Introduction Over the previous decade, Malaysia had enjoyed rapid growth, dropping unemployment, stable inflation and

fiscal surplus. (Financial Liberalization and the Economic Crisis in Asia) Nowadays, the development of Malaysian banking system had a closed relation with the economic growth of Malaysia. From the perspective of macroeconomics, banking system was the key driver to transform and accelerate large savings into capital accumulation which was a supportive stone of output growth. Besides, the financial
darkness in Asia has also shown that a robust financial system is one of the key factors of economic progress. Without it, misallocation of investments could severely interrupt development.

(http://www-wds.worldbank.org/servlet/WDSContentServer/WDSP/IB/2000/01/06/00 0094946_99122006330271/Rendered/PDF/multi_page.pdf)
Referring to the latest economic growth of Malaysia, the overall balance of payments in the first three quarters of 2006 achieved a surplus of RM 27.9 billion, a 44.0 percent decline from the same period in 2005. Net international reserves at end-2006 reached RM 290.4 billion, up 9.5 percent from 2005. At the same time, external debt dropped 8.3 percent from 2005, mainly attributed to a significant decrease in banking sector debt and debt repayment by the public sector. (http://siteresources.worldbank.org/INTEAPHALFYEARLYUPDATE/Resources/550192-1175629375 615/MY-EAP-Update-April2007.pdf) Therefore, it is evident that banking sector plays an indispensable role in determining a countrys economy. In this paper, the overview

of banking sector of Malaysia will be explored in

details. Overview of the framework of Malaysian banking sector The current banking system in Malaysian consists of monetary and nonmonetary
institutions. The monetary institutions are the central bank, Bank Negara Malaysia (BNM), and the commercial banks (including Bank Islam). The nonmonetary institutions divide into two groups. The first group is monitored by BNM including finance companies, merchant banks, discount houses, foreign banks representative offices, and offshore banks in the International Offshore Financial Centre in Labuan. The second group supervised by various government departments and agencies includes development finance institutions, savings institutions, provident and pension funds, insurance companies, and other financial intermediaries. (http://www.adb.org/Documents/Books/Rising_to_the_Challenge/Malaysia/numal_bnk.pdf)

The central Bank Bank Negara Malaysia (BNM) is the central bank of Malaysia, which was established on Jan 26, 1959, under the Central Bank of Malaya Ordinance (CBO), 1958 which provided for the licensing and regulation of the business of banking in the Federation of Malaya. CBO has control over interest rates payable to or by persons other than banks carrying on business in relation to the receipt of money on deposit from members of the public. (Money and Banking in Malaya and Singapore) Also, it is responsible for developing the institutions and
infrastructure that are the foundations of a modern and solid financial system.

The bank may undertake the usual range of central banking business including the issue, management and underwriting of government loans, the operation of bank clearing house and the admistration of the BNM is committed in maintaining the stability of monetary and financial system and keeping a progressive and sane financial sector in order to promote the economic development. Also, it supervises the banking system and the insurance industry. Moreover, BNM is endowed at law with powers of issuing the Malaysian currency, the Ringgit, acts as a banker and economic and financial adviser to the Government, administers the country's foreign exchange control regulations, and acts as lender of last resort to the banking system. (http://www.msc.com.my/business/TheBankingSystem.html) (http://www.pwc.com/extweb/service.nsf/docid/F880C77A61355DA4852571EF0069 69D2)
(http://www.mida.gov.my/beta/view.php?cat=3&scat=30&pg=157)

Objective 1. To issue currency and keep reserves safeguarding the value of the currency; 2. To act as a banker and financial adviser to the Government; 3. To promote monetary stability and a sound financial structure;

4. To promote the reliable, efficient and smooth operation of national payment and settlement systems and to ensure that the national payment and settlement systems policy is directed to the advantage of Malaysia; and 5. To influence the credit situation to the advantage of the country.

Today, Bank Negara Malaysia concentrates on the three areas of central banking,
namely monetary stability, financial stability and the payments system. Also, Bank Negara Malaysia is

entrusted with the role of economic development.

Functions of Bank Negara Malaysia:

a) Financial Stability Bank Negara Malaysia provides an environment that institutions are strong enough to continue to meet their contractual obligations without interruption or without any external assistance. if there is no change in market fundamentals, the prices of transactions will not vary too much over short periods.

b) Monetary Stability In order to maintain the stability of the value of the Malaysian currency, the Ringgit. Bank Negara Malaysia implements different monetary policies to keep the inflation low and protect the purchasing power of the Ringgit from weakening. For example, Bank Negara Malaysia can carry out several monetary instruments including purchase and sale of Bank Negara Malaysia and Malaysian Government papers in order to change the interest rates in the financial system. c) Development Role To boost the economy, Bank Negara Malaysia shoulders the responsibilities to develop the necessary institutions and market infrastructure for the growth of a modern and strong financial system. Besides, through the construction of a strong payment system which is regularly "upgraded", the financial market infrastructure is enhanced. In promoting a good credit culture amongst banking institutions, Bank Negara Malaysia also activates the Central Credit Reference Information System. which collects and circulates credit information on all borrowers. This allows banking

institutions to make informed decisions on loan applications. d) Payment System It is important for a financial system to have payment system. It facilitates efficient funds transferring between parties and for commercial transactions. So, Bank Negara Malaysia is responsible for ensuring stable and efficient payments system for Malaysia. e) Others Bank Negara Malaysia acts as the economic and financial adviser to the Government, co-operation with other countries is built up by participating international meetings. As the economic to the Government, Bank Negara Malaysia highlights the areas that need to be addressed after analysis of the developments in the international and domestic economy. As the financial adviser to the Government, Bank Negara Malaysia provides Government with regular advice on the management of its domestic and external debts and the terms and timing of Government loan programmes.

(http://www.bankinginfo.com.my/_system/media/downloadables/bnm_eng.pdf)

Introduction of Banking system

The Malaysia banking market is serviced by three types of institutions including Commercial banks, Merchant banks and Discount houses In a move to further liberalize the banking market, BNM in late 2005 allowed LIFBs to open four more branches each on the condition that one of the branches must be located in non-urban areas, two in semi-urban areas and one in market centres.

There are also a number of foreign banks that have established representative offices in Kuala Lumpur. However, they are not permitted to conduct normal banking business but to
provide liaison services and facilitate information exchange between business interests in Malaysia and their counterparts.

. In view of the challenging and competitive banking environment, the Government continues to encourage further consolidation of the banking sector. With full liberalisation in 2010, BNM expects the number of anchor domestic banks to further consolidate. Foreign investors are allowed to own up to 30% share equity in domestic banks.> The banking systems capital strength continues to remain strong from the improvements in the level of capitalisation, profitability and asset quality. The risk-weighted capital ratio (RWCR) of the banking system stood at 12.9% end-June 2006, and has been hovering above 12% since 1999
in 2007, there were 9 domestic and 13 locally incorporated foreign commercial banks operating through a network of 1,963 branches across the country. Five of the domestic banks have presence in 18 countries through branches, subsidiaries and joint ventures. For other bank, the details of their number is listed below.

licensed financial institution

There are six major types of licensed financial institutions including commercial banks, Islamic banks, finance companies, merchant banks, discount houses and money-brokers in Malaysia.

The followings are the numbers of different licensed banking institutions in 2007: Licensed Banking Institutions Commercial Bank Islamic Banks Finance Company Merchant Bank Discount House Money-broker 9 8 2 14 7 N/A 13 3 0 0 0 N/A 22 11 2 14 7 7 Local Number Foreign Number Total Number

Licensed Banking Institutions

Commercial Bank Islamic Banks Finance Company Merchant Bank Discount House Money-broker

Banking Institution Commercial bank

Banking services provided Deposit-taking, cheque accounts, various loans, advances and financial guarantees, trade financing and foreign exchange services Similar to commercial banks but banking services based on profit sharing concept versus the use of interest corporate finance and management advisory services,, wholesale financing, securities underwriting and investment

Islamic banks

Merchant banks

portfolio management, loans syndication, arranging for the issue and listing of shares. Discount houses Deposit-taking and accepting money at call and investing in the money market. They also underwrite issues of private debt, securities and commercial paper, as well as undertake fund management activities

a. Commercial Banks Commercial banks are currently the largest players accounting for 96% of banking system assets followed by merchant banks and discount houses. Foreign financial institutions operating in Malaysia are limited to commercial banking and account for 21% of banking system assets. Malaysias commercial banking market consists of 9 domestic anchor bank groups and 9 Islamic banks. Out of the 9 Islamic banks, 6 are subsidiaries of anchor bank groups. The anchor banking groups provide a wide range of financial services covering retail banking
The commercial banks are licensed under the Banking and Financial Institutions Act 1989 (BAFIA). They are the largest and most significant providers of funds in the banking system. Main functions of commercial banks: Provide retail banking services such as the acceptance of deposit, granting of loans and advances and financial guarantees; Provide trade financial facilities such as letters of credit, discounting of trade bills, shipping guarantees, trust receipts and Bankers Acceptance; Provide treasury services; Provide cross border payment services; and Provide custody services such as safe deposits and share custody.

Commercial banks are also authorized to deal in foreign exchange and are the only financial institutions allowed to provide current account facilities.

Commercial banks work significantly in promoting private investment and supporting economic development. Commercial banks absorb public funds with low interest rate through four types of deposits including demand deposit (only commercial banks are allowed to offer this service), saving deposits, fixed deposits and negotiable certificates deposits. And commercial banks lend funds to borrowers in returns for higher interest rate. So, actually it is a mobilizer of public funds, it is in a crucial position to act as a vehicle to bring about a higher flow of private investment.

Investment bank

Now, the functions of an investment bank are diversified by different entities such as the merchant bank, stock broking firm and discount house within a banking group. It is essential for these different entities to boost the levels of efficiency under a more competitive and challenging environment. Besides, BNM has developed a broad framework announced by in March 2005 for the establishment of full-fledged investment banks in Malaysia together with the Securities Commission (SC). The formation of investment banks involves:

A merchant bank and a stock broking company within the same financial group; or Two discount houses and a stock broking company; or A universal broker and a discount house.

The limit of foreign equity participation in the formation of an investment bank is up to 49%. In January 2006, BNM and SC announced that all banking groups have obtained approvals from Minister of Finance to transform the merchant banks, stock broking firms and discount houses within the group into investment banks. Independent discount houses are also welcomed to complete their transformation process into investment banks with the same flexibility. As for the universal brokers, they are now in the process of submitting their applications to become investment banks to BNM and SC. They are given the flexibility in determining the timeframe required for their transformation into investment banks.

Merchant banks in Malaysia are evolving into full-service investment banks offering investment advice and specialised services relating to corporate finance and management. Services provided include international factoring, import-export factoring and asset and fund management. Besides, Merchant banks

run as

intermediaries in the short-term money market and capital raising activities.

Main function play as a role in underwriting and loans syndication provide corporate finance and management advisory services arranging for the issue and listing of shares, as well as investment portfolio management.

For discount houses,

concentrate on short-term money market operations and

mobilize deposits from the financial institutions and corporations. They can invest funds in treasury bills, government securities, banker's acceptances, negotiable instruments of deposit and private debt securities, and accept short-term funds.

With the introduction of the framework for investment banks, there would potentially be 17 investment
banks emerging from this process and discount houses and merchant banks would no longer be in the Malaysian financial landscape. Besides, the mergers between merchant banks, stock broking companies and discount

houses will result in the creation of investment banks that are more effective, efficient and resilient in the changing domestic and international economic environment. The investment banks will continue to be able to conduct activities based on the types of licences approved prior to rationalisation.

financial companies Currently, there are 681 scheduled institutions including building credit companies, development finance companies, factoring companies and leasing companies that provide credit and financing facilities to the public.

Besides, there are several development financial institutions (DFIs) in Malaysia that were set up to develop and provide financing to strategic economic sectors, such as the manufacturing

and exports sectors, small and medium enterprises (SMEs), as well as the agriculture, shipping, infrastructure and maritime sectors. These DFIs plays a complementary with the banking institutions in providing a range of financial and non-financial services to support development of the strategic sectors. Main function of DFI Provide Hire-purchase lending services provide medium to long-term loans, equity capital and guarantees for loans, offer consulting and advisory services in the identification and development of new projects, as well as financial, technical and managerial advice and assistance.
The Export-Import Bank of Malaysia Berhad (EXIM Bank) For example, A fully owned subsidiary of Bank Industri and Teknologi Berhad, Exim Bank, the result of a merger between Export-Import Bank of Malaysia and Malaysia Export Credit Insurance Berhad in December 2005, provides financing and facilitates the export and import of goods, services and overseas projects with emphasis on non-traditional markets. It also provides insurance for export credit, export finance and overseas investment insurance and guarantee facilities. Bank Industri dan Teknologi Malaysia Berhad, renamed Bank Perusahaan Kecil dan Sederhana Malaysia Berhad (or SME Bank) in October 2005, provides a comprehensive range of financial and ancillary services to SMEs.

Services offered by EXIM bank include :

Buyer Credit Facility which is a direct or indirect loan to foreign importers. Supplier Credit Facility which offers working capital loans to Malaysian exporters or credit to foreign buyers.

Meanwhile, the SME Bank or Bank Perusahaan Kecil dan Sederhana Malaysia Berhad' was established in October 2005 to nurture and promote development of the SMEs, by providing a broad range of financial and ancillary services. (http://www.mida.gov.my/beta/view.php?cat=3&scat=30&pg=157)

Offshore Financial Services

Labuan offshore financial centre

The domestic banking system in Malaysia is supplemented by an international offshore financial centre (IOFC) in Labuan, Malaysia. The IOFC provides a full range of financial services from offshore banking, insurance, fund management and trust companies, leasing and financial exchange. Currently, offshore financial services are provided by more than 60 offshore banks, and nearly 80 offshore insurance companies.

Labuan's offshore banking industry covers the business of providing credit facilities and receiving deposits, offshore investment banking, Islamic banking, development finance and leasing.

Other financial services available include insurance and reinsurance provided by offshore insurance companies. Consistent with Malaysia's niche business in Islamic finance and banking, full Islamic banks also provide similar offshore banking services. 'Takaful' and 'retakaful' services are also widely available.

The Government has been actively developing Labuan as an international financial centre, especially the Islamic financial market. There are currently six Islamic financial institutions operating in Labuan, including three Islamic offshore banks and three Islamic investment banks. Labuan is also the centre stage for the listing of international Islamic sovereign bonds (Sukuk) that are Syariah-compliant in all major Muslim countries.

Islamic

As an alternative system, Malaysia offers Islamic banking, which is based on the concept of profit sharing as opposed to the use of interest in the conventional banking system. At
present, there are 11 Islamic banks offering the full range of financial services based on Shariah principles. In addition, eight conventional banks also provide Islamic banking services through a dedicated Islamic window. Islamic financial products and services are made available via 548 branches throughout the country.

Islamic banking has been growing steadily since its introduction in 1983. the Islamic financial system in Malaysia was at a very strong and stable position both at the domestic and international levels.. The domestic level, the contribution of the Islamic financial system to the country's Gross Domestic Product had increased.As of July 2007, Total assets of the Islamic banking industry reached RM133 billion or 12.2% of the total banking systems assets from 6.9% end-2000. Takaful (Islamic insurance) meanwhile took up 6.1 per cent with total assets valued at RM6.9 billion,"
(http://gifc.blogspot.com/2007/07/malaysias-islamic-financial-system.html)

As of June 2006 there are a total of 33 banking institutions servicing the Islamic market, including nine Islamic banks, eight commercial banks, four merchant banks, seven discount houses and five specialised financial institutions (development financial institutions). (http://www.pwc.com/extweb/service.nsf/docid/5F57919BE94329D3852571EF00696D38)
Some major Islamic banking products are listed below: Islamic Principle Al-Wadiah Al-Mudharabah Clarification Guaranteed custody Profit-sharing Purpose For deposit-taking products Investment deposits Banking Products Current deposits, saving deposits General and special investment accounts, project financing, sell and buy back agreements Al-Murabahah Cost-plus For financing facilities BaiBithaman Ajil Deferred payment sale For house financing Working capital financing, bonds, commercial papers Housing loan, negotiable instrument of deposit, commercial property financing, credit card, umrah financing, project financing Al-Ijarah Leasing For leasing and Leasing of

vehicle financing

machines, vehicle financing, financing syndication, bonds

Al-Musyarakah

Profit and loss sharing

For project financing

Project financing, share financing, unit trust financing, financing syndication

(Financial System of Malaysia, 2005)

4 Main Business Areas in Islamic Banking:

Mudharabah (profit-sharing) It is a general agreement between a capital provider and an entrepreneur who uses the funds for its business activities. Any profits made will be shared between both parties according to an agreed ratio while losses are borne solely by the capital provider. Murabahah (cost plus) It refers to the sale of goods at a price including a profit margin which is agreed by both parties. Such sales contract is valid when the price, other costs and the profit margin of the seller are stated at the time of the agreement of sale. Musyarakah (joint venture) It means a partnership or joint venture for a particular business, the allocation of profits will be followed an agreed ratio. For losses, both parties will share the losses on the basis of their equity contribution. Ijarah (leasing) It is an arrangement about leasing. At an rental agreed by both parties, the lessor leases equipment, building or other facility to a client

Malaysia as an International Islamic Financial Centre

So, Islamic banking and finance has been developed as a viable alternative to conventional banking in Malaysia to position the country as the regional Islamic financial centre. In addition to full Islamic banks like Bank Islam Malaysia Berhad and Bank Muamalat Berhad, other financial institutions also offer Islamic banking or interest-free banking services. In this regards, the Malaysian Government start using a strategic initiative through
the financial regulators to create a sound, innovative and competitive international Islamic financial services industry in Malaysia to further strengthen Malaysia 's position as an Internationl Islamic Financial Centre (MIFC).

To meet the best international standards. MIFC offer Islamic financial products and services in any currency to non-residents and residents, in the following niche activities: - origination, distribution and trading of Islamic capital market and treasury instruments; - Islamic fun and wealth management services; - International currency Islamic financial services (including deposits and financing); and - takaful and retakaful.

Under the MIFC measures, efforts are also being intensified towards positioning Malaysia as a centre of excellence for Islamic banking and finance education, training, consultancy and research.

Future trend

Development of Islamic banking The government is committed to improvements across the banking sector and ensuring that it is as internationally competitive as possible. This, combined with Malaysia's large Muslim population, means the country is rapidly developing as an Islamic banking leader.

BNM aims to create an Islamic banking system which operates in parallel with the conventional banking system. Yet, Islamic banking system requires three fundamental elements to qualify as a feasible system, i.e.: a large number of players; a broad variety of instruments; and an Islamic money market. In addition, an Islamic banking system must also reflect the socio-economic values in Islam, and must be Islamic in both substance and form.

(http://www.businessmonitor.com/banking/malaysia.html)

1. Restructuring of the Financial Sector

2. According to the Financial Sector Masterplan launched by BNM on 1 March 2001, the objective of the plan is to develop a more elastic, competitive and dynamic financial system with the best practices, that supports and contributes positively to the growth of the economy throughout the economic cycle, and has a core of strong and forward looking domestic financial institutions that are more technology driven and ready to face the challenges of liberalization and globalization.

The implementation of the Financial Sector Masterplan for the banking sector is summarized as follows: Phrase I: Focusing on measures that seek to strengthen the capability and capacity of domestic banking institutions; Phrase II: Removal of some of the restrictions on foreign players to add competition to the industry; Phrase III: Introducing new foreign competitors as a result of the intensifying

degree of global competition and greater assimilation into the global arena.

Conclusion So far, the overview of financial institutions with a focus on the banking sector is discussed. Actually, Malaysian banking sector is enjoying sustainable growth. At June 2006, The assets in the Malaysian banking system reached RM1.0 trillion (USD273.9 billion) as with total loans amounting to RM 574.7 billion (USD156.3 billion). Growth in banking system assets has been reasonably strong since 2000 with an average CAGR of 7.8% between 2000 and 2005. Besides, The banking system continued to demonstrate a high resilience in the
third quarter of 2007, supported by strong capitalisation, stable profitability and further improvements in loan quality. (Economic and Financial Developments in

the Malaysian Economy in the Third Quarter of 2007)

As mentioned in the beginning, banking sector plays an vital role in economic development. The above-mentioned facts highly indicate that the banks are confident about future economic prospects in Malaysia.