UNIVERSITI TEKNOLOGI MARA CAWANGAN PAHANG,

KAMPUS RAUB

ECO211

MACROECONOMICS

SEMESTER: SEPT 2018 - JAN 2019

SUBMISSION DATE : 15 SEPTEMBER 2018

CENTRAL BANK AND MONETARY POLICY IN MALAYSIA

PREPARED BY: MOHAMAD HIDAYAT BIN BACHO MOHAMAD (2016380661)

DIYANA MARIA BINTI MUHAMMAD (2016602908)

KHYDEANA BINTI ABU JALIL (2107255408)

SHAHIRA BINTI OSMAN (2017255668)

AM110 3G

PREPARED FOR:

MISS INA MURNI BINTI HASHIM

FACULTY OF BUSINESS AND MANAGEMENT

UiTM CAWANGAN PAHANG

 UNIVERSITI TEKNOLOGI MARA CAWANGAN PAHANG,

KAMPUS RAUB

STUDENT’s DETAIL

NAME : 1. MOHAMAD HIDAYAT BIN BACHO MOHAMAD (2016380661)

2. DIYANA MARIA BINTI MUHAMMAD (2016602908)

3. KHYDEANA BINTI ABU JALIL (2107255408)

4. SHAHIRA BINTI OSMAN (2017255668)

1. 2016380661

2. 2016602908

3. 2107255408

MATRIX NUMBER : 4. 2017255668

PROGRAMME/GROUP : AM110 3G

1. 0127095065

2. 01128937582

3. 0179060251

CONTACT NUMBER: 4.0112105 5274

DECLARATION

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Student’s Signature : ___________________ Date: ____________

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We hereby declare that this assignment is our own work and that we have for MACROECONOMICS
(ECO211). Here we declare that:

 This is our original work.

 We did not copy other person work.

 This assignment is all our own work and we have acknowledged any use of the published or
unpublished works of other people.

 We had fulfilled all the assignment’s requirement.

 We did not allow other students to copy our work.

 We understand the implication of plagiarism.

Therefore, we ……………………………………………………………… (student’s name) agree and understand that

if any of the above is found to be untrue, University Technology MARA, Pahang has the full right to
take any disciplinary action according to the policy.

Student’s Signature : __________________ Date: ____________

 CONTENTS

BIL PAGE

1. THE CENTRAL BANK

1.1. The Central Bank of Malaysia

2. TOOLS IN MONETARY POLICY

2.1. Interest Rate
2.2. Discount Rate
2.3. Statutory Reserve Requirements
2.4. Open Market Operation
2.5. Funding Policy

3. SELECTIVE CREDIT CONTROL

3.1. Moral Suasion
3.2. Special Directive

4. REFERENCES
1.0 THE CENTRAL BANK

The Central Bank that is also known as reserve bank is an agency that manage a state‟s
currency, money supply, yet interest rates. There are so many central banks wide world such
as the Federal Reserve Bank (U.S), the European Central Bank (EU), and the Bank of Japan
(Japan).Central bank is essential to every country in this world since it is the main supplier of
currency for most of countries. The central bank is also responsible to ensure that domestic
prices remain stable so that benefit of economic growth are not eroded.

1.1 The Central Bank of Malaysia (BNM)

The Central Bank Malaya Ordinance, 1998(CBO) establishing the Central Bank of Malaysia
(Bank Negara Malaysia or BNM or Central Bank of Malaya until the formation of Malaysia
in September 1993). The CBO was revised in 1994 and is now the Central Bank of Malaya
Act 1958. The CBA defined Bank Negara Malaysia as the bank which constitute the apex of
the monetary and banking structure of the country with the following objectives:

 As issuer of currency and keep the reserves in order to maintain the value of the
currency
 Act as government banker and financial advisor
 To promote monetary stability
 To influence the credit situation to the Malaysia advantage
These objectives of BNM are inter-related and complementary. Hence, BNM have a wider
role which in developing the financial infrastructure, including the capital market that ensure
the monetary measures have good effects on the ultimate objectives that have been identified.
Plus, BNM has recognises the role of monetary policy is essential to attain the price stability.
Little do you know that BNM works closely with other key agencies with government, the
main one is Ministry of Finance (MOF) to achieve this objective.

Maintaining monetary stability, is a key that crucial for sustaining economic growth which
mobilisation of resources and the efficient channelling the resources to productive
investment. Malaysia has several for decades maintained price stability with 3.5% inflation
per annum over these decades. Inflation refers to any increase in price in the price level
within the economy. However, in the context of the macroeconomy, it is concerned about
sustained rise in prices over time rather than one-off increase at a point in time. As we know
that BNM has its ejection to control liquidity to achieve its objective of price stability. These
include open market operation, direct intervention of borrow or lend in the interbank, money
market, the issuance of BNM papers and also variations of the statutory reserve requirement
(SRR).

Issue of Currency, BNM is required by law to sustain a minimum cover of 80.59% in

external assets against the notes and coins in circulation. Back in the history of 1999, the
cover was approximately increase to 550% since BNM practise maintained a cover of 100%
of currency‟s liability that reflecting its commitment to maintain gold and foreign exchange
backing for the MYR. Traditionally, policy of exchanging rate for ringgit is need to be
determined by market forces and to reflect underlying economic fundamentals. Economic
fundamentals are including statistics regarding unemployment, supply and demand, growth,
and inflation, as well as considerations for monetary or fiscal policy and international trade.
Interventions are conducted only to smooth volatile fluctuations.

BNM acts as a banker or adviser to the government. The bank‟s business includes the
process of managing the liabilities of the Government that are in Malaysia whether abroad.
BNM advises the Government on loan programme that means the terms and timing of the
loans and issue of the new types of securities. Yet, BNM also have the authority over trading,
registering, settlement and also redemption of Government securities through its tranding and
settlement system. As the Government‟s adviser, BNM need to sustain a close relationship
with MOF in every level. Twice a year, the Governor will presents BNM‟s assessment of the
economy and the challenges facing economy, as well as a package of policy
recommendations to face the challenges. Therefore, this relationship maintained through the
participation of the governor and BNM officials in various Governmental Committees.

As the role s and functions of BNM undergo dynamic adjustments to face new challenges, its
organisational structure and functions have also undergone changes accommodate new
developments and responsibilities. There are:

 RS (Rancangan Strategik) 2000 Change programme in August 1995

 The Economics Department (In January 1999, Economics Department 1 and
Economics Department 2 were formed)
 The Bank Regulation Department
 The Investment and Treasury Department

 The Bank Examination Department 1 & 2

( Renamed as Banking Supervision 1 and 2)
 The Information Systems Supervision Unit (ISSU)
 Balance of Payments Department
 The Insurance Regulation Department (Renamed as Insurance Supervision
Department in1997)
 The Risk Management Unit (RMU was established in March 1996)
 The Payment Systems Departments (established in April 1996)
 The Statistical Services Department
 The Currency Management and Operation Department
 The Information Services Department
 Finance Department, where the financial administration of BNM‟s placed
 Human Resources Management Department (HRMD)
 Legal Department
 The property and Services Department
 The Security Department that protect the asset of BNM and its employee
 2.0 TOOLS IN MONETARY POLICY

Quantitative is the first tool in monetary policy. There are several elements under
quantitative such as interest rate, discount rate, statutory reserve requirement (SRR), open
market operation (OMO) and funding. Bank Negara Malaysia is entrusted to formulate and
implement this element to ensure an efficient transmission of monetary process.

2.1 Interest Rate

The first element of the quantitative tool is interest rate. Bank Negara Malaysia is
given the power to state the minimum and maximum rates of interest and any other charges.
Domestic banks will impose the interest rates for any types of loans, advances or credits and
deposits. Interest rate policy that has been made by Bank Negara Malaysia is to fulfil the goal
of balancing the price stability and a stable exchange rate to make sure the productive activity
does not lessen the effectiveness. Interest rates need to be in a level that will allow savers to
earn positive real rate of return. At the current interest rate, the real rate return on deposit
need to be maintained at levels occur before the crisis. With this method, the savings in our
nation are able to efficiently mobilise the banking system. Appropriate interest rate levels are
necessary to contain the outflows of funds abroad. One of Malaysia's strengths is the ability
of the banking system to generate an outstanding amount of savings to finance the economic
activity. Malaysia also considers exchange rate stability as an important element for the
recovery process. In this context, appropriate macroeconomic policy including interest rate
policy is a must for comprehensive confidence on the financial system and economic.

There are several interest rates that the Bank Negara Malaysia imposed such as 1-year
rate, 1-month rate, overnight policy rate and many more. Overnight policy rate is the main
element in the monetary policy. Overnight policy rate occurs when major financial
institutions borrow and lend one-day or „overnight‟ funds among themselves. Therefore, the
Bank Negara Malaysia sets a target level for that rate. This target for the overnight rate is
often referred to as the bank‟s interest rate.

In the Monetary Policy Committee (MPC) meeting on 5th September 2018, Bank
Negara decided to maintain the Overnight Policy Rate (OPC) to 3.25%. At the current level
of the OPC, the degree of monetary accommodativeness is consistent with the intended
policy stance. The MPC will keep on continue to monitor and assess the balance of risks
surrounding the outlook for domestic growth and inflation. Bank Negara Malaysia‟s
monetary operations will continue to ensure sufficient liquidity in order to support the orderly
functioning of money and foreign exchange markets and intermediation activity.

During inflationary, it is important to increase the interest rates for the commercial
banks to improve the inflation in the country. Meanwhile during the unemployment period,
interest rates need to be decreased to enable consumers participate in the economy and to
preserve the domestic purchasing power. Controlling the inflationary pressures and
encouraging exchange rate stability are compulsory to rebuild market confidence and
maintain international competitiveness.

2.2 Discount Rate

The next element of quantitative is discount rate. This is the rate charged by the
Central Bank on banks‟ and discount houses‟ loans as Central Bank also acts as a last resort
lender to the banks. The interest rate on the loans that Bank Negara Malaysia makes to banks
is called the discount rate. Discount operations is defined as a deliberate measurement by
BNM to influence the interest rate and liquidity situations depending on various terms and
conditions under which the commercial banks and money market may have temporary access
to Bank Negara Malaysia‟s credit facilities. Banks may borrow from Bank Negara Malaysia
as the last resort lender to the banks. A bank borrows from Bank Negara Malaysia when it
has too few reserves to meet reserve requirements. This might occur because the bank made
too many loans or experienced with recent withdrawals. Therefore, the banking system has
more reserves and this allow to create more money Bank Negara Malaysia can alter the
money supply by changing the discount rate.

Base rate are decided by banks without intervention by the Bank Negara Malaysia and
the rate must be differ from bank to bank depending on their own efficiencies in lending.
Banks with a strong niche in consumer financing such as Maybank and Public Bank will have
the initial edge of being able to offer more attractive and competitive base rate and effective
lending rates (ELR) for their customers.

Bank Bank rate Effective lending rate

CIMB Bank 4.15 4.90
Maybank 3.25 4.60
HSBC Bank 3.89 5.00
Hong Leong Bank 4.03 4.90
Source: Bank Negara Malaysia

Discount rate plays as one of the major roles in determining the inflationary and the
unemployment period. The increment of the discount rate by Bank Negara Malaysia will
decrease the reserves of banks, reduced the credit available to the customers and decrease the
supply of money in the market. The decrement of the discount rate by BNM will increase the
reserves of banks, increase the credit available to the customers and increase the supply of
money in the market.
2.3 Statutory Reserve Requirements

Next, the third element in the quantitative tools is Statutory Reserve Requirements
(SRR). The meaning of statutory reserve requirements is the regulation on the minimum
amount of reserve that banks must hold against deposits. Reserve ratio influence how much
money the banking system can create with each Ringgit of reserve. The Statutory Reserve
Requirement (SRR) is an instrument to manage liquidity. Banking institutions are required to
maintain balances in their Statutory Reserve Accounts (SRA) equivalent to a certain
proportion of their Eligible Liabilities (EL) and this proportion being the statutory reserve
requirements rate.

The statutory reserve requirements may be raised to manage the significant build-up
of liquidity, which may result in financial imbalances and create risks to financial stability.
Conversely, the Bank may lower the statutory reserve requirements if necessary to support
the transmission of monetary policy rates to retail rates. However, it is important to note that
changes to statutory reserve requirements should not be construed as a signal on the stance of
monetary policy, whereby the overnight rate policy is the sole indicator. In the Monetary
Policy Committee meeting, the statutory reserve requirements rate for banking institutions is
3.5% of eligible liabilities and is effective on 1 February 2016. Bank Negara Malaysia said in
the MPC meeting on 21 January 2016, “While the global economy continues to expand, the
recovery in the advanced economies has not been as strong as earlier expected and the growth
in the emerging economies has slowed. The current heightened financial market volatility and
uncertainties also pose additional downside risks to global growth,”.

When inflation occurs, the statutory reserve requirements ration need be increase so
that less amount to be loaned out to public. The money in circulation will be reduced
including the investment and spending of the money. Therefore, the inflation rate will be
stabilised, and the economic growth is stable. Meanwhile during the unemployment period,
Bank Negara Malaysia need to introduce lower ratio so that more amount to be loaned out to
the public. This will show significant increase in money circulation, investments and
spending. This will affect in increment of employment and economic growth.

Table 1.1 – Statutory Reserve Requirements (SRR) Ratio

Source : Bank Negara Malaysia
2.4 Open Market Operation

The next element in the quantitative tools is Open Market Operation (OMO). Open
market operation defined as the purchase and sale government bonds by the Central Bank.
Bank Negara Malaysia buys or sells securities and treasury bills in the open market to
influence the size of bank deposits. In periods of inflation, Bank Negara Malaysia will sell
the market first class bills in its possession to buyers like commercial banks and others. This
reduces the cash reserves of the commercial banks which will reduce their capability to give
loans and advances. Therefore, business activity in the country will be cut short. During
recession, Bank Negara Malaysia bought bills from commercial banks and increases their
cash reserves. Thus, Bank Negara Malaysia influences the lending operations of commercial
banks and ultimately influences business activity and economic conditions in the country. To
overcome the problem of inadequate supply of government papers for an active of open
market operations, Bank Negara Malaysia has stepped up its efforts to further develop and
deepen both the government and securities market. When Bank Negara Malaysia sells the
securities in the open market, it received payment in cash that is paid in form of commercial
bank cheques. Meanwhile, when Bank Negara Malaysia buys the securities, it pays cash to
the banks and this will increase the bank‟s cash balances and enable them to increase credit
for their customers.

2.5 Funding Policy

The last element in the quantitative tools is funding. Funding is described as the
central bank alters the balance of bills and bonds for any given of level of government
borrowing. There are many types of bonds such as the Malaysia Savings Bonds (MSB) in
1993 and the Khazanah Bonds in 1997. Malaysia Savings Bonds were issued with the
objective of increasing individual savings through many ways such as investments in bonds,
while Khazanah Bonds were issued with the purpose of developing a benchmark yield curve
for the ringgit bond market. During inflation, Bank Negara Malaysia will issue more bonds
and fewer bills to reduce the money supply which will contract our economy. Meanwhile,
when unemployment occurs, it is important to issue more bonds and fewer bills to increase
the money supply.
3. SELECTIVE CREDIT CONTROL

Selective Credit Control of the monetary policy used to control the demand and supply of
money in the economy. Central Bank administers control over the credit that the commercial
banks grant. Such a method is used by RBI to bring "Economic Development with Stability".
It means that banks will not only control inflationary trends in the economy but also boost
economic growth which would ultimately lead to increase in real national income stability. In
view of its functions such as issuing notes and custodian of cash reserves, credit not being
controlled by RBI would lead to Social and Economic instability in the country. regulating
stock market credit. The purpose of Selective Credit Control is to controlling the volume of
credit used to purchase consumer durables. Secondly, relating to unemployment and inflation.
The Bank will control the prices and fall in the purchasing value of money to stabilize so that
the public may still purchase goods. Thirdly, to achieve the objective of controlling inflation
as well as deflation. Fourthly, To boost the economy by facilitating the flow of adequate
volume of bank credit to different sectors. Lastly, to develop the economy.
3.1 Moral Suasion
Central bank will give advice to the commercial banks on what they do in order to control
their activates by persuading the commercial bank to restrict lending policy or apply easy
lending policy. In times of high inflation and unemployment. Commercial Bank will seek
advice from Central Bank because the public will demand money to borrow but without any
proof they may payback within the time limit that they've agreed on.

3.2 Special Directive

Central bank dictates the commercial banks in controlling credits. Commercial banks usually
need help from Central Bank to increase or decrease the volume of loans given to the public.
If inflation and unemployment decreases commercial bank and central bank with increases the
volume of loans vice versa if the inflation and unemployment increases the volume of loans
given to the public will be tight.
4. REFERENCES

1. Bank Negara Malaysia (1999). The Central Bank and the Financial System in
Malaysia. Jalan Dato‟ Onn Kuala Lumpur. Sales Publication Counter. Page 137 –
305.
2. Interest Rate Policy.
http://www.bnm.gov.my/index.php?ch=en_press&pg=en_press&ac=3025&lang=bm
3. Statutory Reserve Requirement (SRR).
http://www.bnm.gov.my/index.php?ch=en_fxmm_mo&pg=en_fxmm_mo_overview
&ac=307
4. Factors Aff ecting Foreign Investors‟ Bondholding in Malaysia
http://www.bnm.gov.my/files/publication/qb/2017/Q2/p5_ba1.pdf
5. Statutory Reserve Requirement
http://www.bnm.gov.my/index.php?ch=57&pg=137&ac=30&bb=file
6. http://www.bnm.gov.my/
7. The Central Bank, 1999 Bank Negara Malaysia Kuala Lumpur.
8. Principle Of Macroeconomics (Joseph & David,2004)