ISLAMIC FINANCIAL SYSTEM

NON-BANKING FINANCIAL INTERMEDIARY MODEL

PREPARED BY:

HANIS SHAHIRAH MOHD KHAIRI (G1918762)

MASTER OF SCIENCE (ISLAMIC BANKING AND FINANCE)

ISLAMIC FINANCIAL SYSTEM

SUBMITTED TO:

Assoc. Prof. Romzie bin Rosman

INTRODUCTION

As non-bank financial intermediaries and commercial banks work in duality,

both cannot escape the competition and at the same time complement each other
forcing them to be more efficient and responsive to customers' needs. Non-Banking
Financial Intermediaries mainly have indigenous origin, which is suited to local
conditions and is playing useful role in development of the economy in that particular
locality. It gives a reason for their natural growth.

Non-bank financial intermediaries (NBFIs) comprise a mixed bag of institutions,

ranging from leasing, factoring, and venture capital companies to various types of
contractual savings and institutional investors (pension funds, insurance companies,
and mutual funds). The common characteristic of these institutions is that they
mobilize savings and facilitate the financing of different activities, but they do not
accept deposits from the public.

NBFIs play an important dual role in the financial system. Most NBFIs are also
actively involved in the securities markets and in the mobilization and allocation of
long-term financial resources. The state of development of NBFIs is usually a good
indicator of the state of development of the financial system.

Non-Banking Financial Intermediaries are such institutions as savings and loan

associations, life insurance companies, benefit funds, common trust funds, pension
funds and government lending agencies. These intermediaries pool funds from net
savers and lend them for finance expenditure of business firms and local bodies. In
order to obtain funds from net savers, the intermediaries will issue and sell indirect
securities such as time deposits, common fund stocks, saving and loan shares and
insurance policies. They purchased primary securities to lend funds to ultimate
borrowers.

Cagamas was established in December 1986 for the purpose of serving as a

special vehicle to mobilise low-cost funds to support the national home ownership
policy and to spearhead the development of the private debt securities market in
Malaysia. Cagamas has been in operation for 15 years since commencement of
business in October 1987.
 Since the 1970s, the Malaysian Government has been actively promoting
widespread ownership of housing, especially amongst the low and middle-income
groups. This national objective can only be realised if these groups have ready access
to credit facilities. Such access is only possible if there are willing lenders and the cost
of paying the interest and principal is within the means of the borrowers.

However, the principal providers of housing loans would only be willing lenders
if they were able to secure the necessary funds at an economical cost, and sell some
of the existing housing loans so that such long-term loans do not constitute an
excessive proportion of their total assets.

In the early 1980s, the financial institutions were experiencing a tight liquidity
situation as reflected by their loans to deposits ratio which deteriorated to 98.0% as at
30 September 1986, from 89.0% as at the end of 1980. Hence, the financial institutions
were reluctant to give out housing loans which are considered to be long-term illiquid
assets. In addition, as the financial institutions borrow short-term (largely in the form
of deposits of 12 months or less) and housing loans were long-term (10 to 15 years),
the financial institutions were subject to liquidity risk arising from the mismatch of
maturities of the funds and the housing loans.

The financial institutions also faced financial risk if their source of funds became
more expensive than the rate of return on their housing loans, especially in view of the
fact that the interest rates on the loans for low and medium cost houses costing
RM100,000 and below were fixed at controlled levels.

Moreover, the private debt securities market was virtually absent until the
creation of Cagamas. Up to the 1980s, the debt securities market was dominated by
Malaysian Government Securities.

CONCEPT AND OPERATIONAL

Bank Negara Malaysia first established The Cagamas Model Cagamas which
is also known as (Malaysia’s National Mortgage Corporation) in 1986 as part of a
national plan to promote homeownership through a liquid funding system that will help
financial institutions to overcome the maturity mismatch in their financial position when
they use short term deposits to finance long term housing loans.

In 1986, the Malaysian economy was just beginning to emerge from a recession
and incentives were accorded to the construction sector, including housing, to
stimulate economic growth. Given the legal constraints in effecting a true transfer of
property rights in Malaysia’s real estate laws, Cagamas adopted the simpler form of
purchasing housing loans from their originators with full recourse and to issue
unsecured bearer bonds backed by pools of housing loans. This mechanism was not
considered true securitization but in the Malaysian context, it was a feasible interim
step towards the development of a secondary mortgage market for the following
reasons:

• There was then a lack of statistics and a track record of loans performance to fulfil
rating agency requirements in assessing the credit risks inherent in “pass through”
securitization.

• For the primary lenders, which were commercial banks, finance companies and the
Government Housing Loan Division, liquidity was an issue, not capital adequacy.

• For the loan originators, selling their housing loans to Cagamas at fixed rate or
floating rate with options for periodic review, enabled them to eliminate both their
liquidity and interest risks.

• For a start, the longer term Cagamas bonds (mainly of three and five-year
maturities) as well as the shorter term Cagamas notes (of less than one-year) helped
to fill a void in the market for institutional investors (which included financial institutions,
insurance companies and pension funds).

BUSINESS MODEL

Cagamas purchases both conventional loans and Islamic financing and fund
the purchases through the issuance of conventional and Islamic capital market
securities. Loans / financing are purchased either on a with recourse to the originator
basis (PWR); or on a without recourse basis (PWOR). Cagamas began to purchase
non-mortgage assets beginning of the year 1998. As at to date, mortgage assets
constitute 70% of total assists purchased and 51% from the total assets is Islamic
assets (Rafiza Gazali, 2008).
 Through the issuance of conventional and Islamic securities, Cagamas funds
the purchase of housing loans and house financings through its Purchase With
Recourse (PWR) and Purchase Without Recourse (PWOR) schemes.

Through this, Cagamas is able to provide liquidity to financial institutions at a

competitive cost, encouraging them to provide additional housing loans and house
financings to new applicants at an affordable price. The PWR and PWOR schemes
have now been expanded to include other loans and financings such as hire purchase
/ leasing receivables and personal loans and financings.

Source: Role of Cagamas in the Development of Secondary Mortgage Market in Malaysia (May 2015)

TYPE OF MARKET

Cagamas issues capital securities to finance the purchase of loans/financing

assets (mainly mortgage) from financial institutions and non-financial institutions. The
provision of liquidity to financial institutions at a competitive cost to the primary lenders
of mortgage encourages further expansion of financing for houses at an affordable
cost and increases home ownership by Malaysians.
 The Cagamas model is well regarded by the World Bank as a successful
secondary mortgage liquidity facility. Cagamas’ capital market securities continue to
be assigned the highest ratings of AAA by RAM Rating Services Berhad and
Malaysian Rating Corporation Berhad, denoting its strong credit quality.

Cagamas fulfilled all the key pre-requisites for a successful secondary

mortgage market as proposed by the World Bank.

Source: Role of Cagamas in the Development of Secondary Mortgage Market in Malaysia (May 2015)

REGULATORY AND INSTITUITIONAL FRAMEWORK

Cagamas is backed up by certain regulatory framework since its success in

providing secondary mortgage market and continuously to broaden private debt
securities. Cagamas products are in line with large refinancing lines which has been
provided to primary lenders and at the same time being backed by pools of eligible
assets. Bank Negar Malaysia closely monitor the conducts of Cagamas.
 Since the incorporation of Cagamas in 1986 until late 2002, BNM has offered
strong support since all Governors of BNM have chaired the Board of Cagamas as
well as the strong Board representation from BNM. Cagamas adopted BNM’s policies
and guidelines as practices over the years and they have been proven as the best
practices ever since (Rafiza Ghazali, 2008).

Cagamas single largests shareholder to current is BNM. In developing the

capital market, solid capitalisation and robust asset quality has been reflected by the
strong support from BNM.Cagamas offered more attrative funds to banks and the
reliability and ready availability has been proven of good track record.

Due to the nature of business model of Cagamas, it has been exempted from
stamp duty applied hence resulting in greater and significant in term of purchase of
loans and debts both with recourse and without recourse.

Another nature of Cagamas is, the authorization to borrow and lend funds in
the interbank market. This has tremendeoulsy resulted in great flexibility of assets and
liabilitiues management.

ISSUE & CHALLENGES

Liberalisation of the financial and capital markets and the growing sophistication
among issuers and investors will require innovative approaches to securitisation

Cagamas also deal with few challenges and issues as they continue to operate.
Firstly, the excess liquidity in the banking system. As this concern being raised, the
overall liquidity in the banking system remained ample. Hence, there is urgency for
financial institutions to sell assets to Cagamas. Secondly, the problem arisen with
stable interest rate as a lower interest rate environment means there is no need for
financial instituitions to hedge their interest rates.

Cagamas also faced issues of capital adequacy for financial institutions to

remain healthy. A healthy industry capital ratio-less need to raise if free up capital by
financial institutions. Next, the lower loan growth by the banking sector will further
motivate financial institutions to maintain the loans on their balance sheet as a key
performance measure. Not forgetting, as there is continuously experience downturn in
economy, this scenario is expected to lead to high default rates in the banks (Leong,
2015).

CONCLUSION

Malaysia was the first country in the region and one of the earliest amongst the
developing economies, to establish a secondary mortgage market. At the time of the
establishment of the market, the business and financial community in Malaysia was
not familiar with the concept of a secondary mortgage market and the bond market
was still under-developed.

In the light of today, Cagamas has established the foundation and framework
for other institutions to further develop the mortgage market and to enhance the private
debt securities market.

Its success today has been recognised by other countries such as Indonesia,
Thailand, Kazakhstan, Ghana and Jordan as well as the World Bank and the Asian
Development Bank. With rapidly rising income levels and increased urbanisation,
demand for housing will continue to increase. Thus, the availability of housing finance
at reasonable mortgage rates will continue to play an important role in ensuring home
affordability.

In line with its mission to promote home ownership, Cagamas on its part, will
continually refine, modify and introduce new products to meet the challenges of
ensuring easy accessibility to housing loans at an affordable cost.
REFERENCES

Batchelor, V. B. (2005). A comparable cross-system bank productivity measure:

Empirical evidence from the Malaysian dual banking system.
https://ro.ecu.edu.au/theses/5

Leong, C.C. (2015) Role of Cagamas in the Development of Secondary Mortgage

Market in Malaysia. Cagamas Berhad The National Mortgage Corporation
28th World Congress of International Union for Housing Finance Building
Sustainable Housing Finance Systems: Malaysian Experience

Rafiza Ghazali (2008) Role of Cagamas Berhad in the Secondary Mortgage Market
and Contribution to the Development of the Bond /Sukuk Market in
Malaysia. Euromoney Saudi Arabia Conference 2013.

Role of Cagamas Berhad in the Secondary Mortgage Market and Contribution to the

Development of the Bond /Sukuk Market in Malaysia.