## _cr1498

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### Executive summary and system-wide strengths
- Strong regulatory oversight and post-1997–1998 restructuring supported rapid growth in Malaysia’s financial sector over the last decade.
- Banking consolidation occurred while competition increased under the Financial Sector Master Plan 2001–2010.
- The financial system weathered the 2008 global financial crisis well; the banking sector remained stable due to healthy capital and liquidity levels; impact on the domestic economy was felt primarily through trade channels.
- Malaysian banks are presently well capitalized with comfortable tier 1 capital ratios; domestic banking groups are expected to be able to meet Basel III capital requirements, barring any unforeseen tail-risk scenarios.
- Asset quality has been improving over the last five years.
- Household lending currently accounts for 55 percent of total bank lending.
- Household debt rose to 74.2 percent of GDP in 2011, from 66.3 percent of GDP in 2006.
- Potential risks: a global economic downturn could adversely affect the labor market and strain household balance sheets.
- BNM assessment (Financial Stability and Payments Systems Report 2011): household financial buffers at comfortable levels as growth in household debt accompanied expansion in household financial assets.

### Structure of Malaysia’s financial sector
- System composition and oversight:
  - Banking intermediaries, insurance companies and capital market intermediaries.
  - Banking intermediaries split into Group 1 (supervised by Bank Negara Malaysia (BNM)) and Group 2 (supervised by various government departments and agencies).
  - Capital market intermediaries regulated by the Securities Commission.
  - Offshore financial centre in Labuan supervised by the Labuan Financial Services Authority; Labuan activities conducted in non-Ringgit foreign currencies.
- Diversification and financing shares:
  - Credit intermediation by banking sector and capital market financing shares: 54 percent and 46 percent respectively.
- Growth and development:
  - Banking assets and deposits grew at an annual compounded rate of 14 percent with average real GDP growth of 5.1 percent over the decade.
  - Capital market expanded at an annual compounded rate of 11 percent; funds raised through equity and bond issuance grew at an annual compounded rate of 8 percent.
  - CMP 1 (2000–2010) quantitative achievements (CAGR percent): Stock market capitalization 11.1; Debt securities outstanding 10.8; Derivatives (notional value traded) 19.8; Investment management (AUM) 21.2; Islamic capital market 13.6.
  - By end-2010, more than half of Malaysia’s capital market assets were Syariah-compliant.

### Banking sector consolidation and competition
- Number of domestic commercial banks declined from 22 in 1986 to 8 banking groups currently.
- Top five commercial banking groups account for 70 percent of total banking system assets: Maybank, CIMB Group, Public Bank, Hong Leong Financial Group and RHB Capital.
- Herfindahl Index of bank deposit declined by 27 percent over the decade.
- Financial conglomeration and interlinkages:
  - 8 financial conglomerates account for 73 percent of total assets of the banking system.
  - 6 operate under a financial holding company (FHC) structure; 2 headed by licensed banking institutions.
  - Financial conglomerates under 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.

### Shareholding and public-sector presence
- In four banking groups, government-linked institutions and funds account for between 40–60 percent of total shareholding.
- Institutional names cited: Skim Amanah Saham Bumiputera; Employees' Provident Fund; Permodalan Nasional Berhad; Khazanah Nasional Berhad; Lembaga Tabung Angkatan Tentera; Boustead Holdings Berhad.

### Non-bank intermediaries and DFIs
- Non-bank intermediaries comprise close to 40 percent of total financial system assets; their credit intermediation is sizeable at 93 percent of GDP.
- Domestic capital market: expanded by 2.8 times to MYR2 trillion (US$666.7 billion) by end-2010 from 2000; CMP 2 initiatives estimated to double the market to MYR4.5 trillion (US$1.5 trillion) by 2020.
- Institutional funds rose from 65 percent of GDP in 2000 to 102 percent of GDP in 2010.
- DFIs: 13 in Malaysia, 6 under BNM via the Development Financial Institutions Act 2002.
- DFIs supervised by BNM: gross NPL ratios declined by 1.6 percentage points over the last 3 years to 7.2 percent in 2011; newly impaired loans: 2010: RM611 million; 2011: RM248 million; provision coverage 79 percent (declined from 98.5 in 2009); average leverage ratio in 2011: 13.7 percent (14.8 percent in 2009).

### Resilience during the Global Financial Crisis (2008–2011) and authorities’ measures
- Banking stability indicators:
  - Tier 1 ratio above 10 percent, on average.
  - Limited exposures to subprime securities and foreign borrowing.
  - European banks’ claims amounted to 20 percent of Malaysia’s GDP as at end-2011; collective market share of European banks (locally-incorporated) is 8.9 percent with over 80 percent of their funding in local currency deposits.
- Authorities’ crisis response measures (selected):
  - OPR reduced from 3.5 percent in October 2008 to 2.0 percent in February 2009.
  - PIDM blanket guarantee on all MYR and foreign currency deposits from October 2008 until December 2010 for all banking institutions incorporated in Malaysia.
  - Extension of access to BNM’s standing liquidity facility to insurance companies.
  - Temporary reduction of Statutory Reserve Requirement to 1 percent in 2009 (returned to 4 percent in 2011).
  - Provision of USD liquidity to banks to facilitate trade-related transactions.

### Scenario analyses: absorbing European banks’ deleveraging (Box 3)
- Two scenarios for top 4 Malaysian banks (accounting for two-thirds of total banking assets):
  - Capital scenario: maintain Tier 1 capital ratio at minimum 8.5 percent; domestic banks absorb assets sold by European banks with no haircuts.
  - Liquidity scenario: funding for asset purchases drawn from liquidity buffers up to a maximum loan-to-customer deposit (LTD) ratio of 100 percent.
- Results:
  - If European (excluding UK) banks de-lever by another 50-75 percent, the top 4 banks have between 12 to 8 times capital buffers to absorb those assets while meeting Basel III Tier 1 requirement.
  - Liquidity buffers range between 6 to 4 times of the asset disposal.
  - Tail scenario including U.K. banks de-leveraging by another 50-75 percent: liquidity buffers between 1.4 times and 0.9 times the expected value of assets disposal, though capital buffers remain adequate.
- Caveats:
  - Assumption that domestic banks will absorb assets may be drastic; banks may not draw down cash reserves until LTD reaches 100 percent.
  - U.K. banks’ deleveraging is a tail-scenario; U.K. banks in Malaysia are locally incorporated subsidiaries with dedicated capital and over 80 percent domestic funding.

### Capital adequacy, Basel III readiness and capital structure
- Banking sector RWCR increased 1.6 percentage points since 2006 to 15.1 percent in 2011.
- RWCR at 15.1 percent is above BNM’s minimum requirement of 8 percent and Basel III’s minimum total capital requirement.
- Regulatory comparisons and buffers:
  - Asian peers’ average RWCR: 15.3 percent.
  - Malaysian banks’ tier 1 capital ratio: 12.8 percent, compared to region’s average of 11.4 percent.
  - Capital conservation buffer included: 2.5 percent.
- Reported illustrative metrics (percentages preserved from source table):
  - Capital buffer: 12.1, 8.1, 2.6, 1.7
  - Liquidity buffer: 6.4, 4.3, 1.4, 0.9
- Tier 1 hybrids comprise around 13 percent of total regulatory capital.
- Tier 2 capital composition:
  - 2009: conventional banks 24.4 percent; Islamic banks 16.3 percent.
  - 2011: conventional banks 27.4 percent; Islamic banks 20.3 percent.
- Divergence between commercial and Islamic banks:
  - Islamic banks’ tier 1 ratio declining since 2009; commercial banks’ tier 1 ratio stable.
  - Islamic financing growth: compounded annual growth 38.3 percent versus conventional banks’ 7.9 percent.
- Basel III readiness and scenario analysis (Box 4):
  - As at end-2011: 7 out of 8 domestic banks met Basel III tier 1 and core tier 1 requirements after adjusting for dividend payouts; one banking group has CET1 shortfall around 0.4 percent.
  - Basel III full implementation effective date cited: 1 January 2019.
  - Minimum requirements referenced:
    - Tier 1 capital requirement: 8.5 percent (6.0 percent tier 1 capital plus conservation buffer 2.5 percent).
    - Core Tier 1 capital requirement: 7.0 percent (4.5 percent core tier 1 capital plus conservation buffer 2.5 percent).
  - Box 4 7-year horizon scenario assumptions:
    - Minimum common equity tier I target: 7 percent.
    - Baseline Growth Scenario: annual GDP growth 5 percent; bank credit growth 8.8 percent per year.
    - High Growth Scenario: annual GDP growth 6.5percent; credit growth 12.2 percent per year.
    - Low Growth Scenario: annual GDP growth 2 percent; credit growth 3.6 percent per year.
    - Analysis based on 8 domestic banking groups accounting for 73 percent of total banking system assets; loan growth funded by deposit growth with LTD ratios maintained above 70 percent.
  - Scenario results:
    - Baseline and low growth scenarios: all 8 banks expected to meet Basel III minimum CET1 with earnings retention.
    - High growth scenario: capital sufficient if dividends are not paid; with average dividends paid, 1 bank projected to require additional common equity injections of around U.S.$260 million (0.03 percent of 2011 GDP) to meet CET1 7 percent.
    - Box Table 1 outcome: With Dividend Payout in High Growth scenario: 1 bank shortfall; Additional Equity Capital needed (US$ mil.): 262; Additional Equity Capital needed (as percent of 2011 GDP): 0.03%

### Asset allocation, household lending and vulnerabilities
- Lending composition (2011):
  - Households: 55 percent of total lending.
    - Mortgages (residential property): 26 percent of total lending.
    - Vehicle loans: 12 percent of total lending.
  - Businesses: largely working capital loans 25.3 percent and purchase of non-residential property 6 percent of total lending.
  - Lending to government-linked entities: 12 percent of total lending to business enterprises.
- Trends:
  - Household share of total bank lending increased from 34 percent in 2000 to 55 percent in 2011.
  - Drivers: economic growth averaging 5 percent per year over the past 10 years, lower interest rates, expanded credit coverage, increased product offerings, government initiatives supporting home ownership.
- Commercial vs Islamic banks — household lending composition (2011):
  - Islamic banks: 61 percent of total lending is household financing, about 10 percentage points higher than commercial banks.
  - Commercial banks’ household lending composition: Passenger car 17.0%; Residential property 52.5%; Personal use 6.4%; Credit card 7.3%; Purchase of Securities 5.9%; Non-Residential Property 10.8%.
  - Islamic banks’ household lending composition: Passenger car 39.7%; Residential property 29.8%; Personal use 19.4%; Credit card 1.3%; Purchase of Securities 6.7%; Non-Residential Property 3.0%.
- Unsecured lending:
  - Personal loans and credit cards account for around 15 percent and 5 percent of total household debt respectively.
  - Unsecured lending growth for Islamic banks: compounded annual rate of 47 percent over the last 5 years; 2011 unsecured lending shares: Islamic banks 20 percent of total lending; commercial banks 12 percent of total lending.
- Household debt metrics and buffers:
  - Household debt-to-GDP rising over the last decade; household debt-to-GDP: 74.2 percent in 2011.
  - Households’ financial asset-to-debt ratio: 2.3 times.
  - Three quarters of debts are backed by deposits.
  - BNM introduced Guidelines on Responsible Financing 2011 requiring in-depth suitability and affordability assessments; BNM enhancing household-sector data capture by income category.

### Asset quality, NPLs and provisions
- Gross NPL ratios (2005 to 2011):
  - Commercial banks: 8.9 percent (2005) → 2.7 percent (2011).
  - Islamic banks: 11.6 percent (2005) → 2.6 percent (2011).
- Provision coverage improved from around 60 percent in 2005 to near 100 percent in 2011; banking sector gross NPL ratio and provision coverage as at end-2011: 2.7 percent and 99.6 percent respectively.
- BNM assessment: banks have sufficient collateral cover over NPLs, at 1.4 times.
- Loans under restructuring rose to 1.1 percent of total loans in 2008–2009, later recognized as non-performing following FRS 139 adoption on January 1, 2010.
- Composition of total NPLs:
  - Household: 36.4 percent of total NPLs.
  - Business sector breakdown (percent of NPLs): Manufacturing (including agro-based) 19.9%; Construction 10.4%; Wholesale & retail trade, Restaurants & hotels 8.8%; Transport, storage and communication 6.4%; Finance, insurance and business 5.8%; Electricity, gas and water supply 3.1%; Primary agriculture 1.8%; Mining and quarrying 1.2%; Education, health & others 1.2%; Others 5.0%.

### Residential mortgage asset quality and stress tests
- Banking sector average PD and LGD for residential mortgage lending: 3.1 percent and 19 percent respectively.
- World Bank international stress scenario median PD and LGD: 18.5 percent and 42.5 percent respectively.
- Tabled scenario outcomes (Residential Property 2011):
  - Country-specific adverse scenario:
    - Average PD: 10.0%
    - Average LGD: 30.0%
    - Expected Loss Amount (MYR mil): 8,064
    - Residential loans (MYR million): 260,724
    - Total Loans (MYR million): 990,134
    - Residential NPL (MYR million): 14,496
    - Total NPL (MYR million): 34,644
    - Pro-forma residential NPL ratio: 5.6%
    - Pro-forma total gross NPL ratio 1/: 3.5%
    - Change in Tier 1 capital: -15.4%
  - Tail Scenario from international stress:
    - Average PD: 18.5%
    - Average LGD: 42.5%
    - Expected Loss Amount (MYR mil): 21,133
    - Residential loans (MYR million): 247,655
    - Total Loans (MYR million): 977,065
    - Residential NPL (MYR million): 27,565
    - Total NPL (MYR million): 47,713
    - Pro-forma residential NPL ratio: 11.1%
    - Pro-forma total gross NPL ratio 1/: 4.9%
    - Change in Tier 1 capital: -5.9%
  - Baseline / average:
    - Average PD: 3.1%
    - Average LGD: 19.0%
    - Expected Loss Amount (MYR mil): 1,583
    - Residential loans (MYR million): 268,788
    - Total Loans (MYR million): 998,198
    - Residential NPL (MYR million): 6,432
    - Total NPL (MYR million): 26,580
    - Pro-forma residential NPL ratio: 2.4%
    - Pro-forma total gross NPL ratio 1/: 2.7%
- BNM surveillance:
  - Centralized Central Credit Reference Information System (CCRIS) enables banks to track repayment behavior; loans-in-arrears after a month are reported.
  - BNM monitors counseling and debt management cases conducted by AKPK; recent increases noted.

### Lending to business sector and sectoral vulnerabilities
- Loans to business sector: 38 percent of overall banking system loans; 58 percent of business loans to large corporations, remainder to SMEs.
- SMEs: turnover under MYR25 million; SME gross NPL ratio improved from 10.2 percent in 2006 to 3.9 percent in 2011.
- Exposure to highly leveraged companies (debt-to-equity ratio ≥ 2): 2 percent of total lending to business enterprises or 0.8 percent of total bank lending; impaired loans of these corporations account for 0.4 percent of total impaired loans in the business sector.
- Bank lending to GLCs: 12 percent of total lending to business enterprises and 5 percent of total bank lending; average gross NPL ratio for GLCs: 0.03 percent over the last 3 years.
- Construction sector:
  - Bank lending grew at annual compounded rate of 5.2 percent from 2006 to 2011; construction accounts for around 4 percent of total bank lending and 10 percent of total NPLs.
  - Gross NPL ratios for construction declined from 19 percent in 2006 to 7 percent in 2011.
  - BNM intensified monitoring of the construction sector given growing exposures and property market developments.

### Overseas expansion, internal controls and supervisory monitoring
- Six out of eight Malaysian banking groups have overseas operations in 19 countries; overseas assets account for 19 percent of their total assets.
- Asia comprises 70 percent of assets abroad; overseas lending activities account for 75 percent of total assets of overseas operations.
- Operating income from overseas operations accounts for 30 percent of total operating income; contribution to profitability at group level ranged between 2 percent to 35 percent.
- International experience benchmark: review internal risk management and supervisory response when overseas assets reach 30 percent of total assets.
- BNM monitors material overseas operations monthly and conducts frequent onsite examinations on key material overseas outfits.

### Liquidity, funding and deposit insurance
- Banking system liquid assets-to-deposits and short term funding around 22 percent (in line with region’s average).
- Funding from domestic deposits: 85 percent of total funding.
- CASA deposits contribute close to 40 percent of total deposits.
- Term deposits share high relative to peers; term deposit holders allowed to withdraw prior to maturity without loss of principal (returns may be forfeited).
- Deposit composition: deposits from business enterprises 37 percent of total banking deposits; household deposits 35 percent.
- Deposit placements by one large corporate: 24 percent of total business deposits or 9 percent of total banking system deposits.
- PIDM deposit insurance coverage:
  - Insured up to MYR 250,000 (US$84,000) per depositor per member institution (principal and interest).
  - Insured limit covers 99 percent of existing depositors in full or 33 percent of total deposits in the banking system.
  - Coverage extended to foreign currency denominated deposits and Islamic accounts.

### Liquidity framework and contingency
- BNM’s New Liquidity Framework requires banks to bucket maturing assets/obligations and maintain surplus liquidity:
  - At least 3 percent of total outstanding deposits for the one-week bucket.
  - 5 percent of total outstanding deposits for the above one week to one month bucket after accounting for historical adverse behavior assumptions.
- Major banks manage liquidity risk with contingency plans and internal stress tests.

### Earnings, efficiency, derivatives and market risks
- Profitability and efficiency:
  - ROA 1.5 percent and ROE 16.8 percent for 2011, above regional averages.
  - Cost-to-income ratios relatively lower and comparable to Hong Kong and Singapore.
- Commercial vs Islamic banks:
  - Commercial banks show higher cost efficiency; Islamic banks’ cost efficiency index rose from 73.0 percent in 2006 to 95.1 percent in 2011.
  - Islamic banks operate under increasing returns-to-scale; cost reductions via higher CASA could enhance returns.
- Derivatives:
  - FX derivatives grown at compounded annual rate of 18 percent over last 5 years; IR derivatives at 5 percent.
  - 2011 composition: FX derivatives 69.4 percent of total OTC derivatives; IR derivatives 27.4 percent.
  - Plain vanilla FX swaps/forwards 88 percent of FX derivatives; plain vanilla IRS 60 percent of IR derivatives.
  - Current net exposure to FX and IR derivatives: 0.01 percent of total assets; gross notional close to 70 percent of total assets without netting.
  - Net derivatives gains contribution to pre-tax profits: commercial banks 11.9 percent in 2008, declined through 2010, rebounded to 7 percent in 2011; Islamic banks net derivatives gains picked up in 2010 (~3 percent) before declining in 2011.

### Cross-currency basis swap spreads, offshore NDFs and domestic liquidity
- Mechanism and risk:
  - Dislocations in international funding markets can cause domestic borrowers to borrow locally and swap into foreign currencies, potentially reducing domestic liquidity and widening basis spreads.
- Empirical observation for Malaysia:
  - Effect not significant at present as excess liquidity remains high.
- Figure 54 chart annotations and scales preserved from source:
  - Left-scale tick labels: 0, 50000, 100000, 150000, 200000, 250000, 300000, 350000, 400000 (Excess Liquidity (MYR mil) Left Scale).
  - Right-scale tick labels: -300, -250, -200, -150, -100, -50, 0 (3-year and 5-year series Right Scale).
  - Time-series x-axis labels (date points presented): 1/2/2008 3/2/2008 5/2/2008 7/2/2008 9/2/2008 11/2/2008 1/2/2009 3/2/2009 5/2/2009 7/2/2009 9/2/2009 11/2/2009 1/2/2010 3/2/2010 5/2/2010 7/2/2010 9/2/2010 11/2/2010 1/2/2011 3/2/2011 5/2/2011 7/2/2011 9/2/2011 11/2/2011 1/2/2012.
- Observational implication: high excess liquidity implies transmission where widening basis spreads materially reduce domestic liquidity is not significant for Malaysia at this time.

### Macroprudential considerations and policy implications
- Stylized credit cycle indicators:
  - Real GDP growth: 0.5 percent in 2001 → peak 7.2 percent in 2010 → 5.1 percent in 2011.
  - Private sector credit-to-GDP: 112 percent in 2011.
  - Credit compounded annual growth close to 10 percent over last 5 years.
  - Residential real estate prices: continue to appreciate after adjusting for CPI inflation.
  - Equity market price-to-book value declining since 2011.
- Policy considerations in a late expansionary phase:
  - Bolster banks’ resilience through earnings retention and raising capital base.
  - Extend macroprudential tools to curb exuberance and promote macroeconomic stability.
  - Maintain policy flexibility and space for preemptive measures if macro indicators point to elevated downside risk.

*Prepared by Julian T.S.Chow (IMF) in the context of the 2013 Malaysia FSAP; IMF staff compilation from the provided chapter content.*

### Executive Summary ......................................................................................................

### _cr1498 - Executive Summary ......................................................................................................

### Executive Summary
- Strong regulatory oversight and post-1997–1998 restructuring supported rapid growth in Malaysia’s financial sector over the last decade.
- The banking sector has undergone consolidation while competition increased following measures implemented under the Financial Sector Master Plan 2001–2010.
- The financial system weathered the 2008 global financial crisis well; the banking sector remained stable due to healthy capital and liquidity levels, while the impact on the domestic economy was felt primarily through trade channels.
- Malaysian banks are presently well capitalized with comfortable tier 1 capital ratios.
- Domestic banking groups are expected to be able to meet Basel III capital requirements, barring any unforeseen tail-risk scenarios.
- Although the full implementation of Basel III only begins in 2019, maintaining high equity capital buffers should enhance stability and enable hybrid capital to be retired when they reach maturity or call dates.
- Asset quality has been improving over the last five years.
- Significant growth in lending to the household sector has been driven by sustained economic growth:
  - Lending to households currently accounts for 55 percent of total bank lending.
  - Household debt has risen to 74.2 percent of GDP in 2011, from 66.3 percent of GDP in 2006.
- Potential risks: a global economic downturn could adversely affect the labor market and strain household balance sheets.
- BNM, in its Financial Stability and Payments Systems Report 2011, assessed household financial buffers to be at comfortable levels as the growth in household debt has generally been accompanied by a corresponding expansion in household financial assets.
- Stronger financial positions and risk management capability have enabled domestic banking groups to pursue overseas expansions, mostly within the region.
- The importance to some banks of overseas assets and earnings is reaching levels which, based on international experience, warrant a review of internal controls.
- BNM monitors developments at material overseas operations of banks on a monthly basis and conducts frequent onsite examination on key material overseas outfit.

### I. Structure of Malaysia’s Financial Sector
- Overview:
  - The Malaysian financial system comprises banking intermediaries, insurance companies and capital market intermediaries (Figure 1).
  - Banking intermediaries are in two groups:
    - Group 1 (supervised by Bank Negara Malaysia (BNM)): commercial banking institutions (including Islamic), investment banks (co-regulated with the Securities Commission) and development financial institutions (DFIs).
    - Group 2 (supervision by various government departments and agencies): non-bank financial institutions such as credit co-operatives, other DFIs and a building society.
  - Insurance companies comprise conventional and Islamic (takaful) life and general insurers and reinsurers and are supervised by BNM.
  - BNM regulates the foreign exchange and money market and undertakes oversight of the payment system.
  - Capital market intermediaries are regulated by the Securities Commission and comprise fund management companies, broker-dealers, investment banks and the securities and derivatives market.
  - There is an offshore financial centre in Labuan, supervised by the Labuan Financial Services Authority; Labuan business activities are carried out in non-Ringgit foreign currencies.
- Diversification and financing shares:
  - The financial sector is well diversified.
  - Credit intermediation by the banking sector has increasingly been complemented by capital market developments through growth in provident and pension funds, insurance and mutual funds.
  - The share of financing activity between financial institutions and capital markets is almost equal, at 54 percent and 46 percent respectively.
- Growth over the last decade:
  - Malaysia’s banking assets and deposits grew at an annual compounded rate of 14 percent with average real GDP growth of 5.1 percent.
  - Regional peers’ average banking assets and deposits growth was 12 percent with average real GDP growth of 5.4 percent (Figure 2).
  - The size of the capital market expanded at an annual compounded rate of 11 percent.
  - Funds raised through equity and bond issuance grew at an annual compounded rate of 8 percent (Figure 3).
  - The robust growth was underpinned by two financial sector development blueprints – the Financial Sector Masterplan (FSMP) and the Capital Market Masterplan (CMP).
- Development Financial Institutions (DFIs):
  - There are 13 DFIs in Malaysia of which 6 come under the purview of BNM through the Development Financial Institutions Act 2002.
- Labuan offshore centre:
  - Labuan financial centre activities are conducted in non-Ringgit foreign currencies.
- FSMP and CMP outcomes (high-level):
  - FSMP (2001–2010) objectives implemented in three phases: Phase 1: Enhancing domestic financial sector capacity and promoting financial stability to meet socio-economic objectives; Phase 2: Ensuring level playing field and intensify competitive pressure; Phase 3: Introducing new foreign competition and assimilating into global market.
  - FSMP implementation: all recommendations completed and some ongoing; succeeded by the Financial Sector Blueprint 2011-2020.
  - CMP 1 (2001–2010) objectives: transform domestic capital market, promote investment management industry, enhance competitiveness, strengthen intermediation, provide facilitative regulatory regime, establish Malaysia as an international Islamic capital market centre.
  - By end-2010, 95 percent of CMP 1 recommendations completed; CMP 2 focuses on expanding the role of capital market and governance for investor protection.
- Selected quantitative achievements under CMP 1 (2000–2010):
  - Stock market capitalization: Compounded Annual Growth Rate from 2000-2010 (percent): 11.1.
  - Debt securities outstanding: Compounded Annual Growth Rate from 2000-2010 (percent): 10.8.
  - Derivatives (notional value traded): Compounded Annual Growth Rate from 2000-2010 (percent): 19.8.
  - Investment management (assets under management): Compounded Annual Growth Rate from 2000-2010 (percent): 21.2.
  - Islamic capital market: Compounded Annual Growth Rate from 2000-2010 (percent): 13.6.
  - Additional CMP 1 highlights:
    - Malaysia became the 3rd largest local currency bond market in Asia.
    - Penetration rate of the unit trust industry (measured by unit trust NAV over stock market capitalization) rose from 10.0% in 2000 to 17.8% in 2010.
    - Islamic capital market more than tripled in size from 2000-2010; as at the end-2010, more than half of Malaysia’s capital market assets were Syariah-compliant.

*Prepared by Julian T.S.Chow (IMF) in the context of the 2013 Malaysia FSAP.*

### 4.       The banking sector has undergone consolidation. Overall, competition has

### _cr1498 - 4.       The banking sector has undergone consolidation. Overall, competition has

### Banking sector consolidation and competition
- The number of domestic commercial banks declined from 22 in 1986 to 8 banking groups currently.
- Finance companies were merged into commercial banking groups; discount houses and securities firms were merged to become investment banks.
- One Malaysian commercial bank is placed among the world’s top 200 banks by asset size.
- Consolidation led to cost rationalization and raised competition:
  - The Herfindahl Index of bank deposit declined by 27 percent over the decade as deposits are being priced more competitively.
- The top five commercial banking groups now account for 70 percent of total banking system assets.
- The top 5 commercial banking groups are Maybank, CIMB Group, Public Bank, Hong Leong Financial Group and RHB Capital.

### Shareholding by government-linked institutions
- In four banking groups, government-linked institutions and funds account for between 40–60 percent of total shareholding.
- Specific institutional names mentioned in the shareholding context include:
  - Skim Amanah Saham Bumiputera
  - Employees' Provident Fund
  - Permodalan Nasional Berhad
  - Khazanah Nasional Berhad
  - Lembaga Tabung Angkatan Tentera
  - Boustead Holdings Berhad
- Footnotes clarify:
  - Bumiputera fund managed by Permodalan Nasional Berhad.
  - The EPF is a government agency under the Ministry of Finance.
  - Khazanah Nasional Berhad is the investment holding arm of the Government.
  - Lembaga Tabung Angkatan Tentera refers to the Malaysian Armed Forces Fund Board.
  - Boustead Holdings Berhad is 59.4 percent owned by the Malaysian Armed Forces Fund Board.

### Financial conglomeration and interlinkages
- The financial system has become highly interconnected through the wholesale funding market.
- Financial conglomeration: currently 8 financial conglomerates in Malaysia.
  - 6 operate under a financial holding company (FHC) structure.
  - 2 groups are headed by licensed banking institutions.
- The 8 financial conglomerates account for 73 percent of total assets of 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.

### Non-bank intermediaries and market development
- Non-bank intermediaries (pension and provident funds, unit trusts, insurance companies, DFIs) comprise close to 40 percent of total financial system assets.
- Their credit intermediation is sizeable at 93 percent of GDP.
- Domestic capital market growth:
  - Expanded by 2.8 times to MYR2 trillion (US$666.7 billion) by the end of 2010 from 2000.
  - SC estimates CMP 2 initiatives would double the domestic capital market to MYR4.5 trillion (US$1.5 trillion) by 2020.
- BNM projected that by 2020, market-based financing activities would increase to 52 percent of total financing from 46 percent currently.
- Institutional funds rose from 65 percent of GDP in 2000 to 102 percent of GDP in 2010.
- Assets under management grew by 21.2 percent annually; unit trust net asset value expanded 18.0 percent annually.
- Insurance companies, including takaful operators, account for 22.5 percent of GDP.

### Development Financial Institutions (DFIs)
- DFIs provide direct lending to targeted sectors: agriculture, SMEs, infrastructure, maritime, export-oriented sector, high-technology and capital-intensive industries.
- Asset quality improvements in DFIs supervised by BNM:
  - Gross NPL ratios declined by 1.6 percentage points over the last 3 years, although NPLs remain high at 7.2 percent in 2011.
  - Quantum of newly impaired loans: 2010: RM611 million; 2011: RM248 million.
  - Provision coverage is 79 percent (declined from 98.5 in 2009).
  - Average leverage ratio of DFIs in 2011: 13.7 percent (slightly lower compared to 14.8 percent in 2009).
- Provision coverage and leverage ratio computation notes:
  - Provision coverage reported as a percentage (79 percent).
  - Leverage ratio computed as: Total Shareholders' Funds/Total Assets.

### Co-operatives and other non-bank intermediaries
- Co-operative intermediaries are relatively small at 0.4 percent of GDP.
- Co-operatives divided into:
  - Non-financial cooperatives (housing, farming and agriculture, industrial and transportation).
  - Financial cooperatives (take deposits and extend loans to members; members predominantly fixed-salary earners from the civil service and statutory bodies).
- Other non-bank credit intermediaries include unit trusts, the Employees’ Provident Fund (EPF), pension funds and insurance companies.

### Resilience during the Global Financial Crisis (2008–2011)
- The financial system weathered the 2008 global financial crisis well; impact on domestic economy primarily via trade channels.
- Banking system stability underpinned by healthy capital and liquidity:
  - Tier 1 ratio above 10 percent, on average.
  - Banks had limited exposures to subprime securities and foreign borrowing.
- Interbank–treasury bill spreads widened after Lehman in Q3 2008 but the widening was small compared with Hong Kong and Singapore; spreads normalized by end-Q1 2009.
- During Q4 2011, tightening of global USD liquidity had manageable impact:
  - Reliance on foreign currency funding was minimal.
  - Banks could raise funding through domestic bond market; strong demand from local fund managers, especially for high grade papers.
  - Structural surplus liquidity (banking sector claims on the central bank) remained high.
- European banks’ deleveraging impact assessed as muted:
  - European banks’ claims amounted to 20 percent of Malaysia’s GDP as at end-2011.
  - Collective market share of European banks (locally-incorporated) is 8.9 percent; local currency deposits form over 80 percent of their funding, of which 47 percent are from retail deposits.
  - All foreign banks operate as locally-incorporated subsidiaries; BNM requires approval prior to repatriation of capital reserves.
  - No surges in special dividend payments to parent banks in 2011.

### Authorities’ crisis response measures (selected)
- Reductions to BNM’s Overnight Policy Rate (OPR) from 3.5 percent in October 2008 to 2.0 percent in February 2009.
- Extension of a blanket guarantee by PIDM on all MYR and foreign currency deposits from October 2008 until December 2010 for all banking institutions incorporated in Malaysia.
- Extension of access to BNM’s standing liquidity facility to insurance companies (facility was not utilized by insurance companies during the crisis).
- Temporary reduction of the Statutory Reserve Requirement to 1 percent in 2009 (subsequently returned to 4 percent in 2011).
- Provision of USD liquidity to banks to facilitate trade-related transactions (facility was not utilized by banks during the crisis).

### Scenario analysis: Absorbing European banks’ deleveraging (Box 3)
- Two scenarios tested for the top 4 Malaysian banks (accounting for two-thirds of total banking assets):
  - Capital scenario: maintain Tier 1 capital ratio at a minimum of 8.5 percent (Basel III including conservation buffers); domestic banks absorb assets sold by European banks with no haircuts.
  - Liquidity scenario: use loan-to-customer deposit (LTD) ratio; funding for asset purchases drawn from liquidity buffers up to a maximum LTD ratio of 100 percent.
- Results:
  - If European (excluding UK) banks de-lever by another 50-75 percent, the top 4 banks have between 12 to 8 times capital buffers to absorb those assets while meeting Basel III’s Tier 1 capital requirement.
  - Liquidity buffers range between 6 to 4 times of the asset disposal.
  - Tail scenario including U.K. banks de-leveraging by another 50-75 percent: liquidity buffers would be between 1.4 times and 0.9 times the expected value of assets disposal, though capital buffers remain adequate.
- Caveats:
  - Assumption that domestic banks will absorb assets may be drastic; banks may not drawdown cash reserves until LTD reaches 100 percent.
  - Assumption of deleveraging by U.K. banks is a tail-scenario; U.K. banks in Malaysia are locally incorporated subsidiaries with dedicated capital and over 80 percent domestic funding.

### Banking sector performance — Capital
- Banking sector risk-weighted capital adequacy ratio (RWCR) increased 1.6 percentage points since 2006 to 15.1 percent in 2011.
- RWCR at 15.1 percent is comfortably above BNM’s minimum requirement of 8 percent and Basel III’s minimum total capital requirement.

_Italic: IMF staff compilation from the provided chapter content._

### 10.5 percent.

### _cr1498 - 10.5 percent.

### Capital Adequacy and Buffers
- Regulatory capital to risk-weighted assets: Malaysian level compared to Asian peers’ average of 15.3 percent.
- Malaysian banks’ tier 1 capital ratio: 12.8 percent, compared to region’s average of 11.4 percent.
- Banking sector capital-to-asset ratio: slightly above regional peers’ average (no numeric value provided beyond description).
- Capital conservation buffer included: 2.5 percent.
- Reported adequacy metrics in illustrative table (percentages preserved as shown in source):
  - Capital buffer: 12.1, 8.1, 2.6, 1.7
  - Liquidity buffer: 6.4, 4.3, 1.4, 0.9

### Capital Structure and Hybrids
- Tier 1 hybrids comprise around 13 percent of total regulatory capital, slightly above the region’s average.
- Hybrids share is lower than in Japan, Singapore and Hong Kong SAR.
- Recent global financial crisis observation: most forms of hybrid capital have weak loss absorption capacity.
- Regional trend: some countries replacing hybrids with common equity or contingent capital ahead of Basel III cutoff.

### Tier 2 Capital and Risks
- Tier 2 capital composition:
  - 2009: conventional banks 24.4 percent of capital; Islamic banks 16.3 percent of capital.
  - 2011: conventional banks 27.4 percent of capital; Islamic banks 20.3 percent of capital.
- Risk noted: failure to redeem hybrid securities on call dates can significantly increase credit spreads and lead to funding pressures (example: Deutsche Bank December 2008 event described).
- BNM supervisory stance: use of tier 2 sub-debts subject to stringent approval process; banks’ exposures under close surveillance; banks must obtain BNM approval prior to utilizing tier 2 sub-debt programs to avoid grandfathering exploitation.

### Divergence between Commercial and Islamic Banks
- Islamic banks’ tier 1 ratio has been on a declining trend since 2009; commercial banks’ tier 1 ratio remained stable.
- Drivers of divergence:
  - Islamic banks’ financing growth: compounded annual growth of 38.3 percent versus conventional banks’ 7.9 percent.
  - Capital management: Islamic subsidiaries often managed on a group-wide basis with relatively lower capital at subsidiary level; BNM assesses strong parent capital commitment mitigates group risk.

### Basel III Readiness and Scenario Analysis
- As at end-2011: 7 out of 8 domestic banks have met Basel III’s tier 1 and core tier 1 capital requirements after adjusting for dividend payouts.
- Shortfall: one banking group with CET1 ratio below 7 percent has a shortfall of around 0.4 percent.
- Basel III full implementation effective date cited: 1 January 2019 (full implementation only taking effect in 2019).
- Minimum requirements referenced:
  - Tier 1 capital requirement: 8.5 percent (6.0 percent tier 1 capital plus conservation buffer of 2.5 percent).
  - Core Tier 1 capital requirement: 7.0 percent (4.5 percent core tier 1 capital plus conservation buffer of 2.5 percent).
- Box 4 scenario analysis (7-year horizon) assumptions:
  - Minimum common equity tier I target: 7 percent (minimum common equity of 4.5 percent with capital conservation buffer of 2.5 percent).
  - Baseline Growth Scenario: annual GDP growth rate of 5 percent with bank credit growth of 8.8 percent per year.
  - High Growth Scenario: annual GDP growth rate of 6.5percent with credit growth of 12.2 percent per year.
  - Low Growth Scenario: annual GDP growth rate of 2 percent with credit growth of 3.6 percent per year.
  - Analysis based on 8 domestic banking groups accounting for 73 percent of total banking system assets.
  - Loan growth funded by deposit growth with loan-to-deposit ratios maintained at current levels above 70 percent.
- Scenario results (preserving exact phrasing and figures):
  - In baseline and low growth scenarios with capital generation from earnings, all 8 domestic banks expected to meet Basel III’s minimum core tier 1 capital requirement while supporting economic growth.
  - In a ‘high growth’ scenario, capital is sufficient if dividends are not paid.
  - Even if average dividends are paid, only 1 bank is projected to require additional common equity injections of around U.S.$260 million (0.03 percent of 2011 GDP) to meet the minimum CET1 requirement of 7 percent.
  - BNM indicated dividend requests would unlikely be approved should earnings retention prove to be critical to further strengthen capital.
- Box Table 1 outcome highlights:
  - With Dividend Payout in High Growth scenario: 1 bank shortfall; Additional Equity Capital needed (US$ mil.): 262; Additional Equity Capital needed (as percent of 2011 GDP): 0.03%

### Asset Allocation and Lending Structure
- Lending classification: households and business enterprises.
- Lending to households: 55 percent of total lending.
  - Mortgages (residential property): 26 percent of total lending.
  - Vehicle loans: 12 percent of total lending.
- Lending to businesses: largely working capital loans (25.3 percent of total lending) and purchase of non-residential property (6 percent of total lending).
- Lending to government-linked entities: 12 percent of total lending to business enterprises.

### Trends in Household Lending
- Household share of total bank lending increased from 34 percent in 2000 to 55 percent in 2011.
- Contributing factors:
  - Economic growth averaging 5 percent per year over the past 10 years.
  - Lower interest rates, expanded credit coverage, increased product offerings.
  - Government initiatives supporting home ownership for first-time buyers.

### Commercial vs Islamic Banks — Household Lending Composition
- 2011 household financing share:
  - Islamic banks: 61 percent of total lending, about 10 percentage points higher than commercial banks.
- Commercial banks’ household lending: two-thirds exposure to property lending (residential and non-residential).
- Islamic banks’ household lending: higher exposure to hire purchase (passenger vehicle) and personal loans which account for 60 percent of their total lending to households.
- Specific composition (2011):
  - Commercial banks lending to households: Passenger car (vehicles) 17.0%; Residential property 52.5%; Personal use 6.4%; Credit card 7.3%; Purchase of Securities 5.9%; Non-Residential Property 10.8%.
  - Islamic banks lending to households: Passenger car (vehicles) 39.7%; Residential property 29.8%; Personal use 19.4%; Credit card 1.3%; Purchase of Securities 6.7%; Non-Residential Property 3.0%.

### Asset Quality: NPLs and Provisions
- Gross NPL ratios (2005 to 2011):
  - Commercial banks: declined from 8.9 percent in 2005 to 2.7 percent in 2011.
  - Islamic banks: declined from 11.6 percent in 2005 to 2.6 percent in 2011.
- Provision coverage improved from around 60 percent in 2005 to near 100 percent in 2011.
- Loans under restructuring rose to 1.1 percent of total loans in 2008–2009, later recognized as non-performing following FRS 139 adoption on January 1, 2010.
- Banking sector gross NPL ratio and provision coverage as at end-2011: 2.7 percent and 99.6 percent respectively.
- Regional averages for comparison: gross NPL ratio 2.0 percent and provision coverage 114.7 percent (as presented in source).
- BNM assessment: banks have sufficient collateral cover over NPLs, at 1.4 times.

### Composition of Non-performing Loans
- Non-performing lending composition:
  - Household: 36.4 percent of total NPLs.
  - Business sector breakdown (percent of NPLs): Manufacturing (including agro-based) 19.9%; Construction 10.4%; Wholesale & retail trade, Restaurants & hotels 8.8%; Transport, storage and communication 6.4%; Finance, insurance and business 5.8%; Electricity, gas and water supply 3.1%; Primary agriculture 1.8%; Mining and quarrying 1.2%; Education, health & others 1.2%; Others 5.0%.

### Potential Vulnerabilities and Household Debt
- Household debt trends:
  - Household debt-to-GDP ratio rising over the last decade.
  - After controlling for per capita income, current household debt level is high in comparison with peers.
- BNM analysis suggests:
  - Rising household indebtedness supported by healthy household fundamentals and financial capacity.
  - Households’ current financial asset-to-debt ratio is 2.3 times.
  - Sustained high savings rate should provide sufficient buffer to households if faced with income shocks.
  - Three quarters of debts are backed by deposits.
- BNM supervisory response: Guidelines on Responsible Financing 2011 require banks to conduct in-depth suitability and affordability assessments before offering financing; BNM undertaking efforts to enhance household-sector data capture for granular monitoring by income category.

### Unsecured Lending and Mortgages
- Unsecured financing (personal loans and credit cards) growth:
  - Personal loans and credit cards account for around 15 percent and 5 percent of total household debt respectively.
  - Growth in unsecured lending by Islamic banks: compounded annual rate of 47 percent over the last 5 years, outstripping commercial banks by factor of 4 times.
  - 2011 unsecured lending shares: Islamic banks 20 percent of total lending; commercial banks 12 percent of total lending.
- Residential mortgage financing:
  - Accounts for half of total bank lending to households.
  - Residential mortgages growth: compounded annual rate of 11 percent over the last 5 years.
  - Mortgage sector gross NPL ratios: improved markedly from 8.7 percent (earlier period) — text truncated at end of provided content.

*Source: _cr1498 - 10.5 percent.*

### 2.4 percent on the back of resilient

### _cr1498 - 2.4 percent on the back of resilient

### Residential mortgage asset quality and stress test results
- Banking sector average PD and LGD for residential mortgage lending are currently: 3.1 percent and 19 percent respectively.
- World Bank international stress scenario (for comparison): median PD and LGD could rise to 18.5 percent and 42.5 percent respectively.
- Tabled scenario outcomes (Residential Property 2011):
  - Country-specific adverse scenario:
    - Average PD: 10.0%
    - Average LGD: 30.0%
    - Expected Loss Amount (MYR mil): 8,064
    - Residential loans (MYR million): 260,724
    - Total Loans (MYR million): 990,134
    - Residential NPL (MYR million): 14,496
    - Total NPL (MYR million): 34,644
    - Pro-forma residential NPL ratio: 5.6%
    - Pro-forma total gross NPL ratio 1/: 3.5%
    - Change in Tier 1 capital: -15.4%
  - Tail Scenario from international stress:
    - Average PD: 18.5%
    - Average LGD: 42.5%
    - Expected Loss Amount (MYR mil): 21,133
    - Residential loans (MYR million): 247,655
    - Total Loans (MYR million): 977,065
    - Residential NPL (MYR million): 27,565
    - Total NPL (MYR million): 47,713
    - Pro-forma residential NPL ratio: 11.1%
    - Pro-forma total gross NPL ratio 1/: 4.9%
    - Change in Tier 1 capital: -5.9%
  - Baseline / average:
    - Average PD: 3.1%
    - Average LGD: 19.0%
    - Expected Loss Amount (MYR mil): 1,583
    - Residential loans (MYR million): 268,788
    - Total Loans (MYR million): 998,198
    - Residential NPL (MYR million): 6,432
    - Total NPL (MYR million): 26,580
    - Pro-forma residential NPL ratio: 2.4%
    - Pro-forma total gross NPL ratio 1/: 2.7%

### Household surveillance and early warning
- BNM continues surveillance of household debt-servicing patterns and early warning indicators.
- A centralized Central Credit Reference Information System (CCRIS) enables banks to track repayment behavior; loans-in-arrears after a month are reported.
- BNM monitors trends in counseling and debt management cases conducted by AKPK; recent increases noted.
- BNM monitors overall levels of arrears on a portfolio basis and highlights upward trends at least on a quarterly basis.

### Unsecured lending and counseling trends
- Figures referenced indicate trends in unsecured lending (Commercial and Islamic banks) and in the number of counseling and debt management cases (2009–2011).
- BNM indicated recent increases in AKPK participation and awareness contributed to higher case numbers.

### Lending to the business sector
- Loans to the business sector account for 38 percent of overall banking system loans.
  - Of these, 58 percent are large corporations and the remaining are SMEs.
- SMEs are defined as corporations with a turnover of under MYR25 million.
- Lending quality to SMEs improved: gross NPL ratios declined from 10.2 percent in 2006 to 3.9 percent in 2011.
- About 22 percent of financial institutions’ total exposure to the business sector is to large corporate borrowers.
- Total exposures include loans and private debt securities held by financial institutions.

### Exposure to highly leveraged companies
- Lending to high-leverage companies (debt-to-equity ratio of 2 times and above) accounts for 2 percent of total lending to business enterprises or around 0.8 percent of total bank lending.
- These companies are in building and construction-related materials, property, government-linked companies, oil and gas, and utilities.
- Impaired loans of these highly leveraged corporations account for 0.4 percent of total impaired loans in the business sector.

### Government-linked companies (GLCs)
- Bank lending to GLCs accounts for 12 percent of total lending to business enterprises and 5 percent of total bank lending.
- The average gross NPL ratio for GLCs is very low, at an average of 0.03 percent over the last 3 years.
- Lending to GLCs is subject to the same prudential limits on single customers and the same underwriting practices as other private corporations.

### Sectoral NPL developments and construction sector
- NPLs in utilities and transportation-communication sectors increased during the 2009 slowdown; collectively they contribute close to 10 percent of total gross NPLs.
- Construction sector:
  - Bank lending grew at an annual compounded rate of 5.2 percent from 2006 to 2011.
  - Construction now accounts for around 4 percent of total bank lending and 10 percent of total NPLs.
  - Gross NPL ratios for construction declined from 19 percent in 2006 to 7 percent in 2011.
- BNM has intensified monitoring of the construction sector given growing exposures and property market developments.

### Banks’ overseas expansion and risks
- Malaysian banks' overseas assets: Asia comprises 70 percent of assets abroad.
- Overseas lending activities account for 75 percent of total assets of overseas operations.
- Six out of eight Malaysian banking groups have overseas operations in 19 countries with overseas assets accounting for 19 percent of their total assets.
- Operating income from overseas operations accounts for 30 percent of total operating income; contribution to profitability at group level ranged between 2 percent to 35 percent.
- International experience suggests reviewing internal risk management and supervisory response when overseas assets reach 30 percent of total assets.

### Stylized credit cycle and macroprudential implications
- Real GDP growth: rose from 0.5 percent in 2001 to a peak of 7.2 percent in 2010 before moderating to 5.1 percent in 2011.
- Private sector credit-to-GDP stood at 112 percent in 2011.
- Credit has grown at a compounded annual rate close to 10 percent over the last 5 years.
- Indicators:
  - Equity market price-to-book value has been declining since 2011.
  - Residential real estate prices continue to appreciate after adjusting for CPI inflation.
  - Banks’ credit asset quality has improved, but net interest margins and returns on assets have compressed due to competition.
  - Corporate sector gearing has been reduced while ROE has increased.
- Policy considerations in a late expansionary phase include:
  - Bolstering banks’ resilience through earnings retention and raising banks’ capital base.
  - Extending macroprudential tools to curb exuberance and promote macroeconomic stability.
  - Maintaining sufficient policy flexibility and space for preemptive measures if macro indicators point to elevated downside risk.

### Liquidity
- Banking system liquid assets-to-deposits and short term funding is around 22 percent, in line with the region’s average.
- Funding from domestic deposits accounts for 85 percent of total funding.
- BNM’s New Liquidity Framework requires banks to bucket maturing assets/obligations and maintain surplus liquidity:
  - At least 3 percent of total outstanding deposits for the one-week bucket.
  - 5 percent of total outstanding deposits for the above one week to one month bucket after accounting for historical adverse behavior assumptions.

*Source: _cr1498 - 2.4 percent on the back of resilient*

### 40.      Funding is currently stable with a sizable low-cost domestic deposit base. Banks

### _cr1498 - 40.      Funding is currently stable with a sizable low-cost domestic deposit base. Banks

### Funding and deposit structure
- Banks access stable low-cost current account and savings account (CASA) deposits which contribute close to 40 percent of total deposits.
- The share of term deposits is also high relative to peers and could provide some cushion in the event of large withdrawals of CASA deposits.
- Term deposit holders are allowed to make full withdrawals prior to maturity without incurring any losses to the principal value, although returns may be forfeited.

### Deposit insurance and coverage
- Deposits are insured by the Malaysian Deposit Insurance Corporation (PIDM) up to a maximum limit of MYR 250,000 (US$84,000) per depositor per member institution. This includes both the principal amount of a deposit and the interest.
- According to PIDM, the insured limit provides for 99 percent of existing depositors to be insured in full or 33 percent of total deposits in the banking system.
- Coverage is also extended to foreign currency denominated deposits. All commercial banks licensed under the Banking and Financial Institutions Act 1989 and all Islamic banks licensed under the Islamic Banking Act 1983, including foreign banks operating in Malaysia, are members of PIDM currently. There is also separate deposit insurance protection up to the RM250,000 limit for Islamic accounts.

### Deposit composition and liquidity management
- Deposits from business enterprises comprise 37 percent of total banking deposits, slightly higher compared to household deposits which account for 35 percent.
- Deposit placements by one large corporate accounted for 24 percent of total business deposits or 9 percent of total banking system deposits; this corporate holds balances with most banks in Malaysia.
- Major banks have been managing liquidity risk well with contingency plans in place. On-going efforts to strengthen liquidity management, including internal stress tests, will further strengthen banks’ preparedness in the event of large withdrawals.

### Earnings and efficiency of the banking sector
- Return on assets (ROA) was 1.5 percent and return on equity (ROE) was 16.8 percent for 2011, above regional averages.
- Intermediation cost is lower vis-à-vis peers’ average.
- Cost-to-income ratios are relatively lower and are almost comparable to financial centers such as Hong Kong and Singapore.

### Commercial versus Islamic banks
- Commercial banks’ profitability has been improving after the global financial crisis in 2008 while Islamic banks’ profitability shows signs of moderation from 2010.
- The divergence is largely attributed to overhead cost-to-revenue ratios for Islamic banks which are relatively higher by around 4 to 5 percent due to start up costs of foreign full-fledged Islamic banks; this gap is gradually improving.
- Islamic banks’ overall cost efficiency has been improving significantly over the past 5 years when benchmarked against commercial banks; further improvements to the cost of funds could be made by increasing CASA deposits.

### Floating-rate loan exposure and implications
- Floating-rate loans account for around 40 percent of Islamic banks’ total loans compared to commercial banks’ 75 percent.
- While lower floating-rate exposure may benefit Islamic banks during a policy loosening cycle, profit margins would be reduced in a normalization/tightening cycle. This was evident during the policy loosening cycle in 2009 when Islamic banks’ net profit margins (NIMs) outperformed commercial banks but the gap closed when policy rates were normalized in 2010.
- BNM indicated Islamic banks have intensified efforts in increasing floating rate assets and are actively using hedging instruments such as swaps.

### Data Envelopment Analysis (DEA) findings on efficiency (Box 6)
- Commercial banks continue to exhibit higher cost efficiency than Islamic banks in both 2006 and 2011.
- Over the last 5 years, the cost efficiency gap between commercial and Islamic banks has narrowed by five-fold. From 2006 to 2011:
  - Islamic banks’ cost efficiency index rose from 73.0 percent in 2006 to 95.1 percent in 2011.
- Box Table 1 (FY2011) summary:
  - Commercial Banks: Score 100.0% — RTS indication: Constant
  - Islamic Banks: Score 95.1% — RTS indication: Increasing
  - Mean: 97.6% (2011) and 86.5% (2006)
- The analysis shows Islamic banks are operating under increasing returns-to-scale; one way to enhance returns would be to reduce costs, perhaps by increasing CASA deposits.
- Caveats: assumed constant return to scale; number of banks differs between periods due to new entrants, especially for Islamic banks.

### Derivatives usage, size and risk
- Over the past 5 years, derivatives have been increasingly used by banks to manage risks and as product offerings to corporate clients, largely through the OTC market.
- Growth in FX derivatives has outpaced interest rate (IR) derivatives over the last five years, at compounded annual rates of 18 percent and 5 percent respectively.
- In 2011, FX derivatives comprise 69.4 percent of total OTC derivatives, followed by IR derivatives which account for 27.4 percent.
- Plain vanilla instruments dominate:
  - Plain vanilla FX swaps and forwards account for 88 percent of total FX derivatives.
  - Plain vanilla interest rate swaps account for 60 percent of total IR derivatives.
- Derivative instruments are liquid up to tenors of 3 to 5 years.
- The share of credit derivatives such as credit default swaps (CDS) is negligible, at 0.2 percent.
- Overall, banking institutions’ current exposure to FX and IR derivatives is small:
  - On a net basis, the current exposure to FX and IR derivatives account for 0.01 percent of total assets.
  - Without netting, the gross notional value of these derivatives to total assets is close to 70 percent.
- Performance of derivatives portfolios:
  - For commercial banks, net gains from derivatives amounted to 11.9 percent of pre-tax profits in 2008, steadily declining through 2010 before rebounding to 7 percent in 2011.
  - For Islamic banks, net derivatives gains were flat through 2009, picked up in 2010 to around 3 percent before declining in 2011.
  - The contribution of net derivatives gains remains relatively low in 2011, but sharp increases could raise banks’ exposures to market risks.

### Interlinkages with offshore markets and market dynamics
- The onshore USD/MYR forward appears to be influenced by the offshore non-deliverable forward (NDF); when the divergence between NDF vis-à-vis onshore forward spikes above zero, the onshore forward rate increases and vice versa. A Granger Causality Test with two lags shows changes in NDFs ‘Granger-cause’ changes in the onshore forward.
- Feedback indicates the MYR NDF market is one of the most liquid in Asia, with normal trades of around US$2 billion a day; more recently trading volume has shrunk to around U.S.$350-650 million a day.
- Hedge funds are the biggest players in the offshore NDF market since they cannot access the onshore market, whereas real money investors can and prefer to use onshore because it is cheaper; most non-resident real money investors do not hedge.
- USD/MYR cross currency basis spreads move in tandem with regional currencies such as USD/KRW and USD/SGD, reflecting usage of Malaysia’s bond market by foreign corporations and institutions and swapping proceeds into foreign currencies to lower the cost of debt financing. For instance, Korean issuers have raised approximately MYR7.1 billion (USD 2.3 billion) since 2008 and swapped them back into KRW.

*Source: _cr1498 PDF chapter/section content provided.*

### 54.       International experience shows that a widening of cross currency basis swap

### International experience shows that a widening of cross currency basis swap spreads in some markets could influence the liquidity of domestic markets, particularly during stress

### Cross-currency basis swap spreads and domestic liquidity: mechanism and international experience
- Dislocations in international funding markets could prompt domestic corporations and banks with large foreign currency funding needs to:
  - borrow locally and then swap those proceeds into foreign currencies to fund overseas obligations.
- In some cases, this behavior could lead to a reduction in domestic liquidity, which in turn could feed back into a widening of the basis spreads due to higher funding cost.61,62,63
- Footnotes in the source:
  - 61: "Rising risk premiums and a reduction in dollar funding could also contribute to a reduction in liquidity and widening of basis spreads."
  - 62: "In instances where the central bank sells foreign exchange reserves."
  - 63: "During the Lehman crisis in 2008, an Asian country experienced significant strains in domestic liquidity when one of its largest banks had to fund its own overseas operations and its large corporate clients with overseas obligations through domestic borrowing. The strain on liquidity was compounded by a festival season, during which the demand for cash was high."

### Empirical observation for Malaysia
- "In Malaysia, this effect is not significant at present as excess liquidity remains high (Figure 54)."
- Figure 54 caption labels and series (as presented in the source):
  - Excess Liquidity (MYR mil) (Left Scale)
  - 3-year (Right Scale)
  - 5-year (Right Scale)
  - Annotation: "Widening of basis swap spreads"

### Key data and chart annotations from Figure 54 (as presented in the source)
- Left-scale tick labels shown in the figure: 0, 50000, 100000, 150000, 200000, 250000, 300000, 350000, 400000
- Right-scale tick labels shown in the figure: -300, -250, -200, -150, -100, -50, 0
- Time-series x-axis labels shown in the figure (date points as presented): 1/2/2008 3/2/2008 5/2/2008 7/2/2008 9/2/2008 11/2/2008 1/2/2009 3/2/2009 5/2/2009 7/2/2009 9/2/2009 11/2/2009 1/2/2010 3/2/2010 5/2/2010 7/2/2010 9/2/2010 11/2/2010 1/2/2011 3/2/2011 5/2/2011 7/2/2011 9/2/2011 11/2/2011 1/2/2012

### Implications for monitoring and policy (from source analysis)
- Monitoring indicators:
  - Cross-currency basis swap spreads (e.g., 3-year and 5-year series shown in Figure 54).
  - Domestic excess liquidity measured in MYR (Left Scale in Figure 54).
- Observational implication in the Malaysian context:
  - High excess liquidity at present (as reported) implies the described transmission—where widening basis spreads materially reduce domestic liquidity—is not significant for Malaysia at this time.

*Source: IMF staff compilation as presented in the source content unit.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1498.pdf_