Malaysia
Publication of Financial Sector Assessment Program Documentation—Detailed Assessment of Observance of Core Principles for Effective Deposit Insurance Systems

This paper evaluates and addresses Malaysia’s compliance with the Core Principles for Effective Deposit Insurance Systems (Core Principles), and reviews relevant laws, regulations and regulatory and supervisory practices related to conventional banking sector, and the operations of Perbadanan Insurans Deposit Malaysia (PIDM). Though several weaknesses in the legal framework have been noted in this assessment, there has been no experience with bank failures in Malaysia since PIDM’s establishment in 2005. The paper also covers Islamic deposits, which manage a separate Islamic Deposit Insurance Fund (IDIF).

Abstract

This paper evaluates and addresses Malaysia’s compliance with the Core Principles for Effective Deposit Insurance Systems (Core Principles), and reviews relevant laws, regulations and regulatory and supervisory practices related to conventional banking sector, and the operations of Perbadanan Insurans Deposit Malaysia (PIDM). Though several weaknesses in the legal framework have been noted in this assessment, there has been no experience with bank failures in Malaysia since PIDM’s establishment in 2005. The paper also covers Islamic deposits, which manage a separate Islamic Deposit Insurance Fund (IDIF).

I. Background Information on the Assessment

1. This assessment of compliance with the Core Principles for Effective Deposit Insurance Systems (Core Principles) was conducted as a part of the Financial Sector Assessment Program (FSAP) performed by the International Monetary Fund and the World Bank at the request of the Malaysian government. This assessment was conducted by Claire McGuire, Senior Financial Sector Specialist with the World Bank, during a mission to Malaysia from March 27 to April 13, 2012.

II. Methodology Used for the Assessment

2. The evaluation of the compliance with the Core Principles for Effective Deposit Insurance Systems was conducted on the Malaysia Deposit Insurance Corporation (Perbadanan Insurans Deposit Malaysia or PIDM) utilizing the Methodology for Compliance Assessment adopted in December 2010 by the Bank for International Settlements and the International Association of Deposit Insurers. The Assessment addresses PIDM’s compliance with the Core Principles solely with respect to its operations as an insurer of deposits in commercial banks. In accordance with the Methodology, the Assessment is designed to assess to the extent possible whether the criteria are fulfilled in practice and not just in theory (Methodology at 2).

3. The assessment was based on a review of relevant laws, regulations and regulatory and supervisory practices related to the conventional banking sector and the operations of PIDM. Multiple meetings were held with various members of PIDM staff as well as senior management of PIDM, staff and senior management of Bank Negara Malaysia (BNM), local and foreign commercial and Islamic banks, personnel at the Ministry of Finance and a lawyer in private practice. PIDM completed a self-assessment in preparation for the FSAP and conducted a Workshop using the Core Principles Methodology to assist in the FSAP review.

4. There has been no experience with bank failures in Malaysia since PIDM’s establishment in 2005. As a result the Assessment looked at the relevant provisions of the legal framework without consideration of how the laws had been applied in practice or interpreted by the courts. Several weaknesses in the legal framework have been noted in this Assessment.

5. The Core Principles assessor would like to express her sincere gratitude to PIDM, BNM, MoF and the private sector institutions for their assistance. The assessor received excellent cooperation from the Malaysian authorities and representatives of the private sector.

III. Institutional and Macroprudential Setting, and Market Structure Overview

A. Supervisory Environment

6. Financial oversight is performed by BNM and the Securities Commission (SC). BNM supervises the banking sector (conventional, Islamic, investment (responsibility shared with SC) and development banks) as well as the insurance sector (conventional and Islamic (or takaful) and reinsurance). It also licenses or registers a range of financial intermediaries (leasing, factoring, financial advisors), as well as overseeing the money and foreign exchange markets and the payment, clearing and settlement systems. The SC regulates the securities industry as well as derivatives (other than interest and exchange rate related OTC contracts). PIDM is an operationally independent deposit insurance agency reporting to Parliament through the Minister of Finance.

B. Overview of the Financial System

7. The financial system – both banking and non-banking – is concentrated. The top 5 commercial banks comprise 70 percent of total banking system assets. The onshore banking sector – with some 200 percent of GDP – comprises nearly 60 percent of financial sector assets (Islamic banks are around 20 percent of the banking sector and Labuan Offshore Financial Center banks are an additional 3.5 percent). The majority of bank assets are held by eight financial groups.

8. The banking sector’s asset quality remained healthy with steady improvement in gross NPL ratios from 3.6 percent in 2009 to 2.7 percent in 2011. Total provisions (general and specific) were 99.6 percent of NPLs in 2011; NPLs net of specific provisions stood at 1.8 percent in 2010, below the 5-year average of 2.3 percent. Banks remained well capitalized with system-wide risk weighted capital and core capital ratios at 14.9 percent and 12.9 percent respectively in 2011, a slight decline compared to 2009. This can be attributed to actions by BNM including the tightening of underwriting standards and an increase in risk weights for housing loans.

9. Non-bank credit intermediation is sizable at some 90 percent of GDP. This is accounted for predominantly by the state-run Employee Provident Fund, insurance companies and Development Financial Institutions (DFIs) (specialized financial institutions established by the Government with specific mandates to achieve socio-economic development objectives).

10. There is a small offshore financial sector in Labuan. At year-end 2010 there were 61 approved banks operating in the Labuan OFC, with approximately one-third operating as part of Malaysian financial groups. There are also insurance entities, leasing companies and trust companies operating from Labuan. In recent times, reinsurance activities have grown with many Labuan-based reinsurers having a global scope of operations.

IV. General Preconditions for an Effective Deposit Insurance System

A. Macroeconomic Environment

11. The Malaysian economy grew 5.1% in 2011 after registering growth of 7.2% in 2010. Commodity exports have remained strong but the growth of manufacturing exports has slowed. This follows a strong recovery from the fallout from the global financial crisis. Domestic demand registered strong growth of 8.2% in 2011 as a result of household and business spending and higher public sector consumption. Private investment expanded by 14.4% in 2011 and the public sector continued to provide support to growth, with public consumption expanding by 16.8% in 2011.

12. The Government was proactive in responding to the global financial crisis. Preemptive measures were taken by BNM, including reductions in the Overnight Policy Rate from 3.5% in October 2008 to 2.0% in February 2009, extension of access to the BNM’s standing liquidity facility to insurance companies, temporary reduction of the Statutory Reserve Requirement to 1% (subsequently returned to 4%) and the extension of a Government Deposit Guarantee (GDG) on all RM and foreign currency deposits with commercial, Islamic and investment banks, including all domestic and locally incorporated foreign banking institutions, and deposit taking Development Financial Institutions (DFIs) regulated by BNM. The GDG was lifted in accordance with the announced schedule, accompanied by an increase in deposit insurance coverage from RM 60,000 to RM 250,000 per depositor per member institution.

13. BNM has recently launched a second 10 year Financial Sector Blueprint, covering 2011 to 2020. BNM’s first Blueprint was in large measure a response to the 1997-98 financial crisis and focused on building a stable and strong financial system. The second Blueprint retains the focus on financial sector stability but seeks to strike a balance between tightening regulation in line with global trends in response to the recent global financial crisis while liberalizing other restrictions. The Blueprint also expresses a strong intent to enhance institutional arrangements for effective and orderly resolution of distressed financial institutions by enhancing PIDM’s role as a resolution authority beyond its role with regard to its Member Institutions (MIs) to any large, non-viable financial institution in Malaysia that can affect financial stability. The Blueprint is consistent with the Tenth Malaysia Plan for 2011-2015 which focuses on stimulating private sector investments and inclusive socio-economic development and names financial services as one of the national key economic areas.

B. Sound Governance of Agencies Comprising the Financial Safety Net

14. The Central Bank of Malaysia Act of 2009 provides BNM with a broad range of powers to avert or reduce a risk to financial stability1. These include intervention and resolution measures, including powers to reduce systemic risks that emanate from both regulated and non-regulated entities and to stem institutional or market liquidity shocks. BNM is operationally independent and is able to use its powers without undue influence from external parties.

15. BNM assumes responsibility for addressing financial stability concerns given its mandate, powers and responsibilities and its role as the central bank and supervisory authority for the banking and insurance sectors. Within BNM there is a Financial Stability Committee which serves as BNM’s internal forum for discussing risks to financial stability and deciding on the appropriate policy responses. It is at this Committee that a decision would be made as to the non-viability of an institution, including member institutions of PIDM.

16. BNM also has a Financial Stability Executive Committee (FSEC) established in 2010 under Section 37 of its Act which considers proposals related to its various powers. These powers include the issuance of orders or provision of liquidity assistance to persons or financial institutions which it does not supervise, the purchase of shares or other capital instruments or businesses or assets of a financial institution or the vesting of the business, assets or liabilities of a financial institution in BNM, a corporation established by BNM or another financial institution or other person. Two executive members from BNM and four other members (Ministry of Finance, PIDM, an accountant and a lawyer) make up the FSEC. The private sector members of the FSEC are subject to a Code of Ethics and Conflict of Interest; they are also required to submit annual declarations of compliance with the Code and filings of assets and exposures.

17. BNM is empowered to enter into arrangements with other supervisory authorities to coordinate financial stability measures. BNM engages with the Securities Commission Malaysia and PIDM on a regular basis; the Governor of BNM sits on PIDM’s Board. BNM coordinates with both agencies in the area of surveillance and supervision to facilitate the timely identification of pre-emptive responses to systemic risk.

C. Strong Prudential Regulation and Supervision

18. BNM supervises four-fifths of the current financial system. Banks are well-capitalised and follow prudent risk management practices. BNM conducts regular and thorough reviews of individual banks and bank groups and the system for prudential regulation and supervision is broadly compliant with the Basel Core Principles for Effective Banking Supervision.

D. Well-Developed Legal Framework

19. The legal system is well-developed with clear property rights. The judiciary in Malaysia is independent, professional and benefits from protection of tenure and of an adequate remuneration system. The effective operation of the insolvency and creditor rights framework relies, to a large extent, on the intervention of the courts. The standing of the courts and judges has improved over the years, especially with the creation of commercial judges in Kuala Lumpur. As of a few years ago, there was a substantial backlog of bankruptcy and winding-up cases throughout the Malaysian court system. However, a new case management system has apparently significantly reduced the backlog of old cases as well as made the handling of new cases more efficient. There is general satisfaction with the quality of judges handling insolvency matters in Malaysia’s major commercial centers, particularly in certain jurisdictions such as Kuala Lumpur where such matters are handled by judges in a specially established Commercial Court.

20. Laws are in place under which the banking system and the deposit insurer can operate. The legal structure in Malaysia supports the banking system and the deposit insurer although there is a need to develop a more modern insolvency regime for companies and individuals. There are at present a number of credit information providers, with a supervisor for the activities of all credit information systems, in line with best international practices.

21. A legal framework exists for handling a bank failure that includes a method for effective failure resolution in a timely manner. PIDM’s and BNM’s statutes provide for various methods by which a financial institution can be effectively resolved. The factors that govern decisions on early intervention and non-viability should be made part of PIDM’s statute.

22. Banking laws and regulations are updated as necessary to ensure that they remain effective and relevant to a changing industry. Both PIDM and BNM have had recent, extensive changes to their governing statutes. A significant effort is underway to amend the Banking and Financial Institutions Act of 1989 with a very advanced draft circulating for comment that BNM plans to table in the June Parliamentary session.

23. Information exchange between the deposit insurance system participants and the supervisor is legally protected for all measures necessary in order to protect the deposits and to enable safety-net participants to intervene in case a bank is at risk. All communications are subject to bank secrecy protections under Section 24 of the PIDM Act and PIDM and BNM have ongoing access to information on MIs.

24. Appropriate participants in the financial safety net are entitled to protect depositors through a number of options including transferring deposits from a troubled bank to a healthy bank. PIDM has the power to transfer deposits from a troubled bank to a MI or other institution established for such purpose.

25. Relevant authorities can take legal action against the management of a failing bank. There is authority to take action against those responsible for a failing or failed bank both with PIDM (through a referral to the public prosecutor) and BNM. The public prosecutor also has the authority to take action if appropriate under the Penal Code and a liquidator may pursue a suit under the Companies Act if needed.

E. Sound Accounting and Disclosure Regime

26. Accounting and disclosure regimes support the ability of the supervisor and deposit insurer to adequately evaluate the health of individual banks and the banking system as a whole. Banking institutions in Malaysia are subject to Financial Reporting Standards (FRS) established by the Malaysian Accounting Standards Board which are in full compliance with the International Financial Reporting Standards (IFRS). Banking institutions are also subject to additional disclosure requirements established by BNM, including the Guidelines on Financial Reporting for Banking Institutions (requiring disclosures on deposits, loans, impairment provisions and remuneration) and Pillar II disclosure requirements under Basel II (risk management practices and the capital adequacy of banking institutions). Banking institutions listed on the local stock exchange are subject to additional disclosure requirements set forth by Bursa Malaysia Securities, the securities exchange. In addition, the majority of locally owned banking institutions and several of the foreign owned banking institutions with significant operations in Malaysia are rated by the domestic credit rating agencies.

27. Accounting and disclosure regimes support the accurate and timely identification of information on depositor accounts for the purposes of prompt reimbursements. PIDM is able to collect information on depositors directly from its MIs. PIDM also requires that MI’s external auditors validate filings made with PIDM for the purposes of its Differential Premium System (DPS). There is also high level collaboration and co-ordination between the accounting profession and the regulatory reporting agencies.

28. Accounting and disclosure regimes support the use of risk-adjusted differential premium systems adopted by the deposit insurer. PIDM is able to validate its DPS both directly with its MIs and through validation by MIs’ external auditors.

29. The deposit insurer has the right to carry out or provide for an audit or inspection of a member bank in a timely manner if evidence shows that deposits may be at risk. PIDM has special examination powers under Section 97 of its Act. Such an examination may include the examination of records, books, accounts or other documents and transactions of the MI.

V. Main Findings

30. The deposit insurance framework in Malaysia, managed by PIDM, broadly conforms to best international practice. PIDM was established in 2005 under the Malaysia Deposit Insurance Corporation Act (PIDM Act). PIDM administers a Deposit Insurance System (DIS) which covers deposits in conventional and Islamic banks as well as a takaful and insurance benefits protection system (TIPS) which insures policy owners and takaful certificate holders against the loss of part or all of their benefits in the event of a member institution failure. TIPS coverage was added to PIDM’s mandate on December 31, 2010. Member institutions include all commercial banks, including locally incorporated foreign subsidiaries, Islamic banks licensed under the Islamic Banking Act of 1983, all insurance companies licensed under the 1996 Insurance Act except Danajamin Nasional Berhad and takaful operators registered under the 1984 Takaful Act (except international takaful operators). As of February 1, 2012, PIDM’s membership consisted of 41 banks (25 commercial including 8 domestic and 16 Islamic banks) and 47 insurers (35 insurance companies and 12 takaful operators). The top five commercial banks make up over 60% of total insured deposits.

31. PIDM is funded by annual premiums collected from member banks for both conventional and Islamic deposits, with TIPS funded by annual levies for takaful and insurance benefits. The funds for conventional and Islamic deposits are separately administered with the Islamic deposit insurance fund administered in accordance with Shariah principles. PIDM administers an additional four funds (Family Solidarity Takaful Protection, Life Insurance Protection, General Takaful Protection and General Insurance Funds) for a total of six separate and distinct Funds. PIDM reports to Parliament through the Minister of Finance and is governed by a nine member Board of Directors, including two ex officio members (the Governor of Bank Negara Malaysia and the Secretary General of Treasury, Ministry of Finance).

32. Deposit insurance is compulsory for all deposit-taking conventional and Islamic banks. PIDM protects all retail depositors, including corporate depositors, small businesses and individuals, up to the maximum of RM 250,000 per depositor per member institution. PIDM is legally mandated to reimburse depositors promptly, no later than 3 months after a winding up order. The current reserve level for conventional deposits is 0.14 percent of total insured deposits.

33. PIDM is Compliant with 14 of the 18 Core Principles. PIDM has a number of strengths, including a culture of cooperation with other safety net players, strong performance in its exit from the GDG, a robust public awareness program, ongoing efforts at readiness and planning for potential financial institution resolutions and openness and transparency in its operations and reporting. However, there are several areas for improvement, most importantly the need for MoF to execute a back-up funding agreement with PIDM and to limit MoF’s legislatively mandated involvement in the day-to-day operations of PIDM. A summary of the detailed assessment of compliance with the Core Principles is presented below.

VI. Assessment of the Observance of the Core Principles

34. The ratings for compliance were awarded according to the methodology prescribed in the Core Principles Methodology (December 2010). This methodology established five levels of compliance: compliant, largely compliant, materially non-compliant, non-compliant and not applicable. The criteria for awarding these ratings are as follows:

  • Compliant – When the Essential Criteria are met without any significant deficiencies.

  • Largely Compliant – When only minor shortcomings are observed and the authorities are able to achieve full compliance within a prescribed time frame.

  • Materially Non-compliant – Severe shortcomings which cannot be rectified easily.

  • Non-compliant – No substantive implementation of the Core Principle.

  • Not Applicable – Not considered given the structural, legal and institutional features of the deposit insurance system.

VII. Malaysia’s Islamic Deposit Insurance System

35. PIDM was established in 2005 as a dual deposit insurance system. In addition to covering deposits in conventional banks, PIDM also covers eligible Islamic deposits (savings, current and investments accounts based on Shariah contracts including wadiah, qard, mudharabah, murabahah and wakalah). The Shariah compliant design is based on an arrangement of guarantee with fee or kafalah bil ujr. This system of insuring Islamic deposits was endorsed by the Shariah Advisory Council of Bank Negara Malaysia.

36. The deposit insurance limit for Islamic deposits is at the same level as conventional deposits – RM 250,000 – and the limit is separate from the limit for conventional deposits. There is also separate coverage for trust accounts, joint accounts, professional practice, sole proprietorship and partnership accounts. Islamic and conventional banking businesses pay separate premiums and PIDM manages an Islamic Deposit Insurance Fund (IDIF) separately from its Fund for conventional deposits. Investments for the IDIF are made in Shariah-compliant instruments. Expenditures are charged to IDIF directly if attributable to Islamic member institutions and charged proportionately between Funds if the expenditures are not directly attributable.

37. In 2010 PIDM’s mandate was enlarged to protect takaful and insurance certificate owners in the event of an insurer member failure. The takaful benefits protection system was also endorsed by the Shariah Advisory Council.

Table 1.

Core Principles for Effective Deposit Insurance Systems Assessment Summary Table

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Table 2.

Summary of Compliance with the Deposit Insurance Core Principles

[Key: C = Compliant; LC = Largely Compliant; MNC= Materially Noncompliant; NC = Noncompliant; NA = Not Applicable]

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Table 3.

Recommended Corrective Action Plan to Improve Compliance with the Deposit Insurance Core Principles

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Table 4.

Detailed Assessment of Deposit Insurance Principles

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1

Section 29 of the Act defines a risk to financial stability as a risk which, in the opinion of BNM, disrupts or is likely to disrupt the financial intermediation process, including the orderly functioning of the money market and foreign exchange market or risk that affects or is likely to affect public confidence in the financial system or the stability of the financial system.

2

The public policy objectives of the deposit insurance system refer to the objectives or goals the system is expected to achieve. The mandate of the deposit insurer refers to the set of official instructions or statement of purpose describing its roles and responsibilities. There is no single mandate or set of mandates suitable for all deposit insurers. Existing deposit insurers have mandates ranging from narrow, so-called “paybox” systems to those with broader powers or responsibilities, such as preventive action and loss or risk minimisation/management, with a variety of combinations in between.

3

The term “strategic plan” refers to a document which sets out an organisation’s goals and how it plans to achieve them.

4

See discussion “Preconditions” pages 2, 6 and 8.

5

Although the use of co-insurance can encourage depositors to monitor bank risk taking, it presents a number of serious problems. In order to provide effective market discipline it assumes that depositors will have access to the necessary financial information and that most retail/individual depositors can accurately assess risk. And, even when depositors are in a position to make such determinations, co-insurance provides strong incentives for depositors to run on a bank to avoid even a small loss of their funds.

6

A “blanket guarantee” is a declaration by authorities that in addition to the protection provided by limited coverage deposit insurance or other arrangements, certain deposits and perhaps other financial instruments will be protected. A wide range of factors need to be considered when introducing blanket guarantees, including decisions on the scope of the guarantee (eg the type of institutions, products and term maturities covered) and whether the banks utilising the guarantees will be required to contribute in some manner to the costs of providing the guarantees.

7

A prompt reimbursement is defined to be when depositors are reimbursed within a time frame that does not undermine financial stability and the proper functioning of payment systems.

8

In some circumstances the deposit insurer may seek to pursue the parties responsible for fraud or misconduct even though costs may exceed recoveries.

Malaysia: Publication of Financial Sector Assessment Program Documentation—Detailed Assessment of Observance of Core Principles for Effective Deposit Insurance Systems
Author: International Monetary Fund. Monetary and Capital Markets Department