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BANK

MANAGEMENT
CHAPTER 2
BANK REGULATIONS
AND COMPLIANCE

Why are Banks


Regulated?

Banks are the most highly regulated


industry
Highly regulated due to:
The characteristic of banks
The function they play in the economy

Bank Characteristics

Highly leveraged
Debt account for 90% of bank funding
Main source of funds - deposits

Opaque

Asymmetry information problem is crucial in


banking

Inadequate or weak competition between


banks
Ability to create spill over or contagion effects
to the other industries and the whole economy
3

Bank Functions

Intermediary functions between


surplus unit and deficit unit
Source of funding especially in the
developing countries
Payment systems
Monitor and supervise firms and
economic sectors

Objectives of Banks
Regulation
1.
2.

3.

Prevention of economic disruption


Guard against deposit insurance
losses
Social goals

Prevention of Economic
Disruption

Reduce the risk of large-scale failures that would


adversely affect the level of economic activity

To control the supply of money and credit in order


to achieve a nations broad economic goals

The smooth functioning of the economy is


dependent on the money supply, the payments
system, and an uninterrupted flow of credit
Banks

products such as checkable deposits,


savings deposits and time deposits are
components of the money supply
6

Cont

Banks are the primary source of liquidity


for other financial institutions and are
the transmission belt for the
implementation of monetary policy
Thus, a safe and sound banking system
is essential to a nations monetary
system and financial marketplace
Systemic risk
Failure in a bank would affect other
banks and economy as a whole
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Guard Against Deposit


Insurance Losses

Bank debtors
Creditors depositors and shareholders
The largest number of creditors are
small depositors
Not capable of evaluating the financial
condition of banks or monitoring their
actions
Thus, it is in the public interest to
protect small depositors by having
their deposits insured by a government
agency
8

Cont
The

deposit insurance agency


represents the depositors and
the publics interest to ensure
that banks operate in a sound
fashion
If bank failures are large enough
to exhaust the deposit insurance
fund, the taxpayers will be called
on to repay depositors
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Social Goals

To promote an efficient and effective


banking system that finances economic
growth, impartially allocates credit,
and meets the needs of the customers
and communities that banks serve
To ensure equal opportunity and
fairness in the publics access to credit
and other vital financial services
Banks cannot discriminate against
borrowers on the basis of race,
gender, age, and other factors
10

Cont
Borrowers

must be judged on the basis


of their creditworthiness, and banks
must supply borrowers with accurate
information about the cost of borrowing
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 the priority sectors (housing, small
business, agriculture etc)
11

Cont

To avoid concentrations of financial


power in the hands of few individual
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
SME, agriculture and other priority
sector)
12

What Bank Regulators


Do?
Four primary responsibilities:
1. Chartering
2. Regulating
3. Supervising
4. Examining

13

1. Chartering

Regulator must determine whether


the proposed bank :
have adequate capital and proper
management for its respective
market area
take into account the needs and
convenience of the community,
competition and other factors
14

2. Regulate

Bank regulation the formulation and


issuance by authorized agencies of
specific rules or regulations, under
governing law for the structure and
conduct of banking
Bank supervision concerned primarily
with the safety and soundness of
individual banks, and involves general and
continuous oversight to assure that banks
are operated prudently in accordance
with applicable statutes and regulations
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3. Supervise

Exercise by regulators to ensure that bankers


comply with banking regulations
Bank examinations are one means of evaluating
compliance
Techniques to deal with banks not compliance
with rules and regulations:
Memorandum of understanding (MOU)
Detailing the changes that must occur to
put the bank back in good standing
Cease and desist orders
Prohibit the bank from continuing a
particular course of conduct
Close the bank
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In 1997, there was a shift towards a riskbased supervision whereby more focus were
given to areas of high risk which threatened
the soundness of the banking institutions.
The risk-based supervision places emphasis
on two main elements;
a dynamic off-site surveillance for early
detection of problems in the banking
institutions
an effective planning to customize onsite examinations to suit the size,
activities and risk profiles of the
banking institutions (Bank Negara
Malaysia, 1999).
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4. Examination

Part of the supervisory process


Two types of examination:
1.

To determine the safety and soundness


of the bank
Commonly use the Uniform Financial
Institutions Rating System known as
CAMELS
Capital Adequacy
Asset Quality
Management
Earnings
Liquidity
Sensitivity to market risk
18

Cont

Capital Adequacy

Asset Quality

Refers to amount of regulatory capital


that banks are required to maintain
Reflects the risk associated with
managing assets including the quality of
loans and investments

Management

Assesses to the capability of the board of


directors and managements ability to
measure, monitor and control risk
19

Cont

Earnings

Liquidity

Indicates the profitability of the bank and


sources of those earnings taking risk into
account
Represent the banks ability to meet its
financial obligations when they come due,
and the needs of their customers (deposit
withdrawals and loans)

Sensitivity to market risk

Interest rates, foreign exchange, and the


ability of the bank to manage that risk

20

Cont
2.

To determine whether the bank is in


compliance with all relevant
regulations and laws

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Financial Services Act


2013

Banking institutions in Malaysia are subject


to rules and regulations under FSA 2013.
An Act to provide for the regulation and
supervision of financial institutions,
payment systems and other relevant
entities and the oversight of the money
market and foreign exchange market to
promote financial stability and for related,
consequential or incidental matters.
Date come into force: 30 June 2013, except
section 129 and Schedule 9, see [P.U.(B)
276/2013]
22

FSA 2013

Thus, the Banking and Financial


Institutions Act 1989 (BAFIA), the
Insurance Act 1996, the Exchange
Control Act 1953 and the Payment
Systems Act 2003 are all repealed by the
FSA although licences which were issued
and approvals which were granted under
the repealed legislations are deemed to
have been issued under the FSA and
continue to apply.
23

Feature of FSA 2013

One key feature of the FSA is the formal


recognition of financial groups, as opposed
to individual banking or financial entities, for
the purposes of regulation and supervision.
The FSA empowers the BNM, to exercise
oversight over financial groups for the safety
of any member of the group who is an
authorised person licensed to carry on
banking, insurance or investment banking
business.
24

Cont..

Under the FSA, BNM is endowed with


wide powers to intervene with a bank's
or financial institution's business or
operations to manage risk and ensure
good governance.
This includes an increased focus on
preemptive measures to address issues
of concern within financial institutions
that may affect the interests of
depositors and policyholders, and the
effective and efficient functioning of
financial intermediation.

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The introduction of FSA is


Greater clarity and transparency in the
intended to:

implementation and administration of the


law.
This includes clearly defined regulatory
objectives and accountability of Bank Negara
Malaysia in pursuing its principal object to
safeguard financial stability, transparent triggers
for the exercise of Bank Negara Malaysias
powers and functions under the law, and
transparent assessment criteria for authorizing
institutions to carry on regulated financial
business, and for shareholder suitability;
26

Cont

Provisions for differentiated regulatory


requirements that reflect the nature of
financial intermediation activities and
their risks to the overall financial
system;

Provisions to regulate financial holding


companies and non-regulated entities to
take account of systemic risks that can
emerge from the interaction between
regulated and unregulated institutions,
activities and markets.
27

Cont

The Minister of Finance may subject


an institution that engages in
financial intermediation activities to
ongoing regulation and supervision
by Bank Negara Malaysia if it poses
or is likely to pose a risk to overall
financial stability;

28

Cont

Strengthened business conduct and


consumer protection requirements to
promote consumer confidence in the
use of financial services and products;
Strengthened provisions for effective
and early enforcement and supervisory
intervention

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Ultimately:

The new laws will place Malaysias


financial sector, encompassing the
banking system, the
insurance/takaful sector, the financial
markets and payment systems and
other financial intermediaries, on a
platform for advancing forward as a
sound, responsible and progressive
financial system.
30

Cont..

To provide the regulator with


greater powers to counter future
risks to financial stability in the
financial sector, increase consumer
protection and promote competition
in the broader financial services
sector, and is a step towards global
trends in financial regulations.
31

Cont..

This is especially important to enable


the financial system to meet the new
demands for financing associated with
Malaysias economic transformation
programme both during and beyond the
next decade, the changing
demographics of our population, and the
increasing integration of the Malaysian
economy with the region and the world.
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Requirements or restrictions in
repealed laws which remain applicable:

Obtaining general insurance/takaful outside


Malaysia(section 127 of FSA/ 139 of IFSA)
The prior written approval of Bank Negara Malaysia
must be obtained for property or liability to be insured,
with an insurer outside Malaysia. This requirement has
also been extended to the takaful sector.

Illegal deposit-taking and advertisement for


deposits(sections 136-138 of FSA/ 148-150 of
IFSA)

Accepting deposits without a licence granted under the


FSA/IFSA remains prohibited. Issuing or facilitating a
person to issue an advertisement in relation to making
such illegal deposit is also prohibited.

33

Cont

Restriction on use of certain words (section


139 of FSA/ 151 of IFSA)
Use of certain words (e.g. bank, insurance, takaful)
capable of being construed as indicating the carrying
on of businesses which are regulated under the
FSA/IFSA is not allowed, except with the prior
written approval of Bank Negara Malaysia.

Foreign exchange administration


rules(sections 213-216 of FSA/ 224-227 IFSA)
All prevailing foreign exchange administration rules
remain effective through the issuance of new notices
under the new laws to replace the current ECM
Notices. Further information is available on Bank
Negara Malaysias website
34

Cont

National interest(sections 216 of


FSA/ 227 of IFSA)

The notice on dealings with specified persons (ECM


14) will be replaced with the new Direction issued
pursuant to section 216 of the FSA and section 227
of the IFSA.

Removal of provisions on scheduled


institutions

A company that wishes to carry on leasing, factoring,


development finance or building credit business
(previously referred to as scheduled business under
BAFIA) is no longer required to obtain a written
acknowledgement from Bank Negara Malaysia.
35

Cont

Transitional requirements for existing


shareholders of licensed persons
under FSA (section 279(1) of FSA)
The FSA provides that no person shall
hold 5% or more interest in shares of a
licensed person without the prior approval
of Bank Negara Malaysia. Interest in
shares includes direct and effective
interest under Schedule 3 of the FSA.

36

Cont

Section 279(1) further provides that a person who


holds 5% or more of an effective interest in shares
of a licensed person, but was not required to
obtain an approval under section 45 of the
repealed BAFIA and section 67 of the repealed
Insurance Act 1996 shall be deemed to be
approved under the FSA provided that he submits
such documents or information as may be specified
by Bank Negara Malaysia no later than 31
December 2013. Further information, including the
list of information to be submitted by affected
shareholders are available on Bank Negara
Malaysiawebsite (http://www.bnm.gov.my).

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Main Regulatory Agencies


in the Banking Sector

Bank Negara Malaysia


Securities Commission
Companies Commission of Malaysia
Malaysia Deposit Insurance
Corporation

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List of Guidelines Issued to


the Banking Industry

GP 1 Guidelines on duties and


responsibilities of directors and
appointment of chief
executives
GP 2 Guidelines on submission of
annual
accounts
GP 3 Guidelines on the suspension of
interest on non-performing loans and
provision for bad and doubtful debts
39

Cont

GP 4 Guidelines on staff training fund


GP 5 Guidelines on the credit limit to a
single customer
GP 6 Guidelines on prohibition of loans to
directors, staff and their interested
corporations
GP 7 Guidelines on code of ethics
Part I
: Guidelines on the code of
conduct
for directors, officers
and
employees in the banking
industry
40

Cont

Part II : Guidelines on shares


trading
Part III :Guidelines to prevent misuse
of Bumiputera names in
public
share issues
GP 8 Guidelines on the specimen
financial
statements for the banking
industry
GP 9 Guidelines on money laundering
and
know your customer policy

41

Cont

GP 10 Guidelines on minimum audit


standards for internal
auditors of
financial
institutions
GP 11 Guidelines on consumer
protection
on electronic funds
transfers

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Instruments of Monetary
Control
1.

Money Market Operations

Can be conducted either through


borrowing or lending by BNM in
the interbank market or
the usual open market operations,
which are transacted mainly via
the sale and purchase of
government securities and other
papers either directly or through
repurchase agreements
43

Cont

The scope for an active open market


operations has been constrained by the
limited availability of the Government
papers (Government securities, Treasury
bills and Government Investment Issues)
With the limited supply of papers, the
role of open market operations has been
largely used for providing discount
window facility to the banking
institutions as a last resort in times of
liquidity needs
44

Cont
2.

Statutory Reserve Requirement (SRR)

One of the oldest monetary


instruments for BNM
Is a monetary policy instrument
available to BNM for purposes of
liquidity management
Also served as an instrument to deal
with fundamental changes
Banking institutions are required to
maintain a certain percentage of their
reserves with BNM in the form of cash
reserves
45

Cont
SRR continues to remain an effective
monetary policy instrument in Malaysia
This is attributed to several factors:
Disintermediation of funds away from the
banking system is not pervasive
Total deposits placed with the banking
system accounted for about 87% of
deposits placed with the financial system
High share of bank loans (82%) of the
total financial system
SRR is imposed solely for monetary
purposes, and not for income to either the
Government or BNM

46

Cont
3.

Centralization of deposits with Bank Negara


Malaysia
In order to ensure that the Government
does not accumulate its deposits
unnecessarily with the banking
institutions, Bank Negara Malaysia has
required the Government and Employees
Provident Fund (EPF) to deposits certain
percentage of their cash in Bank Negara
Malaysia.
Bank Negara Malaysia will manage the
Governments money, consistent with the
desired interest rate level and underlying
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excess liquidity conditions.

During a tight liquidity situation, Bank


Negara Malaysia will recycle this money
into the banking system as a temporary
measure to stabilize the banking
institutions Ensure consistency in
operations of the Government and the
EPF with monetary stance

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4.

Selective credit and administrative


measures

BNM influences the credit situation of the


country through several policies on bank
lending.
Guidelines on lending are such as lending
to priority sectors (i.e., small and medium
business sector, agriculture sector,
manufacturing sector etc), hire-purchase
guidelines on motor vehicles and
guidelines on credit cards spending.
If implemented over a protracted period,
may affect efficient allocation of resources
49

Limitations of
Regulations
Moral hazard
the safety net arrangements provided by the
central banks creates moral hazard behavior
among banking institutions
The safety net arrangements such as deposit
insurance systems and lender-of-last-resort
facilities which was intended to protect the
interests of banks customers, banking
system and the economy as a whole cause
the banks customers to take for granted on
the safety of their money in the banks.
the safety net arrangements induce
opportunistic and self-serving behavior

50

Agency capture

Banking regulations can create the


problems of agency capture;
a situation where the regulatory
process is captured by banks and other
financial institutions to be used in their
own interest rather than the interest of
the banks customers.
For example, there are arguments that
the Basle Capital Accord has had too
much input from banking sector
participants and large banks in
particular.
51

Costs of compliance
as banking institutions have to comply with
all rules and regulations imposed on them, it
would create an additional cost for the
banks.
however, banks would not bear the cost of
compliance alone but would pass on to bank
customers which would result in higher costs
of banking services and possibly less
intermediation business.
the costs of compliance to the regulations
may act as a barrier to entry to the market
and this may create a monopoly position in
the banking industry.

52

Impact of bank regulation on


the banking institutions

Positive impacts of banking regulations on


the banking institutions
Increase bank performance
Tight regulations on bank entry,
restrictions on bank activities and
regulations that inhibit the freedom of
bankers to conduct their business boost
the banks net interest margin
Banking regulations increase banks
performance by reducing corruptions
and increase the banks cost efficiency
53

Reduce bank risk taking


Bank regulations are designed to curb
excessive risk taking by the banking
institutions and, thereby reduce the prospect
of credit, liquidity and solvency problems
Good corporate governance
Banking regulations would increase
accountability, transparency and skill level of
the management of the banking institutions.
The bank management will be under greater
scrutiny, thus would have to focus more on
improving their efficiency and
competitiveness.

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Negative impacts of banking regulations to


the banking institutions

Reduce competition among banks

Banking regulations limit competition in the


banking industry as all banking activities,
investments, services offered or take over and
acquisition need to have an approval from the
regulator

Reduce innovations in banking products

Specialization in banking activities (i.e., commercial


banking conduct retail banking activities;
investment banking wholesale banking activities)
products (i.e., only commercial banks can offer
current account to bank customers) and services
reduce innovations among the banking institutions.
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