Malaysian Financial System

TABLE OF CONTENT CONTENT 1.0 INTRODUCTION 2.0 BACKGROUND 3.0 OBJETIVES 4.0 FUNCTIONS OF THE FINANCIAL SYSTEM 5.0 STRUCTURE OF MALAYSIAN FINANCIAL SYSTEM 5.1 Financial Institutions 5.2 Financial Market 6.0 CONCLUSION 7.0 BIBLIOGRAPHY PAGE 2 3 4 5 8 9 12 14 15

Monetary Economics (ECO 553)

Malaysian Financial System

1.0

INTRODUCTION
According to Ibrahim Abdul Rahman, financial system is a well-organized structure

that is monitored closely by a supervisory authority to ensure rules and regulations are adhered to by the financial market participants in the financial system. In Malaysia, financial system is divided into two categories, which are financial institutions and financial market. Financial institutions comprise of banking system and non-bank financial intermediaries. Other than that, financial market comprise four major market which are money and foreign exchange market, capital market, derivatives market, and offshore market. It also comprises the set of institutions, markets and relationships that is involved in borrowing and lending funds and that affects the volume and cost of credit. Furthermore, financial system includes commercial banks, savings, and loan institutions, life insurance companies, the stock and bond markets, investment bankers, and many other institutions and markets in the private sector. Financial system channels household savings to the corporate sector and allocate investment funds among firms. They allow smoothing transactions of consumption by household and expenditures by firms and also enable households and firms to share risks. Different countries have different financial systems. Besides, an optimal financial system relies on both financial markets and financial intermediaries.

Monetary Economics (ECO 553)

Malaysian Financial System

2.0

BACKGROUND
The financial system in Malaysia was first started in year 1859 when the first

commercial bank in Malaysia, a branch of a British exchange bank which is The Chartered Mercantile Bank of India, London and China was established in Penang. Malaysian financial system has gone through evolutionary cycle since then until now. Bank Negara Malaysia was established as the central bank of Malaysia. They introduced our currency, Ringgit Malaysia. Bank Negara Malaysia also ensures that all the members in the financial system follow all the rules and regulations stated. This is to maintain a good and stable financial system. Our banking sectors are also expanding especially Islamic banking sectors. Many new banking products and services have been introduced. This has attracts not only Muslim customers but also non-Muslim customers. Today, Malaysian financial system has emerged as one of the renowned financial markets in the region as well as in the world.

Monetary Economics (ECO 553)

Malaysian Financial System

3.0

OBJECTIVES

The objectives of studying the functions of financial system and the structure of financial system in Malaysia are as follows: 1) To learn how financial systems what is financial systems and how does it works in the economy. 2) To explain why is it important to individuals and to Malaysian economy as a whole. 3) To identify what are the important components in the financial systems.

Monetary Economics (ECO 553)

Malaysian Financial System

4.0

FUNCTIONS OF THE FINANCIAL SYSTEM

Basically, the function of the financial system is to transfer loanable funds from lenders or the surplus units to borrowers or the deficit units. Financial system brings together individuals and institutions providing supply of funds with the demanding funds. It facilitates the channelization of the savings of individuals for example, to various borrowers which are companies where they use the funds to increase the production of goods and services which will then improves the growth of the economy. We can say that the financial system controls the flow of funds. The figure below further illustrates the above function of financial system:

Loanable funds (credit)

Loanable funds (credit)

Ultimate lenders of funds (surplus units)

Financial intermediaries & other financial institutions

Ultimate borrowers of funds (deficit units)

THE FINANCIAL SYSTEM

There are two modes of transferring funds between savers/lenders and borrowers. There are direct transfer and indirect transfer. Direct transfer is where the savers/lenders transfer the funds to the borrowers directly. For example, a household buys a corporate bond from a corporation. The household is lending directly to the corporation. Indirect transfer is where the transfer of funds from the savers/lenders to the borrowers is done through a financial intermediary (indirectly). For example, a household puts money/funds into a savings account of a commercial bank. Then, the bank may lend the funds to borrowers. We can see here that the funds are not directly transferred from the savers and the borrowers but through an intermediary which is the commercial bank. Figure below illustrates the flow of transfer of funds of both modes:

Monetary Economics (ECO 553)

Malaysian Financial System

DIRECT FINANCE LENDERS/SAVERS Household Firms Government Non-residents Funds FINANCIAL MARKET Money Market Capital Market
BORROWERS /SPENDERS

Funds

Firms Government Household Non-residents

Funds Funds FINANCIAL INTERMEDIARIES Credit Institutions Other monetary financial institutions Other INDIRECT FINANCE Funds

1) CREDIT The financial system supplies credit for people to support their purchases of goods and services or to finance capital investment. This allows individuals who have insufficient funds to buy cars or houses for example, to buy their dream cars or houses in credit (personal loans) and pay the loan back in instalment. Same goes to corporations which are in needs of funds to finance their projects. While with investment, the productivity of a countrys resources increases and also increases the standard of living for the citizens.

2) PAYMENTS The financial system provides a mechanism for making payments for everyone. We can make payments in the form of currency/fiat money, checking accounts, and other transaction media. We can also make payment whenever and wherever we want with the help of checks, credit card and debit card. Without the financial system today, Monetary Economics (ECO 553) 6

Malaysian Financial System one still has to take cash wherever he or she goes which would have been impossible. We are moving away from payments made in paper toward a system where funds are moved via computer hook up. 3) MONEY CREATION The financial system makes it possible for money creation. This is through the credit facilities and the mechanism for making payments. Money serves as a medium of exchange in purchasing goods and services. It eliminates the inconvenience of barter system. 4) SAVINGS The financial system provides a place for savings. Individuals and corporations save money today so that they can consume more goods and services in future. Savers lend their savings/surplus funds to borrowers and in return they will gain return in from of interest, dividends, capital gains, and so forth. The financial system usually offers high interest rates to encourage savers to save more money and consume less when the demands from borrowers (deficit units) are high.

Monetary Economics (ECO 553)

Malaysian Financial System

5.0

STRUCTURE OF MALAYSIAN FINANCIAL SYSTEM

Malaysian financial system can be divided into two. There are financial institutions

and financial market. The diagram below further illustrates the structure of Malaysian Financial system.

Financial System

Financial Institutions

Financial Market

BANKING SYSTEM 1.Bank Negara Malaysia 2.Banking Institutions Commercial Banks Investment Banks Islamic Banks 3. Others Discount Houses Representati ve Offices of Foreign Banks

NON-BANK FINANCIAL INERMEDIARIES 1. Provident and Pension Funds 2. Insurance Companies 3. Development Finance Institutions 4. Savings Institutions National Savings Bank Co-operative Societies 5. Others Unit Trusts Pilgrims Fund Board Housing Credit Institutions Cagamas Berhad Credit Guarantee Corporation Leasing Companies Factoring Companies

MONEY & FOREIGN EXCHANGE MARKET 1. Money market 2. Foreign exchange market

CAPITAL MARKET 1. Equity market 2. Bond market -public debt securitites -private debt securitites

DERIVATIVE S MARKET 1. Commodity futures 2. KLSE CI Futures 3. KLIBOR Futures

OFFSHORE MARKET Labuan International Offshore FInancial Center (IOFC)

Monetary Economics (ECO 553)

Malaysian Financial System

5.1

FINANCIAL INSTITUTIONS
Financial institution is a business firm where their assets are stock, bond and loans

instead of real assets such as building, raw material and equipment. Financial institution also provides loans to customer and purchase investment services. It can be divided into 2 major categories which is banking system and non-bank financial intermediaries.

5.1.1

BANKING SYSTEM Malaysian banking system consists of Bank Negara Malaysia, banking institutions,

and non-banking institutions.

1)

BANK NEGARA MALAYSIA (BNM) Bank Negara Malaysia is established on 26 January 1959. BNM is the central bank for

Malaysia. It is regulated by Central Bank Ordinance (CBO) 1958. The objectives and functions of the central bank are as follows: 2) To issue currency and to keep reserves safeguarding the value of that currency To act as a banker and financial adviser to the government To promote monetary stability and a sound financial structure To influence the credit situation to the advantage of the country

BANKING INSTITUTIONS Malaysian banking institutions consist of commercial banks, Islamic banks, and

investment banks.

a) COMMERCIAL BANKS Commercial banks are the largest and most important group of financial institutions in Malaysia. According to Banking and Financial Institutions Act 1989 (BAFIA), commercial bank is an institution that does the business banking which is the business of receiving deposits, paying or collecting cheques, provision of finance and such other business. Commercial banks offer many products to customers such as savings account, current account, loans activities. They also act as intermediaries from the surplus unit to deficit unit. Monetary Economics (ECO 553) 9

Malaysian Financial System b) ISLAMIC BANKS Islamic banks conduct banking business which similar to other commercial banks but they follow the principal of Shariah. They offer Islamic banking products and services which can be used by not only Muslim but also the non-Muslim

c) INVESTMENT BANKS Investment banks provide services such as providing advisory services and management services to corporations. Some of the activities that they do are loan syndication, underwriting services, and portfolio management. They also involve in venture capital financing.

3)

OTHERS DISCOUNT HOUSES Discount houses in Malaysia began it operation in 1963. In 1989, discount houses came under BAFIA. Discount houses are only group that allowed money at call. Discount houses specialize in short-term money market operation and mobilize deposits from financial institutions and corporations. Discount houses were appointed to be sole principle dealer for TB.

5.1.2

NON-BANK FINANCIAL INTERMEDIARIES Basically, Malaysian Non-bank Financial intermediaries are mainly comprise of

Provident and pension funds, insurance companies, development finance institutions, and savings institutions.

1) PROVIDENT AND PENSION FUNDS Provident and pension funds are groups of financial schemes designed to provide members and their dependents with a measure of social security in the form of retirement, medical, death, or disability benefits. Each worker in Malaysia is compulsory to have this account. There are 2 accounts. Each account can be withdrawn in line with their purpose. Monetary Economics (ECO 553) 10

Malaysian Financial System 2) INSURANCE COMPANIES There is 4 types of insurance in Malaysia which is life, general, professional and export credit re-insurance. All types of insurance have the same purpose which is to protect the holder of the insurance from many aspect which their cover to. Insurance also provide saving to the holder in terms of saving for child education or contingency fund.

3) DEVELOPMENT FINANCE INSTITUTIONS Development finance institutions are established by government to promote investment in manufacturing and agriculture sector. These institutions are specialized in middle and long term financing. Some of main development finance institutions in Malaysia are: Bank Pertanian Malaysia Bank Industri & Teknologi Malaysia Bank Pembangunan & Infrastruktur Malaysia Berhad

4) SAVING INSTITUTIONS Main purpose of saving institutions in Malaysia is to promote and mobilise saving to the middle and lower income group and especially people in rural area. Saving institution consists of national saving bank which is Bank Simpanan Nasional and cooperative societies.

5) OTHER NON-BANK FINANCIAL INTERMEDIARIES It acts as intermediaries which connect people who have surplus (lenders) and people who deficit (borrowers). It consists of unit trust, pilgrims fund board, housing credit institutions, Cagamas Berhad, credit guarantee corporation, leasing companies, factoring companies and venture capital companies. They will invest the funds that they receive from the surplus units to generate profit.

Monetary Economics (ECO 553)

11

Malaysian Financial System

5.2

FINANCIAL MARKET

The Financial System in Malaysia is divided into two portions which is financial institutions and financial market. The financial market is below divided into four markets which depend on their own functions and objectives. There are Money and Foreign Exchange Markets, Capital Markets, Derivatives Markets, and Offshore Market.

1)

MONEY AND FOREIGN EXCHANGE MARKET

Money market is a market that provides a short-term utilization of funds among market participants which is Central bank, banking institutions, non-bank institutions such as Pension funds and Unit trust, corporations, and money brokers. It is a place where lenders and borrowers of funds meets and perform their transactions to fulfil their short-term fund desires. Basically, it is also known as financial instruments trading market for surplus and the deficit units in the financial system.

Foreign Exchange market is a necessary market for corporations to complete their international transactions. All corporations that doing import and export business is need to purchase the required currencies for them to effect payment or to convert the currencies received from the other country to a local currency. The participants of foreign exchange market include of commercial banks, Central bank, corporations, non-bank financial institutions, and money broker.

2)

CAPITAL MARKET

The capital market which comprised of the equity and the bond market focus more on long-term investment or instruments. Equity market provides the facility of rising of funds to corporations by issuing stocks and shares and also the trading of shares in the secondary markets. The bond market on the other hand, is another alternative place where private and public sector can raise funds by issuing private and government debt securities.

Monetary Economics (ECO 553)

12

Malaysian Financial System 3) DERIVATIVES MARKET

The derivatives market provides a possibility where domestic and international market participants can manage their risk exposures in an efficient and cost effective method. Derivatives are financial instruments used to manage ones exposure in todays volatile market. A derivative products value depends upon and is derived from an underlying instrument, such as commodity prices, exchange rates, interest rates, indices and share prices. 4) OFFSHORE MARKET

The offshore market is a market where assets are moved actively by market participants who are in surplus and deficit units in an offshore financial centre having specific and unique features. It is a market whereby offshore companies offered a financial products and services that meet the needs of financial market participants in a low tax system. Offshore market in Malaysia is located in Labuan with the establishment of Labuan Offshore Financial Services Authority (LOFSA) in 1996.

Monetary Economics (ECO 553)

13

Malaysian Financial System

6.0

CONCLUSION
As a conclusion, financial system plays a very important role in the economy. Recent

years have seen that financial system that has outgrown in size, lost track of its core functions, and became a major source of risk itself. It is important for a country to have a sound and stable financial system in order to support the economy. Overall, a good financial system brings many advantages to the country where it helps to expand the flow of the economy. A financial system also can affect the financial development with a strong regulation of international capital movements.

Monetary Economics (ECO 553)

14

Malaysian Financial System

7.0

BIBLIOGRAPHY

Kidwell, D. S. (2011). Financial Institutions, Markets, and Money, Eleventh Edition. John Wiley & Sons. Rahman, I. A. (2011). Financial Markets and Institutions. Othman, J. (2009). Islamic Finance. Institut Perkembangan Pendidikan. Howells, P. (2007). Financial markets and institutions (5th edition). Pearson Education Limited. Iqbal, Z. (2007). An Introduction to Islamic Finance : Theory and Practice. John Wiley & Sons (Asia) Pte Ltd. Rose, P. S. (1988). Financial Institution (3rd edition). Business Publications, Inc. Jones, F. J. (1978). Macro Finance : The Financial System and the Economy. Winthrop Publishers, Inc. Money and Banking in Malaysia. (1979). The Economic Research and Statistic Department. Allen, F. (n.d.). Comparing Financial Systems. Retrieved from http://ideas.repec.org/b/mtp/titles/0262511258.html Financial System of Malaysia. (n.d.). Retrieved from http://www.kpmg.com.my/kpmg/publications/tax/I_M/Chapter5.pdf Lets Learn Finance. (n.d.). Retrieved from http://www.letslearnfinance.com/functions-offinancial-system.html The Malaysian Financial System. (n.d.). Retrieved from http://www.ibbm.org.my/v2/wpcontent/uploads/2011/05/Chap-1-amended-010305_2305t060205.pdf

Monetary Economics (ECO 553)

15