FIN536

FINANCIAL MARKETS AND INSTITUTIONS

ASSIGNMENT 2

Name : Mohammad Taufiq Bin Adnan

No. Matric : 2015977933
Group : NBMFF4C
Phone No. : 016-7736730
Question 1

a) Commercial banks are one of the biggest financial intermediaries available if

measured by the
size of their assets. Briefly explain three (3) sources and three (3) uses of funds of
commercial
banks in Malaysia.

a) Three (3) sources of commercial banks in Malaysia are :-

i) Savings accounts

- Savings account is a type of ‘other deposits’ that that is offered by all commercial
banks and some development financial institutions such as savings institutions and
Agrobank. Savings account focuses more of attracting small depositors to place their
fund in a bank. The small depositors comprised of individuals, societies, clubs, and
associations to place money for their savings and at the same time for daily withdrawals.
The majority of account holders are employed individuals where their salaries are
credited into this account.

ii) Current Account

- The current account is normally for individuals, with or without a business, partnerships
and corporations to place money for their daily usage. It is an account whereby funds
may be actively credited and debited into the account (credited for receipt of funds and
debited for any payment made by the account holder). For businesses it is normally for
their working capital such as to pay suppliers or wages for workers, debt payment and
for the usage of the trade finance facilities.

iii) Fixed Deposit

- Fixed deposits (for Islamic banks it is called Investment Accounts) are depository
products offered by financial institutions for the placement of funds by a customer for a
specific period of time. It is a special account for those who have excess funds for
investment purposes. It is a relatively safer form of investment as compared to other
investment instruments.
a) Three (3) uses of funds of commercial banks in Malaysia are :-

i) Term loan

- Term loan is a single loan for a stated period of time or series of loan on specified
dates. The purpose of loan is to acquire machinery or equipment, commercial building,
shop houses, factory, renovation and even for debt refinancing. Unlike OD facility, it is
not for financing day-to-day operation of customer’s business. If it is for the purchase of
an asset, the asset to be purchased will be used as collateral. This type loan may be
disbursed one-lump sum or may also be progressively disbursed. The risk face by banks
for a term loan is higher as compared to other facility such as Overdraft facility.
Therefore, interest charge should be higher & usually depend on the repayment
schedule. The repayment schedule may monthly, quarterly, half-yearly or even yearly
basis.

ii) Housing Loan

- A housing loan is a type of loan given to customers to meet the full or part purchase
price of the house. It is specifically tailored for the purchase of residential property. The
types of residential properties to be purchased include low-cost house, double-storey
house, apartment, condominium, town houses and bungalows. Housing loan is one of
the main categories of loans of a commercial bank other than personal loan and
business loan, thus interest income of banks, being the main the contribution of profits to
the banking sector, comes from housing loan. The housing loan is basically a term loan
(or fixed loan as it is also known) on a long term basis, where the repayment period of
instalment payment range from 10 years to as long as 30 years. One of the evaluation
criteria on the approval of the loan is that the monthly repayment of principal plus interest
should not exceed one third the applicant’s income.

iii) Personal Loan

- Personal loan is a loan given to an individual for specific personal purpose such to buy
personal assets, to invest, to purchase computer or for education. Personal loan is highly
demanded that more institutions are offering including non-bank financial institutions.
Competitions are great that many banks are trying to attract potential borrowers by
offering competitive rates and faster loan processing time. Personal loan are repayable
by monthly instalments over a minimum of 6 months to up to 7 years or more.
b) If loan is the largest component of assets of a commercial bank, what item contributes
the
most on the liability side and how would a commercial bank maintain the level of this
component?

Housing loan is the one of main component of assets in commercial banks and it
contributes most on the liability side. Housing loan is a type of loan given to customer to
meet the full or part purchase price of the house. It is specially tailored for the purchase
of residential property. Banks can maintain the level of housing loan by making regular
observation of customer accounts in terms of paying back the payment. The bank must
make sure the customers meet payment agreement that have been agreed in the
contract.

Besides that, banks can also seize the customer property if they not able to pay
the loan in specific time agreed in the contract. This can maintain the level and keep
banks from losses. Then, bank also can limit the number of housing loans can be taken
by the customers. By this method, customer cannot simply apply for new loan if they
have outstanding loan and the banks can rejects the application if the customers did not
meet the propose requirement.
Question 2

a) Define money laundering. Explain the three (3) steps that criminals can do to legalise
their
illegal income and introduce it into the financial system. Give relevant examples.

Money laundering is the process where illegal, or “dirty” money is put through a
cycle of transaction, or “washed”, so that it comes out the other end as legal, or “clean”
money.

First step is placement. Illegal profits are introduced into the financial system. By
dividing large amounts of cash into less conspicuous smaller amounts that are deposited
directly into a bank account or by purchasing a series of monetary instruments.

Second is layering. Funds, which have entered the financial system, are then
distanced from their source. Done through purchase and sales of investment instruments
or through multiple transfers of funds from different accounts around the world disguised
as payments for goods and services.

Third step is integration. This step is to integrate the illegal proceeds back into the
economy as legitimate funds through legitimate transactions such as business ventures,
luxury assets, lending and investing.
b) Bank XX is experiencing an increase in the non-performing loan (NPL) to gross loan
ratio for two consecutive years probably due to lack of thorough evaluation of credit
application. Bank YY, on the other hand, has not been able to borrow from other banks
to meet its short-term requirement since it has exceeded its credit limit.

The type of risk Bank XX and Bank YY are facing and how can the banks reduce those
Risks are :-

Bank XX, type of risk is credit risk. Credit risk is a risk of non-payment of
borrowing/financing provided to a borrower on maturity date. It arise due to promise cash
flows on the financial claims (fixed coupon bonds issued y corporations and bank loans)
held by financial intermediaries will not be paid in full. When NO DEFAULT, the financial
intermediaries earn coupon on the bonds and interest on the loans. When there is
DEFAULT, the financial intermediaries earn zero interest and may lost part or all
principal lent.

The way to reduce this risk is by doing the credit screening for the customers
before making any loans. Banks must make sure customers are financially strong. Then,
the bank must regularly do the monitoring credit extended. Bank can identify the non-
performing loans account and take proper action. Besides that, the bank also need to do
diversification of credit risk.

For the Bank YY, type of risk is liquidity risk. Liquidity risk occurs when depositors
demands immediate cash (liability) and holders of off-balance sheet exercises right to
borrow (assets). Liquidity crisis due to lack of confidence or unexpected needs for cash
can result in rise in cost and supply restricted.

The way to reduce this risk is the bank must keep an up-to-date balance sheet
that includes accurate data on their current assets and liabilities. By keeping good
records of assets and liabilities, bank can closely follow cash flow and working capital.
Then, bank need to monitor cash flow, which is the timing between when a business
collects it revenues and pays its bills. Bank can use cash flow projections to help plan for
liquidity. Other than that, bank need to improve their cash flow. Maintain cash flow by
improving the process by which they collect loan repayment. Perhaps they can offer
discounts for quick payment is one method to improve collections.