CHAPTER 7

CENTRAL BANKS

Role of Central Bank

Central bank is the most important
financial institution in the financial
system
It is a government agency responsible
for the conduct of monetary policy
involves the management of interest
rate and money supply
BWBB1013 SESSION 1
2009/2010

Banking Regulation
Banks are the most highly regulated
industry
Main objective of bank regulations
designed to protect the public interest

BWBB1013 SESSION 1
2009/2010

Why Banks are Heavily

Regulated
To protect the safety of the publics savings
Banks are among the leading repositories of the
publics savings
To control the supply of money and credit in order to
achieve a nations broad economic goals (such as
high employment and low inflation)
Banks have the power to create money in the
form of readily spendable deposits by making
loans and investments (extending credit)

BWBB1013 SESSION 1
2009/2010

To ensure equal opportunity and fairness in the

publics access to credit and other vital financial
services
To promote public confidence in the financial
system, so that savings flow smoothly into
productive investment, and payments for goods
and services are made speedily and efficiently
To avoid concentrations of financial power in the
hands of a few individuals and institutions
To provide the government with credit, tax revenues
and other services
To help sectors of the economy that have special
credit needs (such as housing, small business and
agriculture)
BWBB1013 SESSION 1
2009/2010

However, regulation must be balanced and limited

so that:
a) Banks can develop new services that the public
demands
b) Competition in financial services remains
strong enough to ensure reasonable prices and
an adequate quantity and quality of service to
the public
c) Private-sector decisions are not distorted in
ways that misallocate and waste scarce
resources (such as by governments propping
up banks that should be allowed to fail)
BWBB1013 SESSION 1
2009/2010

The Impact of Regulation

on Banks
Regulations often block entry into the regulated
industry
Regulation shelters a firm from changes in demand
and cost, lowering its risk
Regulations can increase customer confidence in
banks, which in turn may create greater customer
loyalty toward banks

BWBB1013 SESSION 1
2009/2010

Malaysia
Commercial

banks in Malaysia are under The

Banking and Financial Institutions Act 1989
(BAFIA)
Replace the Banking Act 1973 and Finance
Companies Act 1969
Intended to provide an integrated supervision of
the Malaysian financial institutions and to
modernise and streamline the laws relating to
banking and all other financial institutions under
one supervisory and regulatory legislative regime
BWBB1013 SESSION 1
2009/2010

CENTRAL BANK OF
MALAYSIA
Bank Negara Malaysia (BNM)
Established on January 1959, under the
Central Bank of Malaya Ordinance (CBO),
1958
The CBO was revised in 1994, and now the
Central Bank of Malaysia Act (CBA) 1958
The CBA defined BNM as the bank which
constitutes the apex of the monetary and
banking structure of the country
BWBB1013 SESSION 1
2009/2010

Legislation
To enable BNM to meet its objective, it is vested
with comprehensive legal powers under various
Acts and Ordinance to regulate and supervise the
financial system
These Acts include:

The Central Bank of Malaysia Act 1958 (CBA)

The Islamic Banking Act 1983 (IBA)
Banking and Financial Institutions Act 1989 (BAFIA)
Essential (Protection of Depositors) Regulations 1986
under Section 2 of the Emergency (Essential Powers)
Act 1979
BWBB1013 SESSION 1
2009/2010

10

Cont

Insurance Act 1996 (replaced the Insurance Act 1963)

Takaful Act 1984
6 legislations pertaining to the promotion of Labuan
as an International Offshore Financial Center (IOFC)

The introduction of BAFIA on 1 October 1989 for

licensed institutions, extended BNMs powers for
supervision and regulation from institutions involved
only in deposit-taking to institutions also engaged in
the provision of finance and credit
BWBB1013 SESSION 1
2009/2010

11

Cont
BNM also act as:
An agent to the government on exchange
control matters
Administers the Exchange Control Act 1953,
with the governor having assumed authority as
the Controller of Foreign Exchange on 1 August
1960
1989 through an amendment to the CBA,
BNM was made directly responsible for all
exchange control matters instead of just being
an agent to the government
BWBB1013 SESSION 1
2009/2010

12

1988 governor act as the DirectorGeneral of Insurance and Takaful

BNM was made responsible for the
supervision, regulation and development
of the insurance industry as part of the
financial system

BWBB1013 SESSION 1
2009/2010

13

The Functions of BNM

Maintaining monetary stability
Promoting a sound financial system
Issue of currency and management of the
nations international reserves
Banker / adviser to the government

BWBB1013 SESSION 1
2009/2010

14

Maintaining Monetary
Stability
Ultimate objective of monetary policy attaining
monetary or price stability
Price stability is a key prerequisite for sustained
economic growth
Attaining monetary stability:
Prior 1990s the monetary strategy of BNM was to
target monetary aggregates as the movements of
these aggregates were highly correlated with inflation
Early 1990s developments in the economy and
financial system weakened the relationship
BNM

gradually shifted its focus from monetary targeting to

interest rate targeting
BWBB1013 SESSION 1
2009/2010

15

Cont
BNM

conduct the monetary policy through shortterm interest rates to achieve its ultimate objective
of price stability
BNM used a wide range of monetary instruments to
manage liquidity to achieve its objective of price
stability
These include:
Open market operations
the means of implementing monetary policy by
which a central bank controls its national money
supply by buying and selling government
securities, or other financial instruments.
BWBB1013 SESSION 1
2009/2010

16

 Direct

intervention by BNM to borrow or lend

in the interbank money market
the issuance of BNM papers and variations of
the statutory reserve requirement (SRR)

BWBB1013 SESSION 1
2009/2010

17

Promoting a sound financial

system
The existence of a sound and stable financial
system is necessary for the conduct of monetary
policy
The maintenance of financial stability - dependent
on the existence of stable monetary conditions so
that the balance sheets of corporations and
financial institutions are not adversely affected by
conditions of macroeconomic stress
Essential element for the promotion of financial
stability is the existence of a strong and effective
prudential framework
BWBB1013 SESSION 1
2009/2010

18

 To

ensure that banking institutions operate

in a sound and prudent manner minimising the risk of bank failure which
may affect the whole economy

BWBB1013 SESSION 1
2009/2010

19

Cont
BNM is the sole authority regulating the banking
industry in Malaysia under BAFIA 1989 and also IBA
The BAFIA provides BNM to grant and revoke banking
licenses, and also to take prompt corrective actions to
deal with ailing financial institutions
These powers, among others include:
Removal of directors
Appointment of directors and advisors
Suspension of lending activities
Reduction of capital
BWBB1013 SESSION 1
2009/2010

20

Cont
BNM also act as a banker to the financial
institutions
Conducting supervisions and inspections
To ensure sound and prudent conduct of
operations to safeguard the interest of the
depositors and the public
To ensure that the financial institutions
comply with the banking act
BWBB1013 SESSION 1
2009/2010

21

Cont
Mechanics of supervision:
BNM applies the CAMEL framework to evaluate
the overall financial and general condition of a
banking institution
The CAMEL rating is reviewed once a year
This would provide a means for supervisors to
evaluate the types and severity of problems
that banking institutions are experiencing and
to adopt the necessary supervisory response
BWBB1013 SESSION 1
2009/2010

22

Cont
Inspection

mainly concentrated in the following

areas:
Investment and lending policies
State of its assets
Quality of management
Compliance and statutory requirements and
guidelines and directives issued by the
central bank
BWBB1013 SESSION 1
2009/2010

23

Cont
CAMEL:
C

= Capital Adequacy

The

heart of an institutions safety and solvency

Measure of financial strength and also act as a
cushion in the case of bank losses
A

= Asset Quality

Has

direct impact on the financial performance of a

banking institutions
The quality of assets depends on bank loans and
investments
In recent years, loan losses are often the primary
source of large losses for institutions
BWBB1013 SESSION 1
2009/2010

24

Cont
M

= Management Quality
The most important element of the CAMEL
components
The performance of the other four CAMEL
components will depend on the vision,
capability, agility, professionalism, integrity
and competence of the management
Have greater weightage in the assessment
of overall CAMEL composite rating
BWBB1013 SESSION 1
2009/2010

25

Cont
E

= Earnings Performance
The quality and trend of earnings of an
institution depend largely on how well
the management manages the assets
and liabilities of the institution
Good earnings performance would
inspire the confidence of depositors,
investors, creditors and the public at
large
BWBB1013 SESSION 1
2009/2010

26

Cont
L

= Liquidity Position
A banking institution must always be
liquid to meet depositors and creditors
demand in order to maintain public
confidence

BWBB1013 SESSION 1
2009/2010

27

Cont
Lender

of last resort
The main forms of assistance given by the
central bank:
Rediscounting of eligible bills such as
Treasury bills, Government securities and
Investment Certificates, trade bills and
commercial papers
Borrowing from the central bank against
collateral
Licenses
Licenses are issued by the Minister of Finance
on the recommendation
of the central bank
BWBB1013 SESSION 1
2009/2010

28

Issue of currency & management

of the nations international
reserves
Part III of the CBO provides authority to BNM to
become the sole issuer of Malaysian currency
The central bank commenced to issue its own
currency on June 12, 1967; replacing the
Currency Board as the sole currency issuer
Under the Malaysian Currency Act 1978, the
Malaysian dollar and cent were renamed as
Ringgit and Sen respectively
BWBB1013 SESSION 1
2009/2010

29

Cont
BNM is required to maintain a minimum
cover of 80.59% in external assets against
its notes and coins in circulation
In practice, BNM always maintained a cover
well above 100% of BNMs currency
liabilities, reflecting its commitment to
maintain full gold and foreign exchange
backing for the Malaysian ringgit
BWBB1013 SESSION 1
2009/2010

30

Cont
The countrys official external reserves are
held and maintained by BNM
The central banks international reserves
comprise of gold, foreign exchange and
reserve position with International Monetary
Funds (IMF)
However, gold and foreign exchange had
been the major component of external
reserves held by the central bank
BWBB1013 SESSION 1
2009/2010

31

Banker / adviser to the

government
BNM advises the government on its loan
programmes, including the terms and timing
of the loans and issue of new types of
securities
BNM also responsible for trading,
registering, settlement and redemption of
government securities through its
computerised trading and settlement system
BWBB1013 SESSION 1
2009/2010

32

Under CBA, BNM also provide temporary

advances, known as ways and means
advances to the government to cover any
deficit in the budget revenue
There are legal limitations to the
amount and the duration of loans that
BNM can make available to the
government

BWBB1013 SESSION 1
2009/2010

33

Cont
BNM operates as the governments banker
mainly because of the intimate connection
between public finance and monetary affairs
BNM performs the same functions as the
commercial banks
Provides cheque facilities, accept funds
and make payments on behalf of the
government and undertake the foreign
exchange business of the government
BWBB1013 SESSION 1
2009/2010

34

Cont
Close cooperation between the government
and BNM is also evident from the
centralisation of governments deposits with
the bank
Governments receipts, arising mainly from
the new issue of government securities, tax
and dividend payments are placed with the
bank and managed by the bank depending on
the liquidity situation of the system
BWBB1013 SESSION 1
2009/2010

35

Further reading:
Bank Negara Malaysia, The Central
Bank and The Financial System in
Malaysia: A Decade of Change, 19891999. Kuala Lumpur, Bank Negara
Malaysia, 1999.

BWBB1013 SESSION 1
2009/2010

36