Banking and Insurance liberalization in Malaysia

Dr.Muthi SamudramMonash University Malaysia

Malaysian Economy (Growth rate of GDP in constant prices)

• year 1961-70 1971-1980 1981-1990 1991-2000 2001-2005

• 1 1.4 10.0 6.9 9.5 0.6• 2 6.9 9.4 6.0 8.9 4.4• 3 5.5 11.7 6.2 9.9 5.4• 4 5.8 8.3 7.8 9.2 7.1• 5 5.6 0.8 -1.1 9.8 5.3• 6 6.2 11.6 1.2 10.0• 7 1.0 7.8 5.4 7.5• 8 4.2 6.7 9.9 -7.4• 9 10.4 9.3 9.1 6.1• 10 5.0 7.4 9.0 8.5• Average 5.2 8.3 6.0 6.75 4.6

Contribution of services sector• year A B C D E F•• Shares of GDP (%)

• 1987 2.6 6.5 10.8 17.0 24.1 15.0• 1990 2.7 6.7 13.2 17.5 18.8 15.4• 1995 3.5 7.4 15.2 20.3 13.8 15.0• 2000 3.9 8.0 14.8 23.6 12.6 14.2• 2005 4.1 8.8 14.7 26.4 12.8 13.3•• Average growth rate (%)•• 1987-1990 10.0 10.6 17.2 11.8 1.7 11.4• 1991-2000 11.7 9.1 8.4 12.2 4.4 7.8• 2001-2005 5.6 6.5 4.4 8.6 6.5 4.8

A= Electricity, gas & water B= Transport, storage & communicationC= Wholesale and retail trade, ,hotels and restaurantsD= Finance, insurance, real estate and business servicesE= Government servicesF= Other services

Policy reforms and changes in Banking System

• Banking ordinance 1958 became Banking Act in 1973• Prior to 1973, banking legislation was specific to the type of financial

and non-financial institution• The Central Bank did not have effective regulatory and supervisory

powers to oversea the activities of non-financial institutions.• 1985 recession led to the deposit taking co-operatives and this led

to lack of confidence in the banking system• Financial Institutions Act (BAFIA) in 1989• Empowers the central bank to have wider powers to supervise all

financial institutions and under specific circumstances regulate, schedule and non-scheduled instittutions.

• The branches of foreign-owned banks were required to be locally incorporated with 100% equity

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• The SRR, BLR and two-tier asset ratios were replaced by a single liquidity ratio.

• Until 1991, Base Lending rate (BLR) was determined by the Central Bank. A standardized formula was introduced in 1991 to enable banks to determine the lending rates based on their cost of funds. The deregulation of the

estimation of the BLR allowed market force to determine the lending rates.• The averaging of cost of funds had a lagging effect on the interest rates and

thus undermining the impact of monetary policy- the framework was abolished in 1995.

• The new framework involves the intervention rate- the rate at which banking institutions can borrow form the central bank.

• With the conclusion of the Uruguay Round in December 1993, and given Malaysia’s commitments under GATS, it was evident the Malaysia’s banking sector has to be progressively liberalized.

Commercial banks

• 54 banks have been merged into 10 domestic banks

• Total banks: 10 domestic and 13 foreign and 5 islamic banks– 28 banks

• Foreign banks need to be locally incorporated

• Foreign equity of 30% in domestic banks

Measures to improve banking system

• Two-tier regulatory system• Securitisation of assets-to match the asset and liability

profile of the banking system’s housing loans maturity vsmaturity of deposits

• Credit, financial derivatives and risk management-guidelines on lending, investment in debt securities and NPLs need to be reclassified

• Sectoral loan exposure• Strengthening the supervisory framework• Corporate governance

Commercial banks: Assets, deposits and loans(% of total)

1990 1995 2000 2005

Dom banks assets

75.0 77.6 75.9 77.4

Foreign banks Assets

25.0 22.4 24.1 22.6

Dom banks deposits

71.0 76.0 76.6 78.5

Foreign banks deposits

29.0 24.0 23.4 21.5

Dom banks loans

73.6 75.7 76.2 79.3

Foreign banks loans

26.4 24.3 23.8 20.7

Income & expenditure(commercial banks)

• year• A B C D E F• 1988 61.0 20.9 11.2 11.8 41.9 1.6• 1990 79.4 11.5 10.7 10.3 50.6 2.3• 1993 81.6 11.4 9.4 9.4 53.2 2.3• 1997 89.2 10.4 8.0 7.9 57.8 2.4• 1998 84.2 9.8 5.9 7.1 60.5 2.7• 2000 76.4 14.4 10.2 10.4 39.6 2.5• 2005 91.0 9.1 12.5 14.3 46.3 2.4

A=Interest income as % of total incomeB= Feebased incomeC=Staff costsD=overheadsE= interest expense

F= interest income/total assets

Interest Margins

Interest margins of banks

02

468

10

1214

1980

1983

1986

1989

1992

1995

1998

2001

2004

year

average lendingrate3 month FD rate

Islamic BanksNet change in bad debt* staff* overheads* Total pre- tax

income total income provisions Costs costs profits

Rmmill Rmmill RMmill

1999 280.7 16.900 30.000 28.700 75.600 75.42000 301 20.3 15.300 32.000 37.600 84.900 51.72001 1364.3 1063.3 30.400 10.000 12.600 53.000 844.52002 1626.9 262.6 33.300 9.400 12.700 55.400 947.82003 2174.8 547.9 46.100 7.900 13.100 67.100 960.42004 2484.7 309.9 41.200 9.400 14.800 65.400 988.12005 3197.2 712.5 26.300 12.000 18.800 57.100 1554.8

* these ratios are based on total income

Commitments under GATS

• Banking- The 13 wholly foreign owned ( total banks 28) foreign banks arepermitted to remain wholly foreign owned but need to be incorporated locally.

• Foreign institutions are allowed to hold equity in investment banks (merchant banks, stock-broking and discount houses), but foreign participation in commercial banks is still restricted to an aggregate maximum stake of 30%.

• No new licenses are granted to either local or foreign banks • IN 2004, 3 Islamic banking licenses were issued to foreign Middle Eastern

Islamic banks• The central bank encourages all commercial banks ( domestic and foreign)

to set up full-fledged Islamic banking subsidiaries in which foreigners may take a 49% equity stake.

• Recently foreign banks were allowed to further 6 more branches.

AFAS and FTAs

• AFAS is a regional agreement on trade co-operation in services involving ASEAN members

• Malaysia is not a signatory of the WTO Procurement Agreement (GPA).

• Malaysia’s official policy of procurement has been to support the national policy objectives

• In the FTAs that USA has signed with other countries, there has been strong demand for inclusion of an agreement on access to government procurement.

Policy reforms in Insurance sector

• Prior to 1950, insurance business was conducted by foreign insurance companies

• Until 1988, supervision and regulation were under the purview of Ministry of Finance

• In 1988, the central bank was given the task as banks were incorporating insurance company subsidiaries– Insurance act 1963

• Insurance act 1996 incorporated other aspects of insurance such as broking and adjustment.

• In 1996, BNM introduced a Master Plan for the insurance industry-• At the end of 1999, there were 147 licensees:

• Direct insurers 58• Professional reinsurers 10• Insurance brokers 37• Adjusters 42

Domestic and foreign insurers

•Domestically Foreignincorporate incorporated

• Year Total Life General Life & GeneralReinsurers

• 1963 95 10 76 9 -

• 1987 60 2 41 16 1 51 9

• 1990 57 3 39 15 1

• 1998 58 7 40 11 10(8) 51 7

• 2000 53 7 36 10 11(9) 51 2

• 2002 44 7 28 9 10(8) 42 2

• 2005 42 7 26 9 7(5) 40 2

• () foreign incorporated

Life insurance sector• year Expense rate (%) Net interest earned(*)• 1988 43.5 6.9• 1989 45.7 7.2• 1990 45.9 7.2• 1991 47.2 7.8• 1992 46.4 8.0• 1993 46.7 7.8 (16.5)**• 1994 46.3 6.5(15.2)**• 1995 47.9 6.5• 1996 42.0 6.7• 1997 36.9 7.2• 1998 31.2 7.8• 1999 30.5 6.5• 2000 29.8 5.8• 2001 31.8 5.4• 2002 30.5 5.6• 2003 30.2 5.7• 2004 30.7 5.8• 2005 29.7 5.7(*) rate of return on investment excluding capital gains, (**) rate of return on investment

including capital gains

General insurance

Directpremiums

Average share of direct premiums(%)

Netretention*

Assets

Year RM million Averagegrowth rate

Marine Fire Motor RM million

Averagegrowth

1988 1321.1 75.6 1665.5

1990 1979.1 18.2 4.6 15.1 38.2 77.1 2400.9 15.7

1995 4764.4 19.3 3.9 13.3 40.4 74.4 7643 26.1

2000 5928.6 4.9 4.1 15.6 45.6 85.3 13791 13.1

2005 9386.1 9.7 3.6 13.8 45.4 80.4 7989.4 5.9

Commitments in GATS

• Direct Insurance companies• Modes of supply (1) and (2) unbound except as otherwise specified

in the schedule• (3) branches of foreign insurance companies are required to be

locally incorporated by 30th June 1998 with foreign shareholding not exceeding 51% is permitted

• Foreign holding not exceeding 51% is also permitted for the existing foreign shareholders of locally incorporated insurance companieswhich were the original owners of these companies.

• New entry is limited to equity participation by foreign insurance companies in locally incorporated companies – maximum of 30%.

• Unbound for new licenses• (4) unbound except

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• Temporary presence of natural persons is offered only in respect of supply through the mode of commercial presence

Empirical estimation

• Using autoregressive distributive lag(ARDL) method proposed by Pesaran et.al (2001).

• Variables used are: money-gdp ratio, commercial banks assets ratio, domestic credit ratio- representing the financial deepening in the economy.

• Real gdp per capita,savings ratio, investment ratio, real interest rate, trade opennes as a ratio of nominal gdp

The Bounds Test for Cointegration

F-Statistics Lag 95% critical value bounds

LCB:3.793UCB:4.855

F(Lnm3/Lnopen,Lnpercap) 3 14.67

F(Lnopen/Lnm3,Lnpercap) 2 4.209

F(Lnpercap/Lnm3,Lnopen) 2 11.22

Long run elasticities

• M3 wrt openness: -1.2775(0.000)• M3 wrt percap: 1.8247(0.000)

• Open wrt M3: 0.0783(0.878)• Open wrt percap: 0.7692(0.132)

Empirical results

• Financial deepening is observed following a series of financial sector reforms

• The econometric results show no evidence of economic improvement fueled by deepening of financial sector.

• Financial intermediation affects growth mainly through savings and allocating these funds for productive investment

Conclusions

• The Asian financial crisis has exposed some of the weaknesses of the system

• Huge non-performing loans• Interest rate spread did not gradually decline over the

years. The high profit margin phenomena suggests that efficiency in the banking sector has not been achieved.

• The role of EPF• Domestic financial system needs further consolidation

and interest rates need to be market determined.

Conclusions

• Malaysia remains committed to further liberalization of its financial sector

• Malaysia’s commitment at WTO is an indication of liberalizing the foreign ownership in both banking, insurance and other areas of financial sector.

• After the financial crisis, Malaysia found it necessary to pursue its long term objective of building a competitive and dynamic financial sector

• Set a time line of 10 years-• This includes the Financial sector Master Plan and Capital market

Master Plan. Both were launched in 2002