial system presents opportunities and challenges; clarity for users on product features—particularly greater degrees of risk-sharing—will be important. ### VIII. Key high-priority FSAP recommendations (summary) - Macrofinancial risks and vulnerabilities (Ch. 2) - Enhance monitoring of household sector leverage through more granular data capture including by income; and review effectiveness of macroprudential measures. - Adopt multi-year top-down and bottom-up macroeconomic stress testing, and introduce more conservative credit loss parameters in Bottom Up exercise. - Strengthening Financial Sector Oversight (Ch. 3) - Strengthen framework for consolidated supervision to address FHCs in such areas as consolidated capital standards and risk management expectations. - Ground the operational independence of SC by changing the legal provisions on removal of commission members and protections given to the members of the Commission and to its staff. - Implement proposed new FSA and IFSA at an early date; and strengthen legal and regulatory requirements for Islamic banks. - Strengthen the definition of connected lending. - Labuan International Business and Finance Center (Ch. 4) - Impose prudential and regulatory requirements on Labuan financial institutions in line with international standards and best practice. - Undertake more proactive engagement and effective communication of LFSA with home supervisors and external auditors so as to continue to rely on their work. - Managing Systemic Risks (Ch. 5) - Formalize a high-level committee involving BNM, SC, PIDM, and the fiscal authority with the responsibility for ongoing systemic risk monitoring, information sharing, and crisis action. ### Non-bank intermediaries, pension/provident funds, unit trusts and market structure - Size and composition: - Non-bank intermediaries—mainly GLICs or GLIC-owned—comprise 36 percent of financial system assets. - Rapid growth among pension and provident funds, unit trusts and non-bank financial institutions. - Insurance sector: - Insurance sector accounts for around 6 percent of financial sector assets. - Cross-border operations of domestic insurers are 0.5 percent of insurance industry assets in 2011. - Includes insurance companies in Labuan IBFC, which account for 0.3 percent of total financial system assets. - Financial conglomeration and ownership: - Six financial conglomerates operate under a financial holding company (FHC) structure; two are headed by licensed banking institutions. - These financial conglomerates account for 70 percent of total assets in the banking system. - Financial conglomerates headed by a FHC: CIMB Group, RHB Group, Affin Group, Alliance Group, Hong Leong Group and AmBank Group. - Financial conglomerates headed by a banking institution: Maybank Group and Public Bank Group. - Role of the state sector and GLICs: - Seven GLICs have substantial market presence; combined pension providers EPF, KWAP, and LTAT have combined assets of around RM 565 billion; Khazanah has a further RM 100 billion and PNB RM 214 billion. - GLICs directly hold about 24 percent of the total market capitalization of Bursa Malaysia. - Seven GLICs listed: Khazanah Nasional Bhd (KNB), Kumpulan Wang Simpanan Pekerja (KWSP), Kumpulan Wang Amanah Pencen (KWAP), Lembaga Tabung Angkatan Tentera (LTAT), Lembaga Tabung Haji (LTH), Menteri Kewangan Diperbadankan (MKD), Permodalan Nasional Bhd (PNB). - PNB is supervised by the SC. ### Market structure, capital markets and development finance - Bond and equity markets: - Bond market is the largest in ASEAN and third largest in Asia as a percentage of GDP. - Approximately 60 percent of issuance is Shariah-compliant (sukuk). - End-2011 ratio of market capitalization to GDP was substantially higher than in most high-income countries or other Asian countries. - Retail unit trusts account for over half of AUM; government-sponsored PNB is the largest unit trust provider. - Development finance institutions (DFIs): - Government owns or controls 19 DFIs. At end-2011 they accounted for some 10 percent of banking system assets. - The six large DFIs are supervised by BNM. - Government debt and fiscal risks: - As of December 2011 total federal government debt stood at RM 456 billion, equivalent to 52 percent of GDP. - Over 95 percent of government debt is domestic. - Consolidated public sector deficit projected to has risen to over 5 percent of GDP in 2012 from 3¼ percent in 2011, with a further increase expected in 2013. ### Banking liquidity, household indebtedness, asset quality, and stress testing - Funding and liquidity: - Deposits comprise 85 percent of total funding. - Around one third of deposits are retail deposits. - Deposits from business enterprises, including GLCs, account for 37 percent of deposits. - Deposits from financial institutions account for 16 percent of deposits. - Household metrics: - Lending to households accounts for 55 percent of bank lending. - Household debt reached 74 percent of GDP in 2011. - Households’ current financial asset-to-debt ratio is 2.3 times. - Asset quality and provisioning: - Banking sector gross NPL ratio: 2.7 percent (as at end-2011). - Provision coverage: 99.6 percent (as at end-2011). - Collateral cover for NPLs: banks have collateral at 1.4 times the amount of NPLs. - Stress testing—scope and findings: - Tests: Top-Down (TD) and Bottom-Up (BU); forecast period to 2016; covered credit, market, and liquidity risk; interbank contagion test undertaken. - Macro scenarios: - Baseline: Malaysian real GDP growth remains around 5 percent. - Adverse S1: assumes a sharp recession in 2013 before slow recovery over the next two years. - Adverse S2: prolonged low growth. - Main findings: - Credit loss is the largest driver of capital deterioration in TD results; lower bank income is the second-largest driver in adverse scenarios. - Under adverse scenario S2, capitalization needs are significant. - System-wide capital ratios (simple averages of 36 banks) remain above regulatory minimums on aggregate, but distributional analysis shows smaller banks—especially some smaller Islamic banks—are more vulnerable and some dip below the 4 percent capital threshold in scenarios. - BU results are more optimistic than TD results because BU uses bank-determined PDs and LGDs that are lower in adverse scenarios. - Some banks experienced capital decreases in Basel II and Basel III ratios ranging from 200–560bps. - Liquidity stress findings: - BU ringgit liquidity outcome: post-shock aggregate net surplus of RM 24 billion (approx. US$8 billion) in available cumulative mismatch over a one-month horizon for ringgit-denominated assets and liabilities. - BU U.S. dollar outcome: system recorded a shortfall of US$6.4 billion in U.S. dollar-denominated assets and liabilities; around 76 percent of the banking system recorded a U.S. dollar liquidity shortfall. - TD short-term daily liquidity ST: in a mild stress scenario nearly all banks survive through the week; in a medium stress scenario (half Lehman type event) six banks—predominantly small domestic commercial banks—would fail after day five. - Five-day implied cash-flow test under medium liquidity stress (minimum number of days of survival → number of bank failures → survival rate of banks (Percent) → survival of assets (Percent)): - 0 days → 0 failures → 100.0 → 100.0 - 1 day → 0 failures → 100.0 → 100.0 - 2 days → 0 failures → 100.0 → 100.0 - 3 days → 0 failures → 100.0 → 100.0 - 4 days → 2 failures → 94.4 → 83.8 - 5 days → 6 failures → 83.3 → 70.4 ### Contagion, interbank exposures and overseas expansion - Contagion: - Contagion risk is contained and has a severe impact only in extreme distress involving simultaneous defaults of large domestic commercial banks. - Interbank contagion model scenarios include single defaults and group defaults (e.g., four largest banks, four most connected banks, Islamic/investment banks, seven locally incorporated European Banks). - Overseas expansion: - Overseas assets account for 19 percent of banks’ total assets and 30 percent of total operating income. - Biggest overseas operations are in Hong Kong, Indonesia, Singapore, and Thailand, where exposures of the biggest three Malaysian banks are just below 30 percent of Malaysian GDP. - Traditional lending activities account for around ¾ of these assets; some 90 percent is funded from local deposits. ### Supervisory, legal, and data gaps; policy recommendations - Data and reporting: - FSAP team could not assess Labuan entities’ credit risk profile due to lack of granular data. - Recommendation: LFSA should as a matter of priority improve data reporting requirements of Labuan-based entities in line with onshore bank data reporting standards. - FHCs and consolidated supervision: - Current regime does not appropriately extend to supervision and regulation of FHCs; six of the eight large domestic banking groups have parent FHCs and the legislative framework does not apply on a parent-only or consolidated basis. - Recommendation: for all FHCs there should be a formally designated primary regulator. - Legal and oversight gaps: - BNM lacks explicit legal authority to supervise financial holding companies; shortcomings exist in coverage of the MOU with the SC. - Legal gaps exist in oversight of large pension funds and certain specialized financial companies. - Islamic banks: - Some smaller Islamic banks are more vulnerable in adverse scenarios due to lower starting capital and greater credit concentration in retail lending. ### Risk guidance, FMI, corporate governance, insolvency and AML/CFT - Risk guidance and supervisory independence: - Guidance on certain individual risk areas could be improved; IRRBB and operational risk management requirements are generally in place but detailed regulation and supervisory expectations are being released. - Provisions in the legal framework could potentially compromise BNM’s independence (e.g., Section 70 and Section 73 in BAFIA). - FMI and payment systems: - National FMI (including RENTAS) is well-developed. - Areas for improvement include legal rights over collateral, recognition of netting/novation, and strengthening stress-testing methodology. - Corporate governance and insolvency: - Companies Act is decades old and has gaps; minority shareholders lack explicit rights to equitable treatment. - Restructuring framework exists but insolvency framework should be upgraded; need for a unified insolvency law. - AML/CFT: - Authorities have made good progress since the APG assessment in 2007 and have addressed most deficiencies relevant to the FSAP. ### Crisis management, PIDM, Islamic finance issues, and Risk Assessment Matrix - Crisis management and governance: - Building blocks for a comprehensive crisis management framework are in place. - Recommendation: include all financial sector supervisory agencies with significant oversight roles as regular members of apex committees (notably bringing in the SC). - Deposit insurance (PIDM): - Deposit insurance is compulsory for all deposit-taking conventional and Islamic banks. - Coverage: up to RM 250,000 per depositor per member institution. - PIDM reserve level for conventional deposits: 0.14 percent of total insured deposits. - PIDM payout mandate: reimburse depositors no later than 3 months after a winding up order. - Areas for improvement: MoF to execute a back-up funding agreement; grant PIDM greater authority over operational matters; shorten payout period substantially. - Islamic finance challenges: - Deposits in Islamic banks are covered by PIDM and most customer liabilities of Islamic banks are perceived to be guaranteed, resulting in little differentiation among conventional deposits, Islamic deposits, and Islamic ‘investments.’ - Transition to reclassify liabilities according to legal characteristics is underway and may last some years. - Selected risks (Risk Assessment Matrix): - Slowdown in economic growth — Staff assessment: Medium; Expected impact: Medium. - Sharp reversal of capital inflows — Staff assessment: Medium; Expected impact: Medium/Low. - Decline in real estate and CRE prices — Staff assessment: Medium; Expected impact: Medium. - Sovereign distress — Staff assessment: Low; Expected impact: Medium. ### Appendix highlights — Macroeconomic variables and stress test matrices - Appendix 3: - Annual series shown for years 1996–2016 for Real GDP Growth (percent), Inflation (CPI) (percent), Unemployment (percent), House Prices (index), Stock Prices (KLCI) (Index), Rubber Prices (Sen/kg). - Appendix 4 — Solvency STeM: - Tests covered 36 banks (coverage: 83% of banking system assets) using BU and TD methodologies; macro-scenario horizon 5-year (2012-2016); sensitivity analysis 1-year. - Macro adverse calibrations: S1 (V-shaped recession; peak to trough decline of 2.6SD), S2 (L-shaped recession; peak to trough decline of 1.3SD but persistent low growth). - Regulatory hurdle rates: Basel II CAR 8%; Tier 1 (CCR) 4%. - Appendix 4 — Liquidity STeM: - Multi-factor liquidity shocks on ringgit and US dollar items; BU horizon 1-year; TD up to 1 year with 5-day and 30-day scenarios. - Ringgit BU outcome: RM 24 billion aggregate net surplus over 1 month. - USD BU outcome: US$6.4 billion shortfall; around 76 percent of system recorded a USD liquidity shortfall. - Detailed run-off caps/floors for retail and corporate deposit types and drawdowns on commitments provided. - Appendix 4 — Contagion/Spillover: - Top-down contagion analysis covered 53 banks (coverage: 99.8% of banking system assets) using BNM interbank contagion model with solvency hurdle RWCR < 8%, interbank risk-weight 20%, LGD 100%, % funding not refinanced 50%, fire-sale haircut 50%. - Appendix 5 — Sensitivity shock parameters (selected exact magnitudes): - CRS 4 (Housing Loans): PD=7%, LGD=20% - CRS 5 (Housing Loans): PD=10%, LGD=30% - MRS 1: +300 bps parallel yield shift - MRS 2: -250 bps parallel yield shift - MRS 3: Steepening — Short Term 46 bps; Medium Term 252 bps; Long Term 268 bps - MRS 4: Credit spreads widening — Short Term 142 bps; Medium Term 228 bps; Long Term 256 bps - MRS 5 FX moves: USD +20%; SGD +17%; HKD +15%; JPY +20%; EUR -20%; GBP +15%; AUD +20%; IDR +10% - MRS 6 Equity shock: FBM KLCI decline (-67.3%) to 500 pts - MRS 7 Equity shock: FBM KLCI decline (-47.7%) to 800 pts *Source: _cr1352 - Executive Summary* ### Executive Summary ...................................................................................................... ### _cr1352 - Executive Summary ### Executive overview and reform background - Malaysia experienced significant macro/financial distress in the late 1990s; subsequent reforms included a ten-year Financial Sector Masterplan (2001–2010) led by Bank Negara Malaysia (BNM) and a Capital Market Masterplan (CMP) led by the Securities Commission (SC). - The Financial Sector Blueprint (2011–2020), CMP2 (2011–2020), and a Corporate Governance Blueprint (2011–2015) aim to: - Support transition to a high value-added, high-income economy by 2020. - Intensify regional integration and internationalisation of Islamic finance. - Progressively reduce direct state roles in financial markets and further liberalize markets. ### I. Macrofinancial setting and recent performance - Growth and inflation: - Malaysian economy grew strongly in the first three quarters of 2012; headline inflation fell to 1.3 percent in September 2012. - Capital flows and exchange rate management: - Capital inflows were volatile through 2011; inflows robust in H1 2011 then reversed in H2 2011. - BNM foreign exchange intervention described as limited to smoothing excessive volatility and facilitating orderly exchange rate adjustment. - Policy responses to global financial crisis: - BNM measures included reductions in the Policy Rate, extension of access to BNM’s standing facility to insurance companies, temporary Reserve Requirement reduction, and extension of a Government Deposit Guarantee (GDG) on all RM and foreign currency deposits (GDG lifted in 2011 as scheduled; deposit insurance coverage increased from RM 60,000 to RM 250,000). ### II. Financial system structure and size - Aggregate size: - Overall financial sector assets close to 400 percent of GDP as of end-2011. - Asset-share composition (by asset share): - Banking Institutions: 50.6% - DFI: 5.8% - Labuan IBFC: 7.2% - Insurance Cos.: 5.6% - Pensions & Provident Fund: 16.0% - Fund Management: 12.0% - NBFIs: 2.8% - Banking consolidation: - Number of domestic commercial banking groups reduced from 22 in 1986 to 8 currently. - Consolidation led to cost rationalization and increased competitiveness. ### III. Banking sector soundness and vulnerabilities - Strengths: - Banking institutions are well capitalized; asset quality improved significantly over the last five years; banks are profitable. - Stress tests indicate the banking system is resilient to economic and market shocks overall. - Vulnerabilities: - Some smaller banks are more vulnerable in stress scenarios. - Liquidity is a potential vulnerability given banks’ reliance on demand deposits. - Recent rapid loan growth and strong household debt: - Household debt has risen strongly and is one of the highest in the region. - House prices in urban areas have risen fast. - Overseas credit operations for some Malaysian banks have reached significant levels, posing new supervisory and risk-management challenges. ### IV. Regulatory and supervisory framework assessment - Overall assessment: - Regulatory and supervisory regimes for banking, insurance, and securities are well developed with high compliance with international standards. - Authorities have initiated actions to address most remaining shortcomings; a draft law (passed in December) set to eliminate key gaps in the framework for banking and insurance supervision. - Identified gaps and needed enhancements: - Banking supervision: - Gaps relate to formal powers to include financial holding companies (FHCs) in consolidated supervision; certain legal provisions that could compromise independence; lack of clarity in definition of connected lending. - Insurance supervision: - Need to strengthen regulation of financial guarantee business and enhance transparency (e.g., licensing and acquisitions approval criteria). - Securities regulation: - Enhancements needed to legal underpinning of SC’s operational independence and disclosure deadlines for issuers and substantial shareholders. - Proposed legislative and supervisory actions: - Implement proposed new FSA and IFSA at an early date; strengthen legal and regulatory requirements for Islamic banks. - Strengthen framework for consolidated supervision to address FHCs (consolidated capital standards and risk management expectations). - Ground operational independence of SC by changing legal provisions on removal of commission members and protections for Commission members and staff. - Strengthen the definition of connected lending. ### V. Labuan International Business and Financial Center (IBFC) - Current issues: - Regulatory and supervisory framework for Labuan IBFC needs considerable strengthening. - Recommended actions: - Impose prudential and regulatory requirements on Labuan financial institutions in line with international standards and best practice (including adopting BNM prudential and conduct-of-business requirements used in mainland Malaysia). - Define Labuan IBFC business model more clearly and focus on comparative advantages. - LFSA to undertake more proactive engagement and effective communication with home supervisors and external auditors to continue reliance on their work. ### VI. AML/CFT, deposit insurance, payment systems, and crisis management - AML/CFT: - Malaysia has made significant progress; the criminal framework is comprehensive; the financial sector appears subject to generally adequate AML/CFT obligations and supervision. - Deposit insurance: - Framework broadly conforms to best international practice. - Current reserve level for conventional deposits is sufficient only for payouts in smaller banks—highlighting the need to introduce a back-up funding agreement with the Ministry of Finance (MoF). - Payment system: - National payment system is well-developed with clear demarcation of oversight between SC and BNM. - Assessment concluded Malaysia complied at a significantly high level with the new FMI Principles. - Crisis management: - Building blocks for a crisis management framework are in place. - Important enhancement recommended: formalize an apex monitoring and crisis coordination committee involving BNM, SC, PIDM, and the fiscal authority for ongoing systemic risk monitoring, information sharing, and crisis action. ### VII. Government ownership and Islamic finance - Government involvement: - Government ownership in the financial sector, through direct and indirect holdings, is extensive. - All banks and insurance companies are subject to the same regulations and governance regardless of ownership. - Authorities’ development plans recognize the need for greater private-sector leadership in achieving high-income goals. - Islamic finance: - Malaysia is a global centre for Islamic finance with a facilitative regulatory framework and targeted incentives. - Further development of domestic Islamic financial system presents opportunities and challenges; clarity for users on product features—particularly greater degrees of risk-sharing—will be important. ### VIII. Key high-priority FSAP recommendations (summary of Table 1) - Macrofinancial risks and vulnerabilities (Ch. 2) - Enhance monitoring of household sector leverage through more granular data capture including by income; and review effectiveness of macroprudential measures. - Adopt multi-year top-down and bottom-up macroeconomic stress testing, and introduce more conservative credit loss parameters in Bottom Up exercise. - Strengthening Financial Sector Oversight (Ch. 3) - Strengthen framework for consolidated supervision to address FHCs in such areas as consolidated capital standards and risk management expectations. - Ground the operational independence of SC by changing the legal provisions on removal of commission members and protections given to the members of the Commission and to its staff. - Implement proposed new FSA and IFSA at an early date; and strengthen legal and regulatory requirements for Islamic banks. - Strengthen the definition of connected lending. - Labuan International Business and Finance Center (Ch. 4) - Impose prudential and regulatory requirements on Labuan financial institutions in line with international standards and best practice. - Undertake more proactive engagement and effective communication of LFSA with home supervisors and external auditors so as to continue to rely on their work. - Managing Systemic Risks (Ch. 5) - Formalize a high-level committee involving BNM, SC, PIDM, and the fiscal authority with the responsibility for ongoing systemic risk monitoring, information sharing, and crisis action. *Source: _cr1352 - Executive Summary* ### 21. Non-bank intermediaries, including pension and provident funds, unit trusts and ### 21. Non-bank intermediaries, including pension and provident funds, unit trusts and ### Non-bank intermediaries: size and composition - These intermediaries—mainly GLICs or GLIC-owned—comprise 36 percent of financial system assets. - Rapid growth continues among non-bank intermediaries, including pension and provident funds, unit trusts and non-bank financial institutions. ### Insurance sector - Malaysia’s insurance sector accounts for around 6 percent of financial sector assets. - Insurance penetration and density rates are relatively low but steadily improving, led by the life insurance sector. - General insurance industry remains very fragmented, with a clear trend towards consolidation. - Cross-border operations of domestic insurers are small, at 0.5 percent of insurance industry assets in 2011, spanning four nearby countries. - Includes insurance companies in Labuan IBFC, which account for 0.3 percent of total financial system assets. ### Financial system interlinkages and conglomeration - The financial system is highly interconnected through both funding sources and ownership. - Banks, non-bank financial companies and mutual funds are linked through the wholesale funding market. - Financial conglomeration has grown with major banks owning insurance and fund management companies and securities firms. - Six financial conglomerates operate under a financial holding company (FHC) structure, while two are headed by licensed banking institutions. - These financial conglomerates account for 70 percent of total assets in the banking system. - Four out of the nine life insurers are owned by the large domestic banks; foreign insurers play an important role in the general insurance market. - Domestic banks have a major presence in the takaful market, with the dominant takaful operator being a subsidiary of a large domestic bank. - Financial conglomerates headed by a FHC are CIMB Group, RHB Group, Affin Group, Alliance Group, Hong Leong Group and AmBank Group. - Financial conglomerates headed by a banking institution are Maybank Group and Public Bank Group. ### Financial development indicators (2006–2011) — comparative notes - Credit intermediation is high when benchmarked against regional peers. - Domestic stock market, insurance sector, provident/pension and mutual funds have all grown in tandem with and have outperformed regional peers in various respects. - The corporate domestic debt market continues to grow rapidly but is mostly associated with GLCs. - Notes on data sources and peers: regional peers comprise China, Hong Kong SAR, India, Indonesia, Japan, Korea, Philippines, Singapore and Thailand. (2011 data not available for one indicator.) ### Money market, foreign exchange administration, and capital account - Malaysia maintains a de facto relatively liberal foreign exchange administration regime. - Main capital account restrictions relate to internationalization of the Ringgit (transacting Ringgit outside Malaysia). - Non-residents may buy and sell ringgit through the appointed overseas office of an onshore banking institution for settlement of ringgit assets or international trade of goods and services with residents. - Non-residents may buy and sell ringgit with onshore banking institutions on a spot basis for any purpose, and on a forward basis where there is a confirmed underlying transaction. - Residents without domestic borrowing are free to invest outside Malaysia; no restriction on residents borrowing foreign currency from related companies outside Malaysia, although borrowing from others is subject to limits. ### Liberalization intentions and bank funding considerations - Authorities intend to liberalize remaining restrictions in coming years; sequencing and timing will depend on market circumstances. - Consideration: banks are reliant on a high level of non-retail customer deposits, which are virtually all at call. - Recommendation/advisory: precede liberalization with development of reliably longer-term funding for banks. ### Derivatives usage and exposures - Banking institutions’ exposure to derivatives is small. - Net exposure to off-balance sheet derivatives accounts for 0.01 percent of total assets. - The gross notional value of derivatives to total assets is close to 70 percent (noted as relatively small compared to an emerging Asian country such as India whose ratio is close to 200 percent). - OTC derivatives are largely plain vanilla: in 2011, foreign exchange derivatives comprised 70 percent of total OTC derivatives, followed by interest rate derivatives which account for 27 percent. - Use of credit derivatives is still insignificant. - Non-deliverable forwards are traded offshore; these markets are used by different groups of players and do not move closely in tandem. ### Bond and equity markets - Malaysian bond market size is comparable to more developed markets; bond market is the largest in ASEAN and third largest in Asia as a percentage of GDP. - Efforts accelerated after the Asian financial crisis to resolve maturity mismatch among corporations. - Issuance of private debt securities has been growing and is a consistent source of corporate funding. - Private issuance concentrated in high-grade instruments, issued mainly by GLCs and the major banking groups. - Approximately 60 percent of issuance is Shariah-compliant (sukuk), driven largely by state-related issuers; infrastructure sector is a significant issuer. - Turnover is in line with regional peers. - By regional standards and versus other emerging markets, Malaysia has a large listed equity market: end-2011 ratio of market capitalization to GDP was substantially higher than in most high-income countries or other Asian countries, reflecting the role of long-term institutional investors. - Investment management industry is one of the fastest-growing segments within the capital market; retail unit trusts account for over half of AUM; government-sponsored PNB is by far the largest unit trust provider. - Capital market intermediaries remained resilient through the global financial crisis and are taking steps towards internationalization; Malaysian intermediaries have strengthened their presence in regional markets (particularly ASEAN). ### Role of the state sector: ownership and market influence - Government has substantial de facto ownership in the financial sector: the seven GLICs have large interests in the main Malaysian financial and banking groups. - Examples of holdings: - PNB owns 5 percent of the Maybank group, with a further 45 percent held by PNB managed unit trusts. - Khazanah owns 30 percent of CIMB Group Holdings. - EPF holds an additional 16 percent and 13 percent, respectively, of both Maybank and CIMB Group Holdings. - Authorities state government does not interfere with management: banks are held to same governance and risk management standards; board members and senior management subject to same fit and proper criteria. - The seven GLICs have combined substantial market presence: the pension providers EPF, KWAP, and LTAT have combined assets of around RM 565 billion; Khazanah has a further RM 100 billion and PNB RM 214 billion. - The seven GLICs directly hold about 24 percent of the total market capitalization of Bursa Malaysia and control a large number of GLCs and minority stakes in dozens more. - GLICs are subject to government oversight and participation on their board, usually through the MoF or the Prime Minister’s office; most have beneficiaries represented on their board. - The MoF plays a role in governance and investment decisions of GLICs. - The Putrajaya Committee on GLC High Performance (PCG), chaired by the Second Finance Minister, was established to improve performance and governance of the largest GLCs; program has largely succeeded in improving board practices, training, performance management, and overall performance in the largest GLCs. - The MoF holds “golden shares” conferring special powers in a small number of large companies, including Pos Malaysia. - The MoF chooses Public Interest Directors for the board of Bursa Malaysia in consultation with SC. - There are seven GLICs: Khazanah Nasional Bhd (KNB), Kumpulan Wang Simpanan Pekerja (KWSP), Kumpulan Wang Amanah Pencen (KWAP), Lembaga Tabung Angkatan Tentera (LTAT), Lembaga Tabung Haji (LTH), Menteri Kewangan Diperbadankan (MKD), and Permodalan Nasional Bhd (PNB). - PNB is supervised by the SC. - GLCs are defined as companies with a primary commercial objective in which the Malaysian Government has a direct controlling stake; controlling stake refers to the Government’s ability to appoint BOD members, senior management, make major decisions, etc., for GLCs either directly or through GLICs. ### Government-created entities supporting bond market - Danajamin: a credit guarantee institution set up in 2009 to enable bond issues that might not otherwise come to market at competitive rates. All issuances guaranteed by Danajamin have thus far obtained an AAA rating. - Recommendation: BNM’s plan to develop the capital framework for such financial guarantee insurers should be expedited. - Cagamas (National Mortgage Corporation), established in 1986 to promote home ownership and growth of the secondary mortgage market, is jointly-owned by BNM (20 percent) and commercial and investment banks (80 percent). ### Development finance institutions (DFIs) - Government owns or controls 19 DFIs. At end-2011 they accounted for some 10 percent of banking system assets. - The six large DFIs are all supervised by BNM. - Three DFIs take deposits, have a large branch network, and account for 40 percent of the total number of deposit accounts in the banking system. ### Government debt and fiscal risks - As of December 2011 total federal government debt stood at RM 456 billion, equivalent to 52 percent of GDP, just below the informal ceiling of 55 percent. - Over 95 percent of government debt is domestic. - Market turnover is comparable with regional peers, at around 2.5 times a year. - The consolidated public sector deficit projected to has risen to over 5 percent of GDP in 2012 from 3¼ percent in 2011, with a further increase expected in 2013. - The increase in the deficit reflects major projects being undertaken by Petronas and other public enterprises engaged in the oil and gas sector; the Tun Razak Exchange; and property developments in Iskandar. - Limited fiscal headroom implies fiscal shock could turn financial sector interlinkages into a significant risk factor. ### Cross-border banking flows and overseas expansion - Foreign bank claims on Malaysia are relatively large but not a major risk; eurozone crisis deleveraging impact should be manageable. - Some 80 percent of foreign bank claims on Malaysia (as reported to the BIS) comprise the local operations of foreign banks in Malaysia, which are predominantly funded by local RM deposits. - All foreign commercial banks have to be locally-incorporated. - Over the last decade Malaysian banks have expanded abroad significantly; overseas operations should be carefully monitored. - The six biggest banking groups all have an overseas presence; biggest operations are in Hong Kong, Indonesia, Singapore, and Thailand, where exposures of the biggest three Malaysian banks are just below 30 percent of Malaysian GDP. - Overseas assets account for 19 percent of banks’ total assets and 30 percent of total operating income. - Traditional lending activities account for around ¾ of these assets; some 90 percent is funded from local deposits. - Soundness indicators appear strong, although rising loan-to-deposit ratios need to be watched. - BNM has enhanced supervisory engagement including through annual overseas inspections of key operations, and hosting supervisory colleges. - International experience suggests rapid bank expansion in new markets can pose challenges as bank risk management and supervisory monitoring may fail to keep pace; further deepening of home-host cooperation in supervision and crisis prevention will be important. ### Market distortions and state advantages - Current level of state involvement and benefits that state players and state-sponsored activities enjoy may weaken market development prospects. - Examples include tax incentives for shariah-compliant finance, preferential features of PNB’s largest unit trusts, and increasing commercial activities of DFIs. - Tax incentives granted to Islamic finance are significant; some are designed to compensate for extra issuance costs associated with Islamic products. - For instance, for an issue size of RM 300–500 million, the tax incentive may be equivalent to 0.16–0.25 percent of the issue value. - Authorities state incentives are finite and time-bound and are only accorded to specific contracts to promote new markets; other tax breaks are permanent to “level the playing field” between conventional and Islamic products. - Largest funds of one GLIC enjoy operating advantages over private unit trusts: its largest fund, with some RM 100 billion in assets, is exempt from the mark-to-market valuation requirements applied to other unit trust providers and can use its accumulated surplus to smooth dividend payments to investors. - Board composition (appointed by government; Board of Trustees consists of government ministers) may be perceived to imply a government guarantee of these investments. - Investors’ holdings show a stable value; but for regulatory purposes mark-to-market information has to be provided to the SC. ### Stability assessment — banking institutions - Banking institutions—commercial and Islamic—as a whole well capitalized, and asset quality has improved significantly. - Banking sector risk-weighted capital adequacy ratio (RWCR) increased to 15.1 percent in 2011. - Banks are expected to be able to meet Basel III capital requirements by the 2019 implementation deadline, even allowing for loan growth. - Gross NPL ratio has fallen and provision coverage is close to 100 percent. - Banks are relatively efficient—the average cost-to-income ratio at 43.6 percent is lower than peers’ 48 percent. *Source: IMF staff compilation from the chapter titled "21. Non-bank intermediaries, including pension and provident funds, unit trusts and" in the provided PDF.* ### 44. Banks are liquid at present, with sufficient liquid assets to cover short-term ### _cr1352 - 44. Banks are liquid at present, with sufficient liquid assets to cover short-term ### Banking liquidity and funding - Deposits comprise 85 percent of total funding. - Around one third of deposits are retail deposits. - Deposits from business enterprises, including GLCs, account for 37 percent of deposits. - Deposits from financial institutions account for 16 percent of deposits. - Deposits are predominantly at call but “appear to be stable,” supported by confidence in the banking system, regulation, deposit protection, and a preference for ringgit-denominated deposits (ringgit cannot be held offshore due to residual capital controls). ### Household lending, indebtedness, and buffers - Lending to households accounts for 55 percent of bank lending; most of this is at floating rates and denominated in ringgit. - Household debt reached 74 percent of GDP in 2011. - Households’ current financial asset-to-debt ratio is 2.3 times. - Personal loans and mortgages have been growing rapidly, supported by economic growth and government policies promoting home ownership. - Risk note: potential vulnerability if a global downturn adversely affected the labor market and household balance sheets; asset and liability positions may not match across all household categories. ### Asset quality and provisioning - Banking sector gross NPL ratio: 2.7 percent (as at end-2011). - Provision coverage: 99.6 percent (as at end-2011). - Regional averages for comparison: gross NPL ratio 2.0 percent; provision coverage 114.7 percent. - Collateral cover for NPLs: banks have collateral at 1.4 times the amount of NPLs. ### Stress testing: scope, scenarios, and main drivers - Stress tests performed: Top-Down (TD) and Bottom-Up (BU); forecast period to 2016; covered credit, market (interest rate, exchange rate and equity price moves), and liquidity risk; interbank contagion test also undertaken. - Macro scenarios (three): - Baseline: Malaysian real GDP growth remains around 5 percent (consistent with the latest IMF WEO forecast for Malaysia). - Adverse S1: assumes a sharp recession in 2013 before slow recovery over the next two years. - Adverse S2: prolonged low growth. - Main findings: - Credit loss is the largest driver of capital deterioration in TD results; lower bank income is the second-largest driver in adverse scenarios. - Under adverse scenarios, higher loss rates and lower bank income levels are assumed (consistent with loss levels used in stress tests for comparable Emerging Market countries). - Under adverse scenario S2, capitalization needs are significant. - System-wide capital ratios (simple averages of 36 banks) remain above regulatory minimums on aggregate, but distributional analysis shows smaller banks—especially some smaller Islamic banks—are more vulnerable and some dip below the 4 percent capital threshold in scenarios. - BU results are more optimistic than TD results because BU uses bank-determined PDs and LGDs that are lower in adverse scenarios; BU outcomes are also more optimistic than recently-published BNM sensitivity and scenario analysis under extreme/tail risks. - Credit risk shocks had the greatest impact on capital ratios; losses on housing loans produced the largest impact. - Some banks experienced capital decreases in Basel II and Basel III ratios ranging from 200–560bps. ### Market and liquidity risk findings - Market risk: - Market risk shocks are much less significant than credit risk shocks for most banks, except some investment banks. - Most commercial and Islamic banks have small net open foreign exchange positions; direct exposure to the government is limited. - Increasing the risk weight of government securities from zero to 20 percent in median terms results in only a 25bp decline in capital ratios for the system as a whole, though investment and some commercial banks suffer substantial credit risk shock in this scenario. - Liquidity risk (BU and TD tests): - BU ringgit liquidity outcome: post-shock aggregate net surplus of RM 24 billion (approx. US$8 billion) in available cumulative mismatch over a one-month horizon for ringgit-denominated assets and liabilities. - BU U.S. dollar outcome: system recorded a shortfall of US$6.4 billion in U.S. dollar-denominated assets and liabilities; around 76 percent of the banking system recorded a U.S. dollar liquidity shortfall. - BNM appears well placed to provide both ringgit and foreign exchange liquidity, should the need arise. - TD short-term daily liquidity ST: in a mild stress scenario nearly all banks survive through the week; in a medium stress scenario (half Lehman type event) six banks—predominantly small domestic commercial banks—would fail after day five. - Five-day implied cash-flow test under medium liquidity stress (minimum number of days of survival → number of bank failures → survival rate of banks (Percent) → survival of assets (Percent)): - 0 days → 0 failures → 100.0 → 100.0 - 1 day → 0 failures → 100.0 → 100.0 - 2 days → 0 failures → 100.0 → 100.0 - 3 days → 0 failures → 100.0 → 100.0 - 4 days → 2 failures → 94.4 → 83.8 - 5 days → 6 failures → 83.3 → 70.4 ### Contagion, interbank exposures, and vulnerabilities - Contagion risk is contained and has a severe impact only in extreme distress involving simultaneous defaults of large domestic commercial banks. - Gross interbank exposures model traced contagion paths for single defaults, simultaneous defaults, and defaults of different bank types (domestic and foreign subsidiaries). ### Supervisory, data, and regulatory gaps and policy recommendations - Data and reporting: - The FSAP team could not assess Labuan entities’ credit risk profile due to lack of granular data. - Recommendation: LFSA should as a matter of priority improve data reporting requirements of Labuan-based entities in line with onshore bank data reporting standards. - Financial holding companies (FHCs) and consolidated supervision: - Current regime does not appropriately extend to supervision and regulation of FHCs; six of the eight large domestic banking groups have parent FHCs and the legislative framework does not apply on a parent-only or consolidated basis. - BNM has imposed conditions on FHCs incident to approval of their investments in banks to reduce gaps, but gaps remain in consolidated capital and liquidity requirements and consolidated stress testing expectations. - Recommendation: for all FHCs there should be a formally designated primary regulator. - Legal and oversight gaps: - BNM lacks explicit legal authority to supervise financial holding companies; shortcomings exist in coverage of the MOU with the SC. - Legal gaps exist in oversight of large pension funds and certain specialized financial companies (EPF governed by separate legislation and supervised by the MoF without apparent on-site inspection). - BNM recently started reporting requirements and monitoring for six large unsupervised financial companies, with expectation of stronger powers under new law to address financial stability concerns. - Islamic banks: - Some smaller Islamic banks are more vulnerable in adverse scenarios due to lower starting capital and greater credit concentration in retail lending; reputational risks to the group could arise from solvency deterioration in these banks. *Source: _cr1352 - 44. Banks are liquid at present, with sufficient liquid assets to cover short-term* ### 67. Guidance on certain individual risk areas could be improved. IRRBB and ### _cr1352 - 67. Guidance on certain individual risk areas could be improved. IRRBB and ### Risk guidance, supervisory practices, and independence - Guidance on certain individual risk areas could be improved; IRRBB and operational risk management requirements are generally in place and adhered to, but the release of more detailed regulation and supervisory expectations is currently underway. - Plans are underway to strengthen the regime for credit concentrations. - Although all domestic banking groups currently have independent risk units, there is no regulatory requirement to have these in place. - Provisions in the legal framework could potentially compromise the BNM’s independence: - Section 70 in BAFIA allows the Minister at any time to direct the Bank to make an examination of any licensed institution if he has certain suspicions with regard to a banking institution. - Section 73 of BAFIA authorizes BNM to direct institutions to take corrective actions, but it can remove and/or appoint new officers and directors only with the concurrence of the Minister. - These residual provisions have the potential to undermine BNM’s operational independence despite its wide perception as operationally independent. - Making BNM’s supervisory expectations more transparent and improving domestic coordination and information sharing would enhance supervisory effectiveness: - The criteria applied for considering new licenses and for acquisitions should be made transparent. - Wider public consultation on proposed policy measures in accordance with the Policy Development Framework would add to their credibility. ### Legal and administrative reforms under way - Authorities have initiated legal and administrative measures to address identified gaps: - Enhanced legal authority is being sought under new financial services legislation to enable full application of supervision and regulation of FHCs (including the capital framework). - The proposed FSA will, when enacted, further define the specific objectives of financial regulation and supervision by BNM as the supervisory authority for the banking sector. - The proposed FSA will empower BNM to impose civil and administrative penalties in the event of non compliance with legal provisions, in addition to the existing power to initiate criminal processes. - Gaps in the regulatory framework are being addressed through revised guidance on supervisory expectations. - The regulatory framework specific to Islamic banking was not formally assessed because separate assessment standards for Islamic banking have not yet been developed; some legal and regulatory requirements and powers for the BNM are not firmly grounded in legislation. - It is intended to address these issues in proposed new legislation for Islamic finance. ### Securities, insurance, and development finance institutions - Securities: - The Securities Commission Malaysia (SC) exhibits high levels of implementation of the IOSCO Principles for Securities Regulation. - Regimes governing issuers, auditors, collective investment schemes, market intermediaries and secondary markets, and enforcement, cooperation and information sharing are extensive and effective; no intermediary failure recorded during the recent global financial crisis. - Enhancements advisable: - SC operational independence would be buttressed by changes to legal provisions on removal of commission members and to protections for Commission members and staff. - Disclosure deadlines for issuers and their substantial shareholders should be adjusted to reflect international best practices. - The SC is transitioning from a relatively prescriptive approach toward greater adoption of disclosure-based regulation to promote innovation and regional competitiveness. - Insurance: - The insurance sector does not appear to pose significant risks to financial stability; it is relatively small and fragmented. - Any substantial growth in risk accumulations in Danajamin should be closely monitored given business risks and the still developing regulatory framework for financial guarantee insurance. - Insurance supervision is robust and effective, but some shortcomings in compliance with the Insurance Core Principles exist: - Shortcomings relate to formalizing expectations into guidelines, clarifying approaches in certain areas, enhancing transparency, and expanding the tool kit. - Proposed financial institutions legislation will address concerns with BNM’s powers for group-wide supervision and client monies protection. - Implementation of ICAAP and new risk governance guidance will close current gaps in formal expectations for insurer risk management practices. - Development Finance Institutions (DFIs): - The 2002 Development Finance Institutions Act (DFIA) authorizes BNM to regulate and supervise six DFIs under standards applicable to commercial banks; other DFIs are supervised by ministries or government agencies. - Risks: weaker expertise, conflicts of interest, and potential delays in prompt corrective action by non-BNM supervisors. - Recommendation: authorities should rationalize the DFI sector based on re-evaluation of market gaps, exit DFIs that have fulfilled policy mandates or now serve markets served by commercial banks, and include DFIs partially-owned by BNM in the exit strategy to mitigate supervisor–shareholder conflicts. ### Financial market infrastructure, corporate governance, and accounting - Financial Markets Infrastructure (FMI): - The national FMI (including RENTAS, the wholesale payment system) is well-developed. - BNM oversees payment systems and settlement systems for unlisted government, BNM and private debt securities; SC oversees FMIs for corporate securities and derivatives. - Areas for improvement include: - Strengthening legal rights of BNM over collateral placed to obtain liquidity in RENTAS and enforcement of repo contracts. - Recognizing netting and novation arrangements in securities and derivatives FMIs in legislation. - Strengthening stress-testing methodology for securities and derivatives FMIs. - Strengthening credit risk management at the securities market FMI. - Corporate governance: - SC, Companies Commission of Malaysia (CCM), BNM, and Bursa are active in enforcement and capacity building. - Basic shareholder rights are well established, insider trading is prohibited, and self-dealing/conflicts of interest are regulated. - The Companies Act is decades old, has gaps and lacks clarity; minority shareholders lack explicit rights to equitable treatment and have limited influence on board choice and key decisions. - Accounting and audit: - Accounting and audit arrangements for public interest entities (including banks) are good; those for other entities exhibit some weaknesses. - Accounting and auditing standards are in line with international standards; progress over the last 10 years has improved reporting quality and corporate governance for public interest entities. - Restructuring and insolvency: - Developed framework for informal and semi-informal debt restructuring exists, but insolvency framework should be upgraded. - The hybrid debt restructuring procedure offers virtually the only possibility for company reorganization in distress; a unified insolvency law would rationalize the framework and eliminate contradictions and overlaps. ### Anti-Money Laundering / Combating the Financing of Terrorism (AML/CFT) - Authorities have made good progress since the APG assessment in 2007 and have addressed most deficiencies identified with respect to the FATF Recommendations reviewed in the context of this FSAP. - The review focused on recommendations most relevant in terms of risk, including criminalization of money laundering, financial institution secrecy laws, identification of beneficial owners and politically-exposed persons, reporting of suspicious transactions, transparency of legal persons and arrangements, and cash couriers. ### Labuan International Business and Financial Center (IBFC) - Business profile: - Main business currently: bank lending, reinsurance, leasing and trust company business; capital markets activity is minimal. - In 2011, about 75 percent of insurance business was written by reinsurers/retakaful operators and more than 40 percent of the premiums were for domestic Malaysian risk. - Labuan IBFC plans to shift business model toward private wealth management, offshore companies, captive insurance, Islamic Finance, and services for high net-worth individuals. - Regulatory and supervisory issues: - Legislative framework needs substantial review; 2010 legislation strengthened enforcement powers and cooperation with foreign authorities but should be revised to further meet international standards and strengthen LFSA governance. - Supervisory practices follow a risk-based framework but are not fully embedded or effectively implemented. - A new Financial Stability Committee with BNM and SC representatives has been established to strengthen risk management and surveillance. - Supervisory system relies on home supervisors and auditors but requires more proactive engagement and effective communication; LFSA does not confirm that consolidated supervision adequately accounts for LFIs' operations. - Risks and recommendations: - Prudential and systemic risk may be modest given current IBFC size, but reputational risk from an inadequate regulatory regime is significant. - Authorities have initiated steps to strengthen Labuan’s regulatory regime, including adapting BNM guidelines for insurance and banking and enhancing cross-institutional collaboration. - LIBFC should clearly define its business model and focus on comparative advantages (e.g., back office center for Kuala Lumpur financial services, Islamic wealth and fund management, trust company business leveraging double taxation treaties). ### Managing systemic risks: liquidity, macroprudential measures, and crisis management - Systemic liquidity management: - BNM’s monetary policy framework is based on a typical corridor system, where the overnight interbank interest rate is kept close to the policy rate. - Open Market Operations are mainly conducted through direct deposits with BNM and issuance of BNM bills; a variety of instruments is available and a wide range of collateral is eligible for standing facilities. - BNM signed MOUs with Singapore and Thailand to guarantee reciprocity in collateral acceptance, facilitating Malaysian banks’ operations in those countries. - Throughout the GFC the BNM maintained stable liquidity provision by allowing liquidity-draining operations to roll off and by a temporary reduction in the required reserves ratio; the Malaysian financial sector did not experience any major disruption. - During 2009 and part of 2010, foreign exchange reserves were vigorously used to manage exchange rate volatility after asset liquidations by foreign investors; phases of capital outflows (2008 and 2011) alternated with inflows (2010). - A stable core of domestic investors, notably the EPF and PNB, acted as a buffer against fluctuations in domestic asset demand by non-residents. - The downside risk of sharp and unpredictable portfolio flow reversals remains but should be manageable: - The high share of foreign holdings of government and BNM securities (some 40–45 percent at end-August 2012) indicates vulnerability to capital outflows. - Ample reserves and a strong domestic investor base suggest pressures could be managed relatively comfortably. - Macro-prudential measures: - Since 2010, Malaysia adopted macro-prudential and fiscal measures aimed at curbing household debt and house price rises: - March 2011: eligibility requirements for credit cards revised. - November 2010, January and December 2011: BNM tightened lending conditions based on loan-to-value (LTV) ratios on mortgages. - January 2010: federal government reintroduced the Real Property Gains Tax (RPGT) for housing disposals within five years of purchase; RPGT was further raised in January 2011, and additional increases are contained in the 2013 Budget. - January 2012: minimum price for house purchases by foreigners was doubled. - Early assessment: - Credit card measures appear to have had some success, though too early to fully assess effectiveness. - House price growth remains at historical highs; measures appear to have limited impact on overall volume of residential lending but have altered lending composition. - Analysis indicates macroeconomic factors (income growth, interest rates, population growth) are important drivers of house prices; other factors may include the 2009 elimination of the RPGT and demand by foreigners and Malaysians living abroad. - Authorities should continue monitoring housing loans with LTV ratio above 90 percent, which are concentrated mainly in two banks. *Source: _cr1352 - 67. Guidance on certain individual risk areas could be improved. IRRBB and* ### 96. Formalizing an apex monitoring and coordination committee could enhance ### 96. Formalizing an apex monitoring and coordination committee could enhance ### Crisis management framework and governance - Building blocks for a comprehensive crisis management framework are in place, including deposit insurance and ELA arrangements and powers to resolve financial institutions. - The Financial Stability Executive Committee (FSEC), set up in 2010, enables the BNM to address risks to financial stability arising from entities outside its regulatory sphere, but is not intended to act as a ‘peace-time’ oversight group. - Recommendation: Inclusion of all financial sector supervisory agencies with significant oversight roles (notably, bringing in the SC) as regular members would strengthen FSEC effectiveness and inter-agency communications and risk identification. ### Bank resolution framework - The bank resolution framework provides a comprehensive range of options. - Shortcoming: Could be improved to address resolution of SIFIs, financial groups, conglomerates and FMIs. - Legal constraint: Provisions in law require court approvals or allow judicial appeal of revocation of banking licenses, which could lead to reversal or modification of resolution actions and thus undermine their effectiveness. ### Inter-agency cooperation and cross-border elements - Current arrangements broadly cover information exchange in normal times and upon request. - Improvement area: Enhance arrangements specifically in the context of crisis situations, including cross-border cooperation. ### Deposit insurance (PIDM) - Deposit insurance is compulsory for all deposit-taking conventional and Islamic banks. - Coverage: It covers all depositors up to RM 250,000 per depositor per member institution. - Strengths of PIDM: - Broad conformity with the Core Principles for Effective Deposit Insurance Systems. - Culture of cooperation with other safety-net players. - Strong performance in exit from the blanket deposit guarantee adopted in response to the GFC. - Robust public awareness program. - Ongoing planning for potential financial institution resolutions. - Areas for improvement: - Need for MoF to execute a back-up funding agreement. - Need to give PIDM authority to approve operational matters currently approved by the Minister of Finance to enhance PIDM’s operational independence and effectiveness. - Payout period should be shortened substantially. - Current operational details: - The current reserve level for conventional deposits is 0.14 percent of total insured deposits. - PIDM is legally mandated to reimburse depositors promptly, no later than 3 months after a winding up order. ### Islamic finance agenda and challenges - Authorities have two interrelated Islamic finance agendas: - Continue to support domestic growth of Islamic finance while ensuring proper classification and treatment of different products (potentially involving greater risk-sharing). - Become a global Islamic financial hub and promote development of global Islamic finance in collaboration with other jurisdictions. - Key challenges for domestic agenda: - Deposits in Islamic banks are covered by PIDM and most customer liabilities of Islamic banks are perceived to be guaranteed, resulting in little differentiation among conventional deposits, Islamic deposits, and Islamic ‘investments.’ - Current efforts to reclassify liabilities according to their underlying legal characteristics are underway; transition may last some years and involves market, regulatory and supervisory challenges. - Need to transparently segregate institutions that are deposit-taking from “investment” firms; if hybrid institutions are allowed, authorities must consider implications including moral hazard, regulatory arbitrage, and competitive distortions. - With a move toward higher-risk products, the SC must be involved to ensure compliance with capital-markets activity best practices. ### Key risks from the Risk Assessment Matrix (selected) - Slowdown in economic growth - Staff assessment: Medium - Expected impact on financial stability: Medium - Notes: Domestic demand resilient; elections must be held by mid 2013; weaker external demand (U.S., eurozone, China) remains a real threat. - Sharp reversal of capital inflows - Staff assessment: Medium - Expected impact on financial stability: Medium/Low - Notes: Risk driven by external environment or domestic shocks; ample reserves allow mitigation via exchange rate policies/FX intervention. - Decline in real estate and CRE prices - Staff assessment: Medium - Expected impact on financial stability: Medium - Notes: Gross household debt risen to 74 percent of GDP; mortgages 50 percent of total; BNM has applied a 70 percent LTV on third mortgages/property only; additional direct action (taxes, restrictions) may be needed. - Sovereign distress – MTM reductions in sovereign and GLC linked securities - Staff assessment: Low - Expected impact on financial stability: Medium - Notes: Federal Government debt around 52 percent; inaction on fiscal consolidation could raise sovereign bond yields and CDS spreads; potential adverse sovereign-banking loop if severe budgetary problems arise. ### Selected statistics and indicators (as presented) - PIDM payout mandate: reimburse depositors no later than 3 months after a winding up order. - PIDM reserve level for conventional deposits: 0.14 percent of total insured deposits. - Household metrics cited in risk discussion: - Gross household debt: 74 percent of GDP. - Mortgages: 50 percent of total household debt. - Car (auto) loans: 17 percent of total household debt. *Source: IMF staff report content provided in the PDF chapter/section.* ### Appendix 3. Macroeconomic and Asset Price Variables 2012–2016 ### Appendix 3. Macroeconomic and Asset Price Variables 2012–2016 ### Key variables presented - Real GDP Growth (percent) - Inflation (CPI) (percent) - Unemployment (percent) - House Prices (index) - Stock Prices (KLCI) (Index) - Rubber Prices (Sen/kg) - Source: IMF Staff ### Time coverage (charts) - Annual series shown for years: 1996, 1997, 1998, 1999, 2000, 2001, 2002, 2003, 2004, 2005, 2006, 2007, 2008, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016 *Appendix charts plot each variable (and baseline series) over the 1996–2016 horizon.* --- ### Appendix 4. Stress Test Matrix (STeM) for the Banking Sector: Solvency Risk ### Overview of tests and institutions - Type of tests: - Macro-scenario analysis - Sensitivity analysis - 5 single-factor credit shocks - 7 single-factor market risk shocks - Institutions involved: - 36 banks (commercial, Islamic and investment banks) including exposures of Labuan branches - Coverage: 83% of banking system assets - Data source and reference date: - Supervisory data as at end-2011 - Unconsolidated solo basis to separate commercial, Islamic, investment, Labuan and material overseas subsidiaries - Horizon: - Macro-scenario analysis: 5-year (2012-2016) - Sensitivity analysis: 1-year - Top-down includes contagion risk analysis (instantaneous contagion impact on solvency) ### Methodology - Bottom-Up (BU) by banks: - Macro-scenario analysis: banks use consistent macroeconomic assumptions (harmonized by IMF/BNM), adopt internal models for (i) balance sheet and income projections, and (ii) calibration of credit and market shock parameters - Sensitivity analysis: shocks calibrated by BNM and IMF - Top-Down (TD) by FSAP team: - TD solvency test based on Schmeider et al (2012), using macro assumptions consistent with BU (harmonized by IMF/BNM) ### Macro assumptions (scenarios) - Baseline: Latest WEO forecasts; taking into account conflagration of Europe sovereign debt crisis and GFC - Adverse S1: V-shaped recession and slow recovery (peak to trough decline of 2.6SD with respect to average real GDP growth over the previous 12 years) - Adverse S2: L-Shaped recession and prolonged low growth (peak to trough decline of 1.3SD with respect to average real GDP growth over the previous 12 years, but low growth is persistent) - Macroeconomic conditions/variables included: - GDP, inflation, interest rates, exchange rates, unemployment, property prices, and various asset prices (CPO, crude oil, rubber) - Including GDP, exchange rates and inflation rates for 8 major countries - Financial market indicators (harmonized by BNM/IMF): - KLIBOR and KLIRR rates, KLCI index and volatility, yields on MGS, GII and PDS, average financing/mortgage rates - Magnitudes of shocks determined by past (large) historical events, domestic or external ### Risks assessed and behavioral adjustments - Bottom-Up adjustments and projections: - Balance sheet projections (y-o-y) consistent with business strategy and risk appetite - Loan growth (by business sectors and retail segments) - Growth in trading and investment securities portfolios - Overall RWA growth - Growth in deposits and other main funding sources - Revenue components: net interest income, trading and investment income, fee income and other income - Profit and retained earnings: tax rates and dividend payout rates based on current practices - No planned capital raising activities included - Credit risk shocks: PD and LGD shocks (by loan segments), increases in impaired loans, collateral value shocks - Market risk shocks: MTM losses/gains based on interest rate, FX, equity exposures - Shocks on off-balance sheet exposures and higher drawdowns on credit facilities - Top-Down adjustments and models: - Satellite models linking macro variables: BNM provided satellite model estimations linking system-wide credit growth, impaired loans and gross operating income - BNM provided estimations of credit loss rates (baseline) based on satellite models; FSAP team adjusted adverse scenario credit loss rates using EME FSAP benchmarks and expert judgment - Higher RWAs on sovereign exposures - Consistent industry-wide dividend payout and tax rates applied - Only organic capital growth imputed ### Calibration of risk/shock parameters - Revenue shocks modeled based on actual downturn experience; calibrated y-o-y shocks - Point-in-time credit risk parameters and loss rates, including stressed and adverse credit risk parameters and loss rates - Credit risk shocks: - PD and LGD shocks (by loan segments) or stressed impaired loans flow rates - Shocks on collateral value - Market risk shocks: - MTM losses/gains based on net of interest rate, FX, equity exposures ### Regulatory standards and hurdle rates - Hurdle rate examples: - Basel II CAR (RWCR) 8% - Tier 1 (CCR) 4% - Capital definition: based on Basel II and III (both with local regulatory finishes) - Approaches: StA and F-IRB, A-IRB ### Results reported - Sensitivity analysis: - Median/aggregate impact on CAR/Tier1/RWA and CET1 ratio (bank by bank, by industry and system-wide) - Losses as percentage of capital base, CET1 and RWA - Macro-scenario analysis: - Median/aggregate impact on CAR/Tier1/RWA and CET1 ratio (bank by bank, by industry and system-wide) - Losses as percentage of capital base, CET1 and RWA - Stressed capital distribution by banks - Top-down macro-scenario analysis: - Aggregate impact on CAR/Tier1 and CET1 ratio (bank by bank, by industry and system-wide) - CAR/Tier1 shortfall (system wide) - Stressed capital distribution by banks --- ### Appendix 4. Stress Test Matrix (STeM) for the Banking Sector: Liquidity Risk ### Overview of tests and institutions - Type of tests: - Multi-factor liquidity risk shocks (on ringgit and US dollar denominated assets and liabilities) - Liquidity tests: implied and/or fully funded cash-flow tests, maturity mismatch/rollover risk test, liquidity-solvency link test - Institutions involved: - 36 banks (commercial, Islamic and investment banks) including exposures of Labuan branches - Coverage: 83% of banking system assets - Data source and reference date: - Supervisory data as at end-2011 - Unconsolidated solo basis to separate commercial, Islamic, investment, Labuan and material overseas subsidiaries - Horizon: - BU: 1-year - TD: 5 days, 30 days, up to 1 year ### Methodology - Bottom-Up: - Simultaneous liquidity shocks due to deposit withdrawals, crystallization of commitments and contingencies, higher drawdown of undrawn credit facilities, no rollovers of interbank funding and FX swaps, haircuts on liquefiable assets - Top-Down: - Scenario-based multi-factor liquidity risk shocks applied to MYR and USD exposures, calibrated by BNM and agreed by IMF - Driven by institution-specific and market-wide distress events (market-wide risk aversion, dry-up of interbank/wholesale funding, fire sale of assets, counterparty risk concerns, capital deterioration, credit rating downgrades) - Use of IMF Liquidity Testing approach – Schmeider et al (2012) IMF WP/12/3 ### Risks and shock parameters (RM denominated items, BNM Liquidity Framework) - Bank-specific liquidity shocks on different deposit/instrument types with floors and caps: 1) Retail deposit withdrawals: - Types: Fixed deposit, Savings deposit, Current account deposit, Call money, General investment deposit, Specific investment deposit - Floor: 5% - Capped at 30% 2) Corporate deposit and NIDs withdrawals: - Floor: 30% - Capped at 75% for: Fixed deposit, Savings deposit, Current account deposit, General investment deposit, Specific investment deposit - Capped at 100% for: Call money, Short term deposit, NIDs 3) Drawdown on commitments and guarantees: - Largest drawdown rates observed in past 5 years over 30-day horizon - Floor: 5% - Capped at: - 20% for credit facilities - 100% for liquidity facilities - Common shocks for all banks: 1) No rollover of interbank and FX swaps maturing within 30 days 2) Haircut on Class 1 liquefiable assets: 10% 3) Haircut on Class 2 liquefiable assets: 30% ### USD denominated items - Bank-specific liquidity shocks on deposit types and drawdowns based on largest 30-day horizon run-off and drawdown rates observed in past 5 years - No rollover of interbank and FX swap amounts maturing within 30 days ### Additional top-down shock considerations - Liquidity shock drivers: realization of commitments and contingencies, higher drawdown of undrawn credit facilities, asset encumbrance, failure of rollover of maturity assets, valuation reductions in liquefiable assets, stressed haircuts, discounted cash flows, liquidity losses due to forbearance - Calibrated based on advanced economies Lehman-type (market-wide) events ### Regulatory standards and metrics - Net available cumulative mismatches to accommodate liquidity shocks (up to 1 month) as per BNM Liquidity Framework - Hurdle metrics: duration (days, weeks, months) banks can withstand shocks; number of banks showing shortfall ### Results reported - For ringgit: - Net available cumulative mismatch to accommodate liquidity shocks (up to 1 month) - Surplus as a percentage of remaining ringgit deposits (fixed, savings and current) - Shortfall as a percentage of discounted value of Class-1 and Class 2 liquefiable assets - For US dollars: - Net available cumulative mismatch to accommodate liquidity shocks (up to 1 month) - Surplus as a percentage of remaining US dollars deposits (fixed, savings and current) - Time taken by banks to withstand liquidity shocks (days, weeks, months) - How many banks fall short; as a percentage of liquid assets - Liquid assets divided by short-term liabilities due in 30 days --- ### Appendix 4. Other Systemic Tests — Top-Down Contagion/Spillover Risk Analysis ### Institutions and data - Institutions included: - 53 banks (commercial, Islamic, investment banks), excluding 3 newly-established banks - Coverage: 99.8% of banking system assets - Data and baseline date: - Supervisory data as at end-2011 - Unconsolidated solo basis ### Methodology (BNM interbank contagion model) - Based on gross interbank lending and borrowing relationships among all banks - Measures domino effects from simulated bank failure(s) in interbank market, tracks contagion path and quantifies potential capital losses due to cumulative credit and funding shocks - Identifies potential systemic super-spreaders and less systemic counterparties - Model initialization: simulate trigger bank(s) failure which defaults on interbank borrowing and cuts back funding to other banks (excluding BNM) - Two forms of contagion shocks simulated (simultaneously and iteratively until no additional bank has RWCR < 8%): 1) Credit shocks: - Trigger bank(s) default on outstanding interbank borrowing from all other banks (across all remaining maturity) - Other banks absorb 100% loss from default on interbank loans to trigger bank(s) 2) Funding shocks: - Trigger bank(s) stop providing interbank funding (no-rollover of outstanding interbank funding across all remaining maturity) - Other banks need to replace lost funding; assume 50% of funding needs through interbank market is not replaceable - Replacement through fire sale of assets with a haircut of 50% ### Shock assumptions and parameters - Solvency hurdle rate or failure threshold = RWCR < 8% - Risk-weight for interbank loans = 20% - Loss given default (LGD) of interbank loans = 100% - % of funding not refinanced upon each failure = 50% - Haircut on fire sale of assets = 50% ### Scenario design (simultaneous defaults) - Single default: simulate one-at-a-time hypothetical failures to determine contagion degree and vulnerability - Scenario 1: Four largest domestic and foreign banks (by asset size) — assess "too-big-to-fail" - Scenario 2: Four most connected banks (by interbank borrowing counterparty) — assess "too-interconnected-to-fail" - Scenario 3: Four most connected Islamic banks and investment banks (by interbank borrowing counterparty) - Scenario 4: Seven locally incorporated European Banks (LIEBs) — assess potential interbank shocks from LIEBs amid worsened European debt crisis ### Results reported - Single default simulations: - Degree of contagion effect by each bank measured by contagion path, number of contagion rounds, total banking system capital erosion and resultant system RWCR - Degree of vulnerability of each bank measured by hazard rate and absolute hazard - Scenario-based simulations: - Degree of contagion effect by a group of banks measured by contagion path, number of contagion rounds, total banking system capital erosion and resultant system RWCR --- ### Appendix 5. Types and Parameters for Sensitivity Analysis Shocks ### Credit Risk shocks (CRS) - CRS 1. Defaults of PDS/sukuk and other corporate debt securities by rating - Different default rates applied to corporate debt securities issued in Malaysia/EMEs and advance economies - CRS 2. Credit rating migration shock for PDS/sukuk and other corporate debt securities by rating - Different migration rates applied to corporate debt securities issued in Malaysia/EMEs and advance economies - CRS 3. Shock on risk weight for MGS and GII - Increase in risk weights for MGS and GII from 0% to 20% - CRS 4. PD and LGD shocks on Housing Loans - PD=7%, LGD=20% - CRS 5. PD and LGD shocks on Housing Loans - PD=10%, LGD=30% ### Market Risk shocks (MRS) - MRS 1. Interest Rate Risk Shock: Parallel upward shift in yield curve - +300 bps - MRS 2. Interest Rate Risk Shock: Parallel downward shift in yield curve - -250 bps - MRS 3. Interest Rate Risk Shock: Steepening of yield curve - Short Term (<1 year): 46 bps - Medium Term (1 year to 5 years): 252 bps - Long Term (>5 years): 268 bps - MRS 4. Interest Rate Risk Shock: Widening of credit spreads - Short Term (<1 year): 142 bps - Medium Term (1 year to 5 years): 228 bps - Long Term (>5 years): 256 bps - MRS 5. Foreign Exchange Risk Shock - USD +20% - SGD +17% - HKD +15% - JPY +20% - EUR -20% - GBP +15% - AUD +20% - IDR +10% - MRS 6. Equity Risk Shock - FBM KLCI decline (-67.3%) to 500 pts - MRS 7. Equity Risk Shock - FBM KLCI decline (-47.7%) to 800 pts *Appendix tables define the sensitivity shock types and exact parameter magnitudes used in stress test sensitivity analysis.* *Source: _cr1352 - Appendix 3. Macroeconomic and Asset Price Variables 2012–2016 (IMF Staff). --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1352.pdf_