[COMBATING FINANCIAL FRAUD IN MALAYSIAN BANKING

SECTOR]

WONG SHI WEI

Master of Corporate Law

UNIVERSITI UTARA MALAYSIA
[2023]
[COMBATING FINANCIAL FRAUD IN MALAYSIAN BANKING
SECTOR]

WONG SHI WEI (828765)

A project paper submitted to the Ghazalie Shafie Graduate School of

Government in fulfilment of the requirement for the Master of Corporate
Law Universiti Utara Malaysia
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 PERMISSION TO USE

In presenting this thesis in fulfilment of the requirements for a postgraduate degree

from Universiti Utara Malaysia, I agree that the Perpustakaan Sultanah Bahiyah
UUM may make it freely available for inspection. I further agree that permission for
the copying of this thesis in any manner, in whole or in part, for scholarly purpose
may be granted by my supervisor(s) or, in their absence, by the Ghazali Shafie
Graduate School of Government (GSGSG). It is understood that any copying or
publication or use of this thesis or parts thereof for financial gain shall not be allowed
without my written permission. It is also understood that due recognition shall be
given to me and to Universiti Utara Malaysia for any scholarly use which may be
made of any material from my thesis.

Requests for permission to copy or to make other use of materials in this thesis, in
whole or in part, should be addressed to:

Dean (Ghazali Shafie Graduate School of Government)

UUM College of law, Government and International Studies (UUM COLGIS)

Universiti Utara Malaysia

06010 UUM Sintok

i
 ABSTRACT

This study intends to provide light on how bankers in Malaysia perceive the
significance of Preventing and Detecting banking fraud as well as creative ways to
do so in order to combat financial fraud in the country's banking sector. The results
of 12 surveys given to Malaysian bankers, academics, and attorneys revealed that
artificial intelligence and specialized software are the most efficient ways to prevent
financial fraud in the country's banking sector. Bankers and the general public must
also increase their Expertise and Awareness in order to combat today's high-tech
fraud. In terms of assessing Malaysia's present degree of bank fraud prevention, this
study should be useful to both academics and practitioners.

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 ACKNOWLEDGEMENT

Foremost, I would like to express my sincere gratitude to my supervisor Prof. Madya

Dr. Mohd Zakhiri Bin Md. Nor for the guide and support on my project paper and
also his patience, motivation, enthusiasm, and his immense knowledge. His guidance
helped me in all the time on writing of project paper. I could not have imagined
having a better supervisor and mentor for my project paper.

Besides my supervisor, I would like to thank the rest of my course mate for their
encouragement, insightful comments and also their guidance.

I need to thank Assoc. Prof. Dr Ruzita for her guide on register project paper and of
course her guide for my whole postgraduate time.

Last but not the list, I would like to thank my family, my parents Wong Boey Sang
and Ng Chin Yin, for giving birth to me at the first place and supporting me
spiritually throughout my life.

Again, thanks to my supervisor, Prof. Madya Dr. Mohd Zakhiri Bin Md. Nor.

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 TABLE OF CONTENTS

PERMISSION TO USE...........................................................................................................i
ABSTRACT...........................................................................................................................ii
ACKNOWLEDGEMENT.....................................................................................................iii
TABLE OF CONTENTS.......................................................................................................iv
LIST OF TABLES.................................................................................................................vi
LIST OF FIGURES..............................................................................................................vii
LIST OF APPENDICES......................................................................................................viii

CHAPTER ONE INTRODUCTION........................................................................2

CHAPTER TWO BACKGROUND.........................................................................5

CHAPTER THREE RESEARCH QUESTIONS....................................................6

CHAPTER FOUR RESEARCH OBJECTIVES.....................................................7

CHAPTER FIVE RESEARCH METHODOLOGY...............................................8

5.1 Research Design.....................................................................................................8
5.2 Research Scope.......................................................................................................8
5.3 Types of Data.........................................................................................................8
5.4 Data collection Method..........................................................................................9
5.5 Analysis of Data.....................................................................................................9

CHAPTER SIX SIGNIFICANCE..........................................................................10

CHAPTER SEVEN LIMITATIONS......................................................................12

CHAPTER EIGHT LITERATURE REVIEW.....................................................14

8.1 What is Financial System?...................................................................................14
8.2 Why Financial Regulation is important?..............................................................19
8.3 What is financial fraud?.......................................................................................29
8.4 Malaysia Regulatory Framework.........................................................................31
8.4.1 The set of regulations that apply to banks..................................................31
8.4.1.1 Bank Negara Malaysia...................................................................32
8.4.1.2 Security Commission Malaysia.....................................................35
8.4.1.3 Companies Commission in Malaysia............................................36
8.4.1.4 Labuan FSA...................................................................................36
8.4.1.5 Development Financial Institutions Act 2002...............................37

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 8.4.2 Licencing....................................................................................................38
8.4.3 Digital Banking..........................................................................................40
8.4.4 Prudential regulation..................................................................................42
8.4.4.1 Relationship with the prudential regulator.....................................42
8.4.4.2 Management of banks....................................................................44
8.4.4.3 Regulatory capital and liquidity.....................................................46
8.4.4.4 Recovery and resolution................................................................48
8.4.5 Conduct of Business...................................................................................51
8.5 Fraudulent Cases of Financial Reporting.............................................................58
8.5.1 Fraudulent classification............................................................................58
8.5.2 Fraudulent cases statistic............................................................................59
8.5.3 Fraudulent cases detection.........................................................................60
8.5.4 Fraud cases reporting in Malaysia – Bank Sector......................................63

CHAPTER NINE RESULTS AND DISCUSSION...............................................69

9.1 Statistic on awareness of different fraud..............................................................69
9.2 Main causes of fraud............................................................................................70
9.3 Impact of the fraud...............................................................................................71
9.4 What is the strategic to compact the financial fraud? And current anti-fraud
measures and strategies employed by Malaysian banks............................................72
9.5 Main challenge to help bank sector to combat fraud............................................74
9.6 Any innovative solutions to help bank sector to combat fraud?..........................75
9.7 Important of establish specialized courts or legal mechanisms dedicated to
handling financial fraud cases in the Malaysian banking sector................................76

CHAPTER TEN CONCLUSION...........................................................................77

10.1 Conclusion..........................................................................................................77

REFERENCES.........................................................................................................79
APPENDICES......................................................................................................................83

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 LIST OF TABLES

Table 8.1...............................................................................................................................63
Table 9.1...............................................................................................................................67
Table 9.2...............................................................................................................................68
Table 9.3...............................................................................................................................69
Table 9.4...............................................................................................................................69
Table 9.5...............................................................................................................................71
Table 9.6...............................................................................................................................71

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 LIST OF FIGURES

Figure 9.1 Current anti-fraud measures and strategies employed by Malaysian banks..........73
Figure 9.2 Important to establish specialized courts or legal mechanisms............................76

vii
 LIST OF APPENDICES

Appendix A Questionnaire....................................................................................................83
Appendix B Dataset..............................................................................................................85

viii
 CHAPTER ONE
INTRODUCTION

Any nation's economic stability and growth are greatly influenced by the

banking sector. The banking industry does, however, face a number of hazards and

difficulties, such as financial fraud and misbehaviour, in addition to its considerable

contributions. The general stability and credibility of the economy are gravely

threatened by these illegal operations, which not only compromise the integrity of

financial institutions but also destroy public confidence in the system. In nations

across the world, including Malaysia, regulatory frameworks and policies have been

formed to encourage transparency, accountability, and ethical behaviour within the

finance industry. These governments recognise the significance of good governance

and the need for action against financial misconduct and fraud.

Fraud poses a serious danger to organisations everywhere. Fraud has become

more commonplace recently and is probably going to continue to do so in the future.

Losses attributed to the fraud lawsuits involving Enron, Worldcom, and Satyam are

expected to total more than $20 billion. The major types of fraud include reporting of

finances fraud, property theft, and corruption. Comparing instances of dishonesty and

asset theft, fraud with financial statements is reportedly the type of fraud that results

in the most loss. As incidents like Megan Media, Transmile Berhad, United U-Li,

and Repco Holdings Bhd demonstrated, Malaysia is not exempt from fraud. Fraud

causes businesses to lose an average of 6% of their yearly earnings. It is crucial to

invest a lot of work in finding a reliable model to identify fraud due to the rise in

fraud instances and their adverse negative effects.

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 Given well-known financial scandals (like Enron, Worldcom, and Wirecard),

an acceptable financial disclosure standard is crucial for shareholder confidence. A

company's financial misconduct may have seriously negative implications on its

access to finance, its employees, its clients, its suppliers, and the whole economy.

Many contentious debates on the tools that may stop or even identify unethical and

opportunistic corporate behaviour have recently erupted. This systematic literature

review, which focuses on historical research on the connection between corporate

governance and businesses' financial wrongdoing, is conducted in light of this

significance. Firms' financial misbehaviour is defined as contravening national,

international, and/or related business law accounting laws and standards. As a result,

distinguish clearly between earnings management and corporate financial

malfeasance. There is a "grey zone" between earnings management and breaches of

accounting rules since it is known that discretionary accruals and associated proxies

for earnings management may be important indicators of a firm's financial

wrongdoing. The Continental European accounting literature primarily emphasises

that earnings management is in compliance with the relevant legislation and

regulations, in contrast to the US-American literature, which does not distinguish

clearly between infractions and earnings management. Cite prior evaluations of the

literature and meta-analyses, but leave out studies that look at the connection among

governance of businesses and profits management.

Must divide all of the corporate governance factors into four tiers using the

corporate governance framework: group, person, company, and institutional level.

Identify the three primary forms of organisations' financial wrongdoing, which pose

a serious danger to the capital markets: financial restatements, fraud occurrences, and

enforcement efforts. Recognise that not all restatement are the product of fraud; they

3
can simply be the consequence of inadvertent mistakes. Financial scandals at

companies reduce confidence among businesses, gatekeepers, market players, and

other stakeholder groups since these companies may fail or have severe financial

difficulties if these scandals become public. There is concrete evidence that these

might be negative financial effects, such as sharp declines in firm valuation,

increased capital expenditures, or even greater managerial change. The infamous

Enron incident and the bankruptcy of Wirecard, a former member of the German

"DAX 30" fintech group, serve as two illustrative examples of how trust in the

capital markets has significantly declined. Future corporate governance legislation,

such as whistle-blower systems or risk management tools, are now being discussed

by several national and international lawmakers, including the European

Commission and the British Government.

Three things determine whether firms will conduct improperly. Incentives

and forces must exist before misbehaviour may occur. Second, there needs to be a

mind-set or reason for doing inappropriately. Third, that has to be any circumstance

that promotes or offers an opportunity for inappropriate behaviour. Incentives or

opportunities may be influenced by inadequate top management oversight, complex

organizational structures, or weak controls as a result of careless control monitoring

or control circumvention. The concept of the theory of agency, both internal and

exterior corporate governance should act as oversight mechanisms to lessen the

chance of executives engaging in financial misconduct 1. Corporate governance

traditionally refers to "the means by which lenders to corporations reassure

themselves that they will receive a return on their investment." According to the

1
Guo, Lixiong, Patrick Lach, and Shawn Mobbs. "Tradeoffs between Internal and External
Governance: Evidence from Exogenous Regulatory Shocks." Financial Management 44, no. 1 (2015),
81-114. doi:10.1111/fima.12066.

4
concept of corporate governance, may infer that management's relationship with

other stakeholders who contribute non-financial resources to the company is just as

important as its relationship with shareholders in determining the fate of a company2.

However, there have no research has been explicitly undertaken in Malaysia

to investigate the history of the businesses involved in financial misconduct and

fraud as well as the effects on both the offenders and the businesses after this type of

fraud was discovered by the regulator. Without this investigation, it might be

challenging to comprehend the history of the companies engaged in financial fraud

and misbehaviour as well as the impact on both the perpetrators and the companies

after the offense was uncovered. As a result, the purpose of this research is to look

into how the banking industry can best combat financial fraud and misconduct, as

well as what happens to offenders' businesses and their customers if a regulator

catches a scam.

2
"Relationship of Shareholders’ Agreements to the Management of a Company." International
Handbook on Shareholders´ Agreements, 2018, 47-60. doi:10.1515/9783110517026-003.

5
 CHAPTER TWO
BACKGROUND

Financial fraud and misbehaviour are prevalent issues that may have negative effects

on economies and communities. These problems have drawn a lot of attention in

Malaysia and many other nations because of the harm they do to the integrity and

stability of the financial system. Regulatory frameworks and governance procedures

have been put in place to promote transparency, accountability, and ethical behaviour

in the financial industry in order to prevent financial malfeasance and fraud. In order

to lessen financial misbehaviour and fraud, this study article intends to give a

thorough review of the efficacy of rules in fostering governance in Malaysian

finance. This study aims to evaluate the effect of these initiatives on reducing

financial misbehaviour and fraud by looking at the regulatory environment,

legislative frameworks, enforcement mechanisms, and institutional structures in

Malaysia. Additionally, it seeks to pinpoint any weaknesses or difficulties in the

current regulatory system and offer suggestions for improving governance

procedures and averting such mistakes in the future.

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 CHAPTER THREE
RESEARCH QUESTIONS

1. What are the most common types of financial fraud prevalent in the

Malaysian banking sector?

2. What are the underlying causes and contributing factors to financial fraud in

the Malaysian banking sector?

3. What are the existing measures and strategies implemented by Malaysian

banks to combat financial fraud?

4. What policy or legal changes can be implemented to improve the prevention

and prosecution of financial fraud in the Malaysian banking sector?

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 CHAPTER FOUR
RESEARCH OBJECTIVES

1. To identify and analyse the various types of financial fraud occurring in the

Malaysian banking sector.

2. To investigate the root causes and factors that contribute to financial fraud in

the Malaysian banking sector.

3. To evaluate the effectiveness of current anti-fraud measures and strategies

employed by Malaysian banks.

4. To propose policy or legal recommendations that can enhance the prevention

and prosecution of financial fraud in the Malaysian banking sector.

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 CHAPTER FIVE
RESEARCH METHODOLOGY

Five.1 Research Design

A quantitative research approach will be employed to gather and analyse numerical

data related to the Combating Financial Fraud in Malaysian Banking Sector. This

approach allows for the systematic examination of statistical relationships and

patterns within the data, providing a more objective and generalizable understanding

of the research topic.

Five.2 Research Scope

The study will focus on the Malaysian context and will examine the existing laws

and regulations governing Malaysian Finance on Misconduct and Fraud, including

the Financial Services Act 2013, Securities Commission Act 1993, Capital Markets

and Services Act 2007 and Anti-Money Laundering, Anti-Terrorism Financing and

Proceeds of Unlawful Activities Act 2001 and Companies Act 2016.

Five.3 Types of Data

The study will rely on primary data obtained through semi-structured interviews with

key stakeholders such as academician, law enforcement agencies, and industry

players. Secondary data sources will also be used, including academic journals,

government reports, and news articles.

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Five.4 Data collection Method

The primary data will be collected through semi-structured interviews with key

stakeholders involved in Combating Financial Fraud in Malaysian Banking Sector.

The interviews will be conducted in-person or via google form. The secondary data

will be collected through a comprehensive review of academic journals, government

reports, and news articles

Five.5 Analysis of Data

The primary and secondary data collected will be analysed using thematic analysis.

This involves identifying and categorizing patterns and themes in the data to draw

conclusions and recommendations.

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 CHAPTER SIX

SIGNIFICANCE

The significance of this study rests in its capacity to offer insightful

information about the efficiency of regulatory measures in Malaysia's financial

industry. Policymakers, regulatory agencies, and financial institutions may benefit

from knowing the advantages and disadvantages of current legislation in order to

identify possible improvement areas and put in place specific measures to lower

financial misbehaviour and fraud.

Other than that, policymakers can use the study's findings as a roadmap to

identify regulatory loopholes and create new laws and regulations that are especially

intended to combat and prevent financial misbehaviour and fraud in Malaysia's

banking industry. The research can aid in the creation of more rigorous and thorough

legislation that are suited to successfully combat illegal activities by pointing out

gaps in the existing regulatory framework.

Furthermore, this study can also offer light on efficient information and data

gathering methods that can be used to identify and look into cases of financial fraud

and misbehaviour. This can help law enforcement and regulatory organisations

improve their surveillance skills and their capacity to spot and detain those engaged

in fraudulent operations. The study can help create a better and more secure financial

10
environment in Malaysia by enhancing market surveillance and enhancing the ability

to spot and catch fraudsters.

On the other hands, the results of this study may eventually result in a decline

in financial misbehaviour and fraud, improving Malaysia's financial system's

transparency and dependability. Regulatory bodies may considerably reduce the risks

connected with fraudulent operations, such as money laundering and other financial

crimes, by increasing governance through effective legislation. The trust of investors

can be increased as a result, as can participation in the financial market and the

general expansion and development of Malaysia's financial industry.

In summary, this study's value resides in its ability to influence policy and

practise by assessing how well rules promote governance in Malaysian finance while

lowering financial misbehaviour and fraud. Policymakers, regulatory bodies, and

financial institutions may benefit greatly from the research's findings by using them

to improve regulatory measures, spot and stop fraudulent activity, and establish a

more safe and open financial environment in Malaysia.

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 CHAPTER SEVEN

LIMITATIONS

There are a number of reasons for the study's limitations on the efficiency of

rules in boosting governance in Malaysian finance to lower financial misbehaviour

and fraud. The availability of data is one major restriction. The study largely depends

on thorough and reliable information about instances of financial fraud and

misbehaviour in the Malaysian banking system. However, the study's ability to reach

firm conclusions may be hampered by the data's restricted availability. Data that is

inaccurate or incomplete can create biases and have an impact on the evaluation of

the efficacy of the rules as a whole.

Furthermore, the reporting of situations of financial fraud and misbehaviour

is still another restriction. Some situations might not be reported or be

misrepresented for a variety of reasons, such as worries about their reputation or their

fear of the legal repercussions. The results of the study and the accuracy of any

conclusions formed about the efficacy of legislation may be affected by this

reporting bias. The study should address any possible constraints brought on by

underreported or inaccurately described incidents, which might bias our perception

of the prevalence and effects of financial misbehaviour and fraud as a whole.

Other than that, the challenges with compliance and enforcement impose

further restrictions on the study. Although laws may be in place to prevent financial

12
fraud and misbehaviour, how they are actually applied and enforced might differ.

Inadequate resources, corruption, or regulatory capture are just a few examples of

factors that might obstruct effective compliance and enforcement. The analysis

should take into account any inconsistencies that may exist between the stated goals

of regulations and how they are actually implemented since these inconsistencies

may affect how well regulations are really seen to promote governance.

Lastly, it is critical to acknowledge the regulatory landscape's flexibility as a

drawback. Since rules governing the financial sector are constantly changing, new

policies and initiatives could be implemented during or after the research period. The

efficacy of rules in tackling financial malfeasance and fraud may be impacted by

these developments. The study should be aware of any potential restrictions brought

on by evolving legal requirements since they may impact the accuracy and

applicability of the inferences made.

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 CHAPTER EIGHT
LITERATURE REVIEW

Eight.1 What is Financial System?

Economic analysis claims that financial markets are inherently flawed. These

market flaws are exactly where financial intermediaries got their start. They could act

as an alternative for government involvement by offering a market solution for those

market shortcomings.

First, since they are more concerned about the future than other types of

economic activity, financial operations are inherently risky and unpredictable.

Trading risk and liquidity are the primary functions of the financial system in the

distribution of funds among savers and borrowers. As a result, expectations have a

significant impact on how financial assets are valued. Price developments are

challenging to forecast, though, because all market participants sometimes have

access to just a limited quantity of information. In other words, uncertainty exists,

and it varies from quantifiable risk in that ambiguous occurrences cannot be given a

probability that can be objectively determined. Market prices swiftly and collectively

(also known as "herd behaviour") react to the new price expectations when new

information becomes available. This mechanism accounts for the financial markets'

extreme volatility and innate instability along with their low transaction costs3.

3
Isaenko, Sergey. "Transaction costs, frequent trading, and stock prices." Journal of Financial
Markets, 2022, 100775. doi:10.1016/j.finmar.2022.100775.

14
Second, when market actors possess disparate knowledge, asymmetric information

problems develop. As a result, it's possible that one side doesn't know enough

regarding the other party in order to make wise judgements. This is undoubtedly true

in the financial markets, where one party frequently has more knowledge of the risk

being traded than the other side. For instance, an investor is more aware of the risk

involved in his investment than the lender is. Market efficiency is hampered by

asymmetric information. It causes issues with adverse selection prior to the

transaction as well as moral hazard following the transaction. Due to inadequate

information, the lender is unable to effectively discern between applicants with

excellent and bad risks prior to making an investment, which results in adverse

selection.

As a result, the loan rate will rise due to the so-called "lemon premium," and

several riskier projects won't receive funding. Moral hazard expenses increase the

loan rate and limit the number of projects that may be funded since they are incurred

by the lender in order to ensure that borrowers are spending their funds as planned.

As a result of their expertise in borrowers' knowledge and ability to resolve these

asymmetric information issues, financial intermediaries are created in this process.

Therefore, information gathering and dissemination on debtors and financial assets

are the main services offered by financial institutions. Similar information issues

arise in the principal-agent relationship between creditors and financial institutions,

though. How can the lender, who is the principal, ensure that the financial

intermediary, who serves as the agent, behaves in his best interest? For instance,

15
depositors are unaware of how risky a bank's portfolio is. Shouldn't these financial

service providers, who provide market remedies to market flaws, also be governed

and supervised by the government?

Third, compared to other economic sectors, financial markets and institutions

have a tendency to be more intertwined. The remainder of the financial system and

the whole economy may be significantly impacted by events in one single market or

institution. This explains the existence of so-called systemic risk, which can have

disastrous consequences, along with a substantial potential for "herd behaviour." In

the analysis of the global financial crisis, this issue has gotten particular attention. In

particular, the leverage and illiquidity of financial intermediaries combine in a

potentially disruptive way with the persistence of disequilibrium pricing and the risk

of contagion from counterparties4.

Fourth, money is the particular commodity at the centre of the financial

system. Price stability has historically been a prerequisite for money to function

properly. Money creation must be kept under control since there is a connection

between prices and the amount of money in circulation. However, since creating

money is lucrative, it cannot be assumed that an unchecked money supply will

provide price stability. There may be a particular requirement to regulate these

specialised middlemen since the banking industry produces money. The global

financial crisis has brought to light a problem: It can be exceedingly challenging for

4
Hu, Conghui, Yu-Jane Liu, and Ning Zhu. "Leverage and Illiquidity Contagion." SSRN Electronic
Journal, 2016. doi:10.2139/ssrn.2807277.

16
central banks to regulate the effective amount of money. In prosperous times, a

variety of assets beyond the purview of central banks' open market activities may be

accepted as collateral for short-term funding, which is the same as money 5. Everyone

can produce money, according to Minsky, but getting it recognised is the challenge.

Because they are "merchants of debt," banks are experts at having their obligations

recognised as payment6.

Unluckily, financial assets that were once thought to be liquid may suddenly

turn out to be illiquid and unacceptable as collateral. This is similar to the system

losing its money. Financial intermediaries may be forced to sell assets at so-called

"fire sale" prices, that is, for a lesser price than the assets are worth, when they are

unable to refinance their short-term positions. In the end, this causes defaults,

contagion (or the fear of it), increased illiquidity, and even lower asset values7. The

incapacity of central banks to halt this downward price-liquidity cycle with

traditional monetary policy has to be acknowledged. They eventually had to

implement assistance initiatives focused on private debt to meet the urgent liquidity

needs of investors.

Fifth, a significant portion of the assets produced by financial intermediation

are in the form of public and private benefits. The benefit that money and finance

bring to the parties involved in private transactions is known as the private good.

5
"Short-term interest rates." Interest rates, 2017. doi:10.1787/2cc37d77-en.
6
Peston, Maurice, and Hyman P. Minsky. "Stabilizing an Unstable Economy. A Twentieth Century
Fund Report." The Economic Journal 97, no. 387 (1987), 776. doi:10.2307/2232952.
7
Brunnermeier, Markus K. "Deciphering the Liquidity and Credit Crunch 2007-08." SSRN Electronic
Journal, 2008. doi:10.2139/ssrn.1317454.

17
However, the global trade and exchange mechanisms involved, both in the present

and over time, take on characteristics of public policy and become public goods. A

healthy financial and monetary system has positive external impacts on society that

go well beyond the sum benefits of individual private transactions. In essence, the

trading and liquidity of financial assets lower the cost of credit and expand its

accessibility for general consumer spending and investment. Because benefits to one

individual do not restrict another person's access to the same benefits, liquidity is

non-rival. Since liquidity is essentially a convention and is never genuinely

"consumed," this is true for both lenders and borrowers. Additionally, because

liquidity exhibits qualities of a network good, the benefits for everyone increase as

more people use it (for example, on secondary markets).

Finally, the gains of efficiency are non-excludable because everyone can

profit from finance's contribution to economic prosperity on a more general social

level. When liquidity is limited, these public good characteristics lead to negative

externalities because the premium for parting with ineffective cash rises regardless of

the amount of money and other stores of value that are readily available8.

The entire financial system can be viewed as consisting of a number of

closely related elements, including financial markets that directly connect investors

and savers, the financial infrastructure, which includes clearing, payments, and

settlement systems as well as regulatory and supervisory authorities, and a wide

8
Barwise, Patrick. "Does Public Service Television Really Give Consumers Less Good Value for Money
than the Rest of the Market?" A Future for Public Service Television, 2018.
doi:10.7551/mitpress/9781906897710.003.0007.

18
range of financial intermediaries that pool risks and funds while providing a variety

of financial services. The fact that intertemporal transactions are fundamentally

based on uncertainty and trust is crucial to understanding how they work. As a result,

modern financial institutions are constantly working to offer advantageous but

unavoidably flaw-prone means of turning uncertainty into risks that can be measured

and valued. In this process, which involves both possibilities and risks, banks are

essential players. Banks enable capital to flow to valued projects that will only

generate cash in the future through the financing of investments that are long-term

with short-term liabilities. This inconsistency in bank operations is referred to as

transformation of maturity, which is a well-known technique for reducing financial

uncertainty. The drawback is that in order to maximise profit from this activity,

banks and other intermediaries issue liquid liabilities to raise leverage. Although

these liabilities are seen as being relatively "safe," their low-risk premiums actually

overestimate the effect of uncertainty. When these liabilities are no longer regarded

as legal tender and governments are unwilling or unable to support their issuers or

otherwise make loans against the assets they have invested in, financial instability

results.

Eight.2 Why Financial Regulation is important?

The financial markets do not function properly, mostly because of knowledge

asymmetries. Due to the borrower's private knowledge of the possible return and risk

of the investment project, an agency issue between the financier (principal) and

borrower (agent) occurs when funds are reallocated between market participants. As

19
a result, ideal loan arrangements frequently involve additional expenses (a so-called

"external finance premium"). They include a fee for the risk of credit as well as

expenses for credit risk assessment and tracking borrower conduct. These are

deadweight costs related to the agency problem and are specifically caused by the

moral hazard and adverse selection issues discussed in the preceding section.

The market itself, mostly through financial intermediation, may be able to

address these information problems, or it may be necessary for the government to

step in. Financial intermediaries emerge to relieve individual investors from doing a

range of sophisticated and time-consuming screening and monitoring tasks. As a

result of their specialisation in certain information activities, they may profit from

size economics, which lowers the cost of producing information and, as a result, the

premium associated with external financing. Because cost duplication by multiple

parties is socially unproductive, there may be a "natural monopoly," as suggested by

a number of observers, in the execution of certain information tasks9.

However, the primary justification for the development of financial

intermediaries is on their capacity to resolve issues with free riders in the information

creation process brought on by issues with non-appropriability of information.

Information frequently lacks rivalry, which means that one person's use of it does not

reduce its availability for use by others. This is one of the properties of information

that contribute to the public benefit. Furthermore, it could be costly to keep some

9
Tsuneki, Atsushi. "Socially Optimal Liability Rules for Firms with Natural Monopoly." SSRN Electronic
Journal, 2009. doi:10.2139/ssrn.1462571.

20
people from accessing this information given how inexpensive technology has

become to transmit information. Free riders are a concern due to the non-

excludability of those who fail to pay for information. As a result, the market is

unable to generate enough knowledge to end information asymmetries. Because there

isn't enough information available on the market, the government may need to

regulate disclosure of information. Large numbers of investors have little motivation

to expend time in vetting and monitoring participants in the financial markets.

Contrarily, if they can generate additional profits from the creation of information,

financial intermediaries have an incentive to make investments in information and to

serve as delegated monitors for several individual depositors who deposit their assets

with the intermediary10.

By redirecting savings from tiny, ignorant depositors to small and medium-

sized investors, whose trustworthiness is sometimes difficult to assess, banks have a

specific role as financial intermediaries on this regard. Individual depositors are

faced with challenging information issues since the utilisation of their savings

necessitates a lot of 'private' information. Instead of purchasing market paper when

granting private loans, banks invest in credit risk information.

Making private loans is the main way that banks are able to make money

using the data they generate and avoid issues with free riders. The fact that these

loans are not traded prevents other investors from taking advantage of the

10
Koi-Akrofi, Godfred Y. "Complementary Assets and Value Creation Beyond Information Technology
Investments." International Journal of Managing Value and Supply Chains 11, no. 2 (2020), 17-40.
doi:10.5121/ijmvsc.2020.11202.

21
intermediary's verification and surveillance activities by monitoring what the

financial institution is doing and driving up the loan's price to the point where the

bank is not compensated for providing information. As a result, banks often enjoy

better intermediation margins in the financial markets as compared to external

finance premiums.

The realities surrounding the global financial crisis have brought into

question the aforementioned conventional understanding of banking. Banks are now

able to "sell" loans due of securitization, a late 1980s financial invention that reached

its zenith in the middle of the 2000s. Through securitization, loans are bundled into

non-recourse vehicles and turned into securities that are sold to the general public,

institutional investors, and hedge funds. Private placements are preferable because

they have far lower regulatory expenses (Zingales, 2009). Financial intermediaries

change their business models from "relationship banking" to "transaction banking"

by selling loans. The solution's clear conclusion is that market forces will move

financial risk and the underlying asymmetry of knowledge. However, there are two

issues. First off, the selling banks' counterparties are primarily professional investors

who make investments on behalf of final savers but may mistreat them. Financial

institutions must still manage asymmetric information, therefore. The financial crisis

of 2007–2008 also demonstrates that banks and other leveraging intermediaries

stored or otherwise repurchased a sizeable amount of the loans that were

securitized11. The so-called "shadow banking," a kind of financial intermediation that

11
Jermann, Urban. "Interest Received by Banks during the Financial Crisis: LIBOR vs Hypothetical
SOFR Loans." 2021. doi:10.3386/w29614.

22
relies on short-term liabilities that are almost as liquid as money but are not insured

or subject to the same regulations as deposits, was really a major cause of this

catastrophe. The divide between market-based and bank-based financial systems has

become obsolete, if not muddled, at this point since markets still require banks to

supply investors with liquidity while banks still depend on markets to support their

intermediation margins.

Another benefit of relationship banking is that non-tradable loans require

banks to monitor moral hazard and control borrower behaviour. In the literature on

corporate governance, it is emphasised that banks can operate as active gatekeepers,

keeping an eye on the conduct of their corporate customers. The function of banks as

a source of corporate monitoring has certain public good features because it has been

discovered that a nation's level of corporate governance has a significant influence on

its economic performance. But when market funding is involved, such when

corporate bonds are issued, this monitoring duty is more challenging. These

disparities are at the core of the debate between the market-funding model of

company investments in the Anglo-Saxon world and the bank financing methods,

which are still popular in Continental Europe12. The susceptibility of many banks in

Continental Europe to the decline in the equity and debt markets suggests that the

corporate governance of banks has recently taken a backseat to the role of banks in

the governance of non-financial companies. Markets and financial intermediaries

play an important part in the informational process, which suggests that the primary

12
"Mobilizing Financing for Climate Smart Investments in the Mekong Delta." 2020.
doi:10.1596/34202.

23
function of government action is to complement market forces. First, financial

markets require regulation to the point where financial intermediaries are unable to

offer remedies for information breakdowns. This is the area where transactions on

the financial market are regulated. Second, financial intermediaries reduce

information issues, but as a result of their functioning, other information and

monitoring issues arise. Financial institutions need to be regulated and overseen in

order to resolve this.

The argument for government interference in the functioning of financial

markets has historically been based on asymmetric information issues that raise risks

of fraud, carelessness, ineptitude, and other issues. Therefore, financial authorities

adopt and enforce certain company behaviour regulations. But are issues with

incomplete and asymmetric information not also relevant to markets for non-

financial goods and services? It seems that in today's complex financial markets,

quality issues and related information issues may be considerably more challenging.

Economic analysis classifies goods and services into three groups based on

informational flaws. First off, informational issues are less serious for searchable

commodities that may be examined before purchase. Additionally, marginal

consumers effectively restrain providers' opportunistic behaviours through the

market. Due to providers' rivalry for the marginal customer, this occurs. Therefore,

the marginal consumer who invests in knowledge and looks about for the best

price/quality ratios will also safeguard uneducated people. Second, this reprimanding

impact on suppliers could also be felt by those whose products are regularly bought.

24
However, if they are only sometimes purchased, it would take longer. Third, it is

unlikely that marginal buyers will conduct informed comparison shopping for

credence items, the quality of which is considerably harder to evaluate. For

inexperienced investors, many financial services, particularly those including the

provision of financial advice, should be seen as credibility products13.

Given the institutionalisation of the savings and securities markets, the

contrast between skilled and inexperienced users of financial services is very

important. Modern investor protection should concentrate on institutional investors

and their conflicts of interests with clients, counterparties, and corporate

management, as opposed to the background of US financial regulation in the 1930s,

which placed an emphasis on individual protection of "widows and orphans"14. There

are two significant effects of this strategy on financial regulation. On the other hand,

conduct of business regulations should empower ordinary investors to wisely choose

institutional providers of investing services in both the debt and stock markets.

Besides that, disclosure regulation should place more of an emphasis on the systemic

vulnerability of the marketplaces in which these products are traded, financed, and

insured than on the transparency of complicated financial instruments for novice

investors.

That is to say, there may be a shift in the focus of securities regulation from

concerns with transparency and competition to ones with financial stability. Private
13
"McMeel and Virgo On Financial Advice and Financial Products." Financial and Banking Law, 2014.
doi:10.1093/law/9780198705956.001.0001.
14
Neo, Dora. "SINGAPORE: BOOSTING REGULATION TO PROTECT VULNERABLE INVESTORS."
Financial Advice and Investor Protection, 2021, 236-259. doi:10.4337/9781800884625.00024.

25
information generation and sale, which are carried out by information intermediaries,

may help to solve information challenges. For instance, rating agencies examine and

keep tabs on the financial market's bond issuers' creditworthiness. Private

intermediaries are unable to fully resolve these information challenges due to the

public goodwill of information and the free rider dilemma associated with it. The

global financial crisis has made it clear that credit rating agencies have failed to

evaluate and monitor risk.

But it's still unclear how regulation will proceed. There are varying views on

whether ratings are inaccurate due to conflicts of interest, are exaggerated because

they have a "regulatory licence"15, or simply underestimate systemic risk due to

model uncertainty surrounding financial innovations like property backed

securities16. The conclusion from this discussion is that, if there is a problem with

rating agencies, it is not simply that they could deceive inexperienced investors but

also that financial stability might be compromised by widespread illusions of safety

reinforced by high ratings. To the degree that ratings and their dependability

influence the terms of funding for financial intermediaries, the fact that ratings and

the models on which they are based are subject to ambiguity, inaccuracy, or blatant

fraud becomes problematic for stability. Ratings can cause funding issues even in the

15
Efing, Matthias, and Harald Hau. "Structured Debt Ratings: Evidence on Conflicts of Interest." SSRN
Electronic Journal, 2013. doi:10.2139/ssrn.2336111.
16
"Mortgage‐Backed Securities and Asset‐Backed Securities." Advanced Financial Risk Management,
Second Edition, 2013, 639-655. doi:10.1002/9781118597217.ch29.

26
absence of conflicts of interest, as the recent European sovereign debt crisis has

demonstrated17.

On the one hand, financial institutions aid in resolving the information issues

in the financial markets. The majority of financial assets issued by financial

institutions, on the other hand, are information-intensive and consequently difficult

to analyze and liquidate. This is especially true with banks, where depositors are kept

in the dark regarding the caliber and risk of the asset portfolio. Be aware that

"shadow banking" has a similar set of problems when intermediaries invest in

securities that are too sophisticated to be examined and fund such investments with

short-term obligations. Moral hazard issues arise from information asymmetries

because financial institutions may behave contrary to the interests of their loans. For

instance, banks are compelled to issue riskier but high-yield loans. Furthermore,

there is a free rider issue because many investors have little motivation to contribute

in the supervision of financial institutions. Particularly, tiny, inexperienced

depositors who have no motivation to carry out numerous monitoring tasks own the

majority of the debt held by banks. However, by the nature of the debt claims they

issue, financial institutions may be punished and these moral hazard costs may also

be decreased. The danger that savers may abruptly withdraw their money will

regulate their conduct by making short-term debt claims, as do the banks.

17
Paudyn, Bartholomew. "Crisis and Control." Credit Ratings and Sovereign Debt, 2014, 30-82.
doi:10.1057/9781137302779_2.

27
 However, moral hazard issues might even get worse if such short-term loan

claims are protected, as is the case with deposit insurance. The only uninsured

creditors with incentives to keep an eye on banks' risk-taking are those who can't

withdraw financing all at once, such when banks issue a set amount of subordinated

debt.

However, market discipline by uninsured creditors has a double-edged effect

since it affects the stability of certain institutions and maybe the entire system.

Financial stability and the prevention of moral hazard do really trade off. Taxpayers

eventually bear the expense of the safety net that systemically significant

intermediaries have access to in case of disaster, which naturally encourages greater

risk taking than is socially desirable. To lower the costs of moral hazard to individual

savers and taxpayers, government regulation and oversight are required. The main

way to combat the shortcomings of market discipline is to mandate the fast and

accurate disclosure of financial information. This can also be accomplished by

boosting the incentives for bankers and bank shareholders to behave responsibly,

such as by raising their ownership in the bank by enacting capital adequacy

regulations that call for greater contributions of their own money 18. However, as the

most recent financial crisis demonstrates, such safeguards taken at the institution-

level are not necessarily enough to keep systemic risk in check.

18
"Bank capital adequacy versus deposit insurance." Money and the Market, 2013, 40-47.
doi:10.4324/9781315011615-10.

28
Eight.3 What is financial fraud?

According to Bank Negara Malaysia, fraud is "an purposeful act of

dishonesty regarding financial transactions with the sole intent of achieving private

gain". Fraud is a violation of both civil and criminal law. According to Bank Negara

Malaysia, 'white collar criminals' with specialised expertise were often involved in

complex financial transactions in fraud instances.

Black's Law Dictionary defines fraud as the fraudulent portrayal of a truth,

especially via speech or acts, false or misleading assertions, or the concealment of

information that should have been made public. Intentional fraud is a general phrase

that encompasses any creative ways that human intellect may come up with to

defraud someone, as opposed to negligence, which is always negative. It also covers

any surprise, trick, clever, or unfair way that someone is taken advantage of. The

American Heritage Dictionary of the English Language defines "fraud" as a

purposeful act of deceit undertaken to get an unfair or illegal benefit. A fraud is a

scam, a swindle, or a cheat; it can also refer to someone who poses as someone else,

an impostor, or a fake. The majority of fraud offenses nowadays, when technology is

developing quickly, are committed in some way involving computers. Therefore, it is

necessary to define fraud using technology-neutral language, paying special attention

to its geographic breadth. This definition makes it possible for the courts to

successfully prosecute even the most skilled fraudsters. This is crucial because

fraudsters or penetration testers will commit fraud while they get a chance, and this

29
chance has varying implications due to evolving technology. However,

"misrepresentation" is defined as giving a false or misleading account of a significant

element, item, or fact related to the claim. Equipment, supplies, or inventory theft,

misuse of assets, fraud in the procurement process, check fraud, forgeries, and

dishonest or faked invoicing are all examples of misappropriation of assets. This

study's main objective is to evaluate the system for preventing financial fraud.

According to accounting rules and reports, fraud is defined as "an purposeful act

resulting in an important error in the financial records which are part of an

investigation" (AICPA).19.

Deceptive behaviour may have civil as well as criminal repercussions.

Traditionally, civil lawsuits were the main means of controlling fraud. At least in the

common law's history, the employment of the criminal law as a regulatory tactic is a

comparatively recent development20. The civil repercussions of fraud continue to be

of significant relevance today since it is obvious that police and other regulatory

agencies lack the resources to thoroughly examine every fraud charge that comes to

their notice.

19
"Consideration of Fraud in a Financial Statement." Audit and Accounting Guide, 2018, 217-230.
doi:10.1002/9781119557630.ch12.
20
Mitchard, Paul. "Legal aspects of financial fraud." Financial Markets Regulation, 1997, 155-170.
doi:10.1007/978-1-349-25867-3_12.

30
Eight.4 Malaysia Regulatory Framework

Eight.4.1 The set of regulations that apply to banks

The Financial Services Act of 2013 (FSA) and the Islamic Financial Services

Act of 2013 came into effect on June 30, 2013, consolidating and repealing the

Banking and Financial Institutions Act of 1989 (BAFIA), the Islamic Banking Act of

1983, the Insurance Act of 1996, the Payment Systems Act of 1996, and the Banking

and Financial Institutions Act of 1989. The Acts provide the BNM additional power

to handle possible risks to market stability, enhance consumer protection, and

promote competitiveness within the financial services sector. They aim to create a

regulatory framework for both conventional banking and for Shariah-compliant

market. The Acts also contain provisions to safeguard any instructions, guidelines,

announcements, or notifications previously issued pursuant to any legislation that

had been abrogated in connection with any provision contained in the Acts prior to

their implementation.

Malaysia has established an independent mid-shore authority on the island of

Labuan, which off the coast of Borneo, that was declared a worldwide offshore

financial centre in October 1990, in order to augment the activities of its financial

sector in Kuala Lumpur, Malaysia. According to the Labuan Financial Services

Authority Act of 1996 (the Labuan FSA Act), Labuan is governed and operated by

the Labuan Financial Services Authority (the Labuan FSA)21. The location changed

21
Act 545: Labuan Financial Services Authority Act 1996 & Orders. 2014.

31
its name to the Labuan International Business and Financial Centre (the Labuan

IBFC) in 2008, and that same year, Labuan IBFC Incorporated was created as the

location's marketing division. Together, the Labuan FSA and the Labuan IBFC seek

to advance Labuan IBFC's standing as Asia's top mid-shore international business

and financial hub. Federal legislation that are particular to the Labuan IBFC must be

followed by organisations working there. The Labuan Financial Services and

Securities Act of 2010 (LFSSA) governs banks in Labuan, while the Labuan Islamic

Financial Services and Securities Act of 2010 (LIFSSA) governs banks in Labuan22.

Eight.4.1.1 Bank Negara Malaysia

The BNM, a statutory corporation wholly owned by the government, was

created by the Central Bank of Malaysia Act 1958 and is still in existence nowadays

pursuant to the Central Bank of Malaysia Act 2009 (CBA), and took effect on

November 25, 2009. The BNM reports to the Minister of Finance (the Minister) and

updates him on monetary and financial sector regulations.

The BNM is given the power to supervise the governance of financial

companies by the legislation and the CBA. The CBA legitimises the duality to all of

both the conventional and the Islamic financial systems in Malaysia and lays the

legal groundwork for the growth of an Islamic financial system within the Malaysian

financial system by granting the BNM the authority and resources it needs to carry

out its mandates.

22
Act 704: Labuan Financial Services and Securities Act 2010 & Regulations. 2014.

32
 The BNM's main goals are the careful conduct of monetary policy, the

stability of the financial system, and the growth of a strong and forward-thinking

financial industry. To carry forward the aforementioned, the BNM is responsible for

assisting government agencies on the economy and overseeing the handling of the

public debt. Additionally, it is the only body in charge of maintaining the nation's

foreign currency reserves and printing new money. The BNM also monitors and

oversees payment networks, currency markets, and currency markets in addition to

performing the subsequent regulatory and supervision duties over financial

institutions23.

The Acts provide the BNM the authority to govern banking institutions, and it

does so using a risk-based supervisory methodology that keeps an eye on and

assesses how each financial institution manages its unique set of business risks.

A concept paper on risk management and internal controls for money services

business, published in September 2012, details the recommended legal requirements

on risk management and internal controls for the conduct of money service business

that are consistent of the associated functioning and governance structures outlined in

the Money Services Business Act of 2011 and the Money Services Business

Regulations (BNM 2001, 2010). All licensees are obliged by Section 36 of the

Money Services Business Act of 2011 to establish and maintain appropriate internal

control mechanisms, including risk management, to safeguard the security and

23
Krizek, Tomas. "Regulatory Interventions, Central Bank Support, and Official Oversight and Control
of Wholesale International Financial Markets." SSRN Electronic Journal, 2011.
doi:10.2139/ssrn.1842424.

33
soundness of their financial holdings service organizations. Along with enhancing

consumer protection, these laws prevent the money services sector from being

exploited to facilitate illicit activity, money laundering, and terrorism funding. The

recommendations provide minimal requirements, including licensee compliance with

putting in place suitable risk management and internal control mechanisms for their

company.

To manage and mitigate the identified risks, licensees must put in place the

proper procedures, controls, and systems. Initiating written internal procedures and

rules on how to conduct of financial service company activities; establishing

balances and checks within the bank; ensuring a sufficient level of staff competency;

and establishing an independent review function are some of these processes.

The Board of Directors (BOD) is in charge of ensuring that the overall

AML/CFT measures adopted by reporting institutions are adequately under control.

Senior management must make sure that the BOD is completely committed to

developing efficient internal control mechanisms for AML/CFT and that it receives

timely information. For the implementation of AML/CFT procedures within the

notification organization, including those required for customer acceptance rules,

consumer meticulousness, documentation, ongoing surveillance, declaring of unusual

transactions, and combating the financing of terrorist activity, the BOD sets the

essential necessities and authorizes the policies. To guarantee successful

implementation of the AML/CFT measures and to ensure the separation of duties

34
between those implementing the rules and regulations and those enforcing the

controls, the BOD should also clearly define the positions of authority. Accordingly,

the BOD should make sure of the following:

1. The selection of a compliance officer for the corporate headquarters and each

division or subsidiary; and

2. The efficiency of internal audits in reviewing and appraising the safeguards

against money laundering and terrorism funding.

Eight.4.1.2 Security Commission Malaysia

In addition to the aforementioned, financial companies and investment

companies that provide capital market services are governed by the Securities

Commission (SC), an administrative agency endowed with investigative and

enforcement powers established by the Securities Commission Act of 1993 (SCA).

With the primary objective of safeguarding investors, the SC is directly

accountable for the regulation, oversight, and monitoring of all people licensed by

the Capital Markets and Services Act 2007 (CMSA). The SC is the organization in

charge of regulating the Malaysian capital market. In accordance with the CMSA,

the SC also has the responsibility principally in charge of encouraging and promoting

the expansion of the financial and derivatives industries while also keeping an eye on

and supervising publicly listed companies to ensure compliance with securities

regulations.

35
 The CMSA serves as a comprehensive framework that regulates the offering

and licensing of capital markets products and services, market activity, the issuance

of securities, and the management of takeovers and mergers. In Malaysia, the SC

must approve all debt issuances (bonds and sukuk), and certain guidelines and

practise notes issued by the SC under the CMSA also apply.

Eight.4.1.3 Companies Commission in Malaysia

Banks in Malaysia are under general supervision of the Companies

Commission of Malaysia (CCM), as the FSA and the IFSA are required to be

incorporated under the Companies Act 2016 (CA) in order to engage in banking

operations. The Labuan Companies Act of 1990 mandates that banks in Labuan be

established or registered, although the IFSA permits foreign Islamic banks to operate

via both a nationally incorporated subsidiary and also a regionally registered

corporation.

Eight.4.1.4 Labuan FSA

According to the Labuan FSA Act, the Labuan FSA is the only legislative

authority in charge of regulating, overseeing, and developing the Labuan IBFC.

Authority's website states that its main responsibilities include serving as the primary

regulatory, enforcement, and supervisory body for the international business and

financial services industry, as well as promoting and developing Labuan as a global

hub for business and financial services, implementing the country's objectives,

36
regulations, and goals for the growth and administration of international business and

financial services in Labuan, and more.

The aforementioned covers the licencing, regulation, and monitoring of

licenced firms that should be operating inside Labuan IBFC in order to ensure that

they adhere to the relevant national and international standards and best practises.

Additionally, under the overall supervision and control of the Minister, the Labuan

FSA is in charge of administering numerous important pieces of law, such as the

LFSSA and the LIFSSA, as well as developing rules for the conduct of business and

financial services in the Labuan IBFC.

Eight.4.1.5 Development Financial Institutions Act 2002

Development financial institutions (DFIs), that are specialized financial

institutions developed by the government in order to exclusively foster the growth of

key regional socioeconomic areas like the agricultural sector, small and medium-

sized enterprises, infrastructures shipping, export-oriented sectors, and

technologically advanced and capital-intensive companies, are subject to regulation

and supervision by the BNM in accordance with the Development Financial

Institutions Act of 2002 (DFIA).

The DFIA's provisions give the BNM the authority to keep an eye on these

institutions' operations and financial health as well as their primary goal of offering

specialised financial products and services to meet the needs of their respective focus

areas. The BNM is also tasked with making sure that DFIs are capable of carrying

37
out their separate mandates in a way that is both financially viable and adds to the

general security of the banking sector.

Eight.4.2 Licencing

All individuals doing banking, investing, or insurance activities are required

by the Acts to possess a current licence issued by the Minister. The BNM and the

Ministry of Finance continue to have jurisdiction over these companies 24. For the

purpose of conducting insurance, financial institution, and investment-related

banking operations, licenses may be granted, revoked, or subject to restrictions by

the Minister. In some cases, the Minister may also have the authority to conduct

investigations. While licenses for Islamic banks and foreign Islamic banks are

particularly issued under the IFSA, licenses for investment and commercial banks are

explicitly issued under the FSA25.

Anyone who wishes to engage in capital market activities (aside from

registered persons) must first obtain a licence from the SC, which is the only body

with the authority to grant and approve licences to capital market intermediaries

engaging in the regulated activities specified by the CMSA. Capital market

intermediaries who are qualified and compliant are granted a licence under the

CMSA single licencing framework, allowing them to engage in one or more

regulated activities.
24
"The Regulatory Boundaries of Bank Activities." Limitations on the Business of Banking (RLE
Banking & Finance), 2012, 31-64. doi:10.4324/9780203108260-6.
25
Rosman, Romzie, Mohamed F. Abdul Khir, and Nur A. Saat. "Accounting Issues in the Reporting of
Profit Sharing Investment Accounts in Islamic Banks' Financial Statements under IFSA 2013." ISRA
International Journal of Islamic Finance 7, no. 1 (2015), 129-137. doi:10.12816/0021399.

38
 The two primary categories of licenses are the new capital markets operations

participants' licenses, which are granted to representations of administrators, and the

first capital markets services licenses, which are granted to principals. With the help

of these licences, representatives of principals are able to conduct one or more

regulated activities on the principal's behalf.

The Labuan LFSSA gives the Labuan FSA the authority to award licences for

the operation of Labuan banking business, which means that:

Accepting deposits on current accounts, bank accounts, savings accounts, or any

other accounts that the Labuan FSA may specify;

1. Labuan investment banking business;

2. Labuan financial business;

3. Labuan Islamic banking business; and

Any further transactions that the Labuan FSA specifies with the Minister's

consent may be made in any currencies (including the Malaysian ringgit where

allowed by the Acts or other applicable laws in effect). The Labuan FSA may also

provide licences for the operation of Labuan Islamic banking enterprise under the

LIFSSA.

39
Eight.4.3 Digital Banking

The BNM released the the granting of license Guidelines for Digital Banks in

the month of December 2020 during the initial phase of operations, coinciding with a

financial asset limit of not more than 3 billion ringgit for a period of three to five

years. This document incorporates the streamlined regulatory structure applicable for

digital financial institutions, which are characterized as "banks that carry on their

banking operations completely or substantially through electronic or digital means." 26

The simplifications aim to preserve the stability and dependability of the banking

sector and the best interests of depositors while enabling innovative technological

applications to enhance people's and businesses' financial well-being. Digital banks

must comply with all regulatory requirements that are equivalent to those that are

imposed on established banks after the initial stage is complete.

Out of the 29 applications for digital bank licences submitted in accordance

with the Financial Services Act 2013, the BNM named the five finalists in April

2022. Refer to the act that mention in Section 10(1) of the FSA and IFSA, the

evaluation criteria also took into account the applicants' moral character and also

must have the integrity, the nature and sufficiency of their financial resources, the

soundness and viability of their business and also the technology plans, and their

capacity to meaningfully address financial inclusion gaps. Applications were judged

according to each assessment criterion's consistent judgements as well as in relation

to other applications.
26
"Policy Document on Licensing Framework for Digital Banks." Bank Negara Malaysia. Accessed
June 8, 2023. https://www.bnm.gov.my/-/policy-document-on-licensing-framework-for-digital-
banks.

40
 We can significantly increase opportunities for our society to participate in

economic activity by adopting electronic devices more generally for everyday

transactions. Digital banks are expected to substantially expand financial inclusion. 27.

This will facilitate improved financial management, reduce transaction costs, and

assist us overcome geographical challenges.

Following the announcement, the selected applicants have to undergo

following a period of operational readiness, which will be confirmed by BNM by an

inspection before they are allowed to start operations. This process is expected to

take between 12 and 24 months.

BNM will continue to work with the banking and fintech industries, as well

as relevant stakeholders, in connection alongside the five advantageous pushes set

forth in the Banking and Financial Services Blueprint 2022–2026 to continuously

increase access to financial products and services across the country and among all

societal segments.

27
Digital Banks Are Anticipated to Further Enhance Financial Inclusion, We Can Considerably Improve
Chances for Our Society to Engage in the Economy by Embracing Digital Technology More Broadly for
Everyday Transactions." Bing. Accessed June 8, 2023. https://www.bing.com/search?
q=Digital+banks+are+anticipated+to+further+enhance+financial+inclusion
%2C+we+can+considerably+improve+chances+for+our+society+to+engage+in+the+economy+by+em
bracing+digital+technology+more+broadly+for+everyday+transactions.&cvid=7fd97a01b8444f9d823
42978d7143709&aqs=edge..69i57.599j0j9&FORM=ANAB01&PC=U531.

41
Eight.4.4 Prudential regulation

Eight.4.4.1 Relationship with the prudential regulator

From the perspective of corporate responsibility, the legislation formalize the

duties of financial institution directors and impose stringent transparency

requirements on both those directors and the holding companies for those

institutions28. Directors should report to the Board of Directors the nature and extent

of their direct or indirect involvement in each material transaction or material

contract with the banking organization where they hold office. A financial

institution's chairman of the board, executives, nor chief executive officer cannot be

selected, chosen, reappointed, or re-election without the BNM's approval in line with

the Acts.

In accordance with the Acts, the BNM is also given the power to establish the

requirements for a financial institution's chairman, executives, chief executive

officer, top executives, and, in the case on Islamic financial institutions, members of

the Shariah committee. Along with criteria for skill and ability and financial

integrity, requirements may also include minimum requirements for probity,

credibility, and personal integrity. Whether the prescribed fit and adequate conditions

have been met is entirely up to the BNM's judgement.

Follow the act that stated in Section 126 of the BAFIA and Section 158 of the

SCA, the BNM and the SC jointly established the Guidelines of Investment Banks to
28
Hogan, Warren, and Rowan Trayler. "Bank Governance: Perceptions from Experiences." Handbook
for Directors of Financial Institutions, 2008. doi:10.4337/9781848443938.00015.

42
further guarantee the correct division and coordination of their various legislative

obligations, particularly with regard to investment banks. The Guidelines state that

the BNM is going to be in charge of conducting prudential regulation on investment

banks in order to guarantee their security and soundness in the best interests of

depositors, while the SC could be in control of monitoring the market as well as the

business conduct of investment financial institutions in order to encourage integrity

of the market and safeguard shareholders in the capital market.

The strict fit and proper requirements for the BNM are also outlined in

additional rules found in the Fit and Proper Criteria of June 2013 published under the

FSA, which should be read in conjunction with the Corporate Governance standards

published in August 2016 (the CG rules; sometimes known as the CG standards). In

accordance with the DFIA's requirements, the BNM also published Fit and Proper

Criteria in June 2017 for DFIs.

43
Eight.4.4.2 Management of banks

The CG Guidelines mandate that the boards of directors that take management

position in financial institutions create specialist board committees to supervise

crucial or significant functional areas, to handle issues needing in-depth analysis or

assessment, and to be accountable for the committees' actions. According to the CG

Guidelines, these specialised committees include the following members and assist

the board in carrying out its duties29:

1. a committee charged with overseeing nominations for the board of directors,

senior management, and company secretaries:

a. Board nominations and removals;

b. the general make-up of each group;

c. Measures for Assessing Directors, Senior Managers, and Company

Secretaries' Performance and Development; and

d. accurate and appropriate evaluations and assessments;

2. a compensation committee in charge of examining the compensation of

directors and actively monitoring the layout and functioning of financial

institutions' compensation systems;

29
McGee, Robert W. "An Overview of Corporate Governance Practices in Malaysia." Corporate
Governance in Developing Economies (n.d.), 209-213. doi:10.1007/978-0-387-84833-4_24.

44
 3. a risk management committee in charge of developing risk management

strategies, such as identifying the characteristics of and exposure to risks

associated with banking, methods for identifying, monitoring, managing, and

controlling each risk, and the kind and frequency of risk management system

evaluation procedures;

4. A committee of auditors to provide checks and balances inside the financial

institution and independent monitoring of both internal and external auditing

activities and internal controls.; and

5. A Shariah committee to oversee Shariah compliance in the matter of Islamic

financial institutions.

The Acts, the CA, and any pertinent corporate governance-related rules,

recommendations, and circulars that the BNM may occasionally publish should all

be reviewed in conjunction with the CG recommendations.

45
Eight.4.4.3 Regulatory capital and liquidity

The Acts grant the BNM the power to establish requirements for prudential

matters (like the liquidity and funding adequacy) that financial organizations must

adhere to in order to maintain solid financial standing and conduct their company's

operations, circumstances, and activities with ethics, competence, and expertise.

These authorities claim that the BNM announced the Basel III-compliant Liquidity

Coverage Ratio (LCR) methodology in August 2016. According to this framework,

financial institutions must retain adequate high-quality liquid assets (HQLA) on an

entity and consolidated level to survive an extreme scenario of liquidity crisis for a

period of 30 days. By January 2019 and moving ahead, banking institutions must

constantly keep a sufficient stock of HQLA to maintain an appropriate LCR of

100%, in accordance with the LCR framework, that became effective on August 25,

2016.

In addition to the Acts, the CBA says that the BNM may require financial

businesses to deposit a reserve with it in order to execute monetary operations and

details the criteria and method for computing such reserve 30. In order to manage

liquidity, the BNM issued the Statutory Reserve Requirement Guidelines in January

2016. According to these regulations, traditional and Islamic financial institutions

must maintain statutory reserve requirement (SRR) holdings within their mandatory

30
"Central Bank Of Malaysia Act 2009." Human Verification. Accessed June 9, 2023.
https://www.bnm.gov.my/-/central-bank-of-malaysia-act-2009-1.

46
reserve funds that are equivalent to a specific proportion of their eligible liabilities,

or the SRR rate, which is presently 2%.

A financial firm may only be granted a license under the Acts if its equity

funds are at least the minimum amount set by the Minister, or are more. The BNM

issued the Guidelines on Capital Funds and the Guidelines on Capital Funds for

Islamic Banks in 2013 to ensure that financial institutions maintain a minimum

amount of capital to function and carry out their duties.31.

The BNM published a policy statement on the Domestic Systemically

Important Banks (D-SIBs) Framework for D-SIBs on February 5, 2020. This

document outlines the BNM's evaluation process for identifying D-SIBs in Malaysia

as well as the initial list of D-SIBs. D-SIBs are banks with financial issues that might

have a severe negative impact on the national banking system and the overall

economy. Higher capital requirements established for these institutions would

enhance the regulatory framework that was put in place to limit the risks provided by

D-SIBs to the sustainability of the Malaysian banking sector and the greater

economy. This will make the Malaysian banking sector more stable and secure.32.

Aligned with the priorities of BNM to implement Basel III reforms under the

FSB (2022–2026), The Basel III reforms' proposed requirements and guidelines for

31
Saeed Alawsie, Husham. "Challenges in Implementation of Capital Adequacy Guidelines in Bahraini
Islamic Banks." International Journal of Business and Administrative Studies 6, no. 1 (2020).
doi:10.20469/ijbas.6.10001-1.
32
"Domestic Systemically Important Banks (D-SIB) Framework - Bank Negara Malaysia." Accessed
June 9, 2023. https://www.bnm.gov.my/-/domestic-systemically-important-banks-d-sib-framework.

47
calculating the capital expenditure charge for the standardized approach for credit

risk are outlined in the Capital The appropriateness Framework (Basel III - Risk

Weighted Assets): Standardized Approach for Credit Hazard Exposure Draft, which

was released by the BNM on January 20, 202333. When they go into effect, these

criteria will take the place of the current Part B of the Capital Adequacy Framework

(Basel II - Risk-Weighted Assets) and Capital Adequacy Framework for Islamic

Banks (Risk-Weighted Assets), both of which were released on May 3, 2019. The

banking companies that are now listed as D-SIBs are Public Bank Berhad, CIMB

Group Holdings Berhad, and Malayan Banking Berhad.

Eight.4.4.4 Recovery and resolution

The Companies Act of 1965 was largely repealed and replaced by the CA,

which was introduced in early 2017. Financial institutions are governed by the same

general insolvency laws that apply to companies, which are presently included in

Part IV of the CA34. The CA allows for both mandatory and voluntary winding up

and as well got the the appointment of receivers and managers to oversee

corporations. The Act's Part VIII (corporate rescue mechanisms) includes provisions

for corporate voluntary agreements and judicial oversight that became effective on

March 1, 2018, in addition to the Companies (Corporate Rescue Mechanism)

33
"BNM Sets Out Focus Areas for Financial Sector for 2022-2026." Moody's Analytics | Risk
Management, Credit Ratings Research, Software. Accessed June 9, 2023.
https://www.moodysanalytics.com/regulatory-news/jan-24-22-bnm-sets-out-focus-areas-for-
financial-sector-for-2022-2026.
34
ACCA - https://www.accaglobal.com. "Malaysian Companies Act 2016: an Overview." ACCA Global.
Accessed June 9, 2023.
https://www.accaglobal.com/an/en/student/exam-support-resources/fundamentals-exams-study-
resources/f4/technical-articles/mys-comp-act.html.

48
provisions 2018. However, there are particular procedures for dealing with financial

companies that default on their loans when they are due under the Acts including the

Malaysian Deposit Insurance Corporation Act 2011 (MDICA).

The Perbadanan Insurans Deposit Malaysia (PIDM) (also known as the

Malaysia Deposit Insurance Corporation (the Corporation)) is an insurance

programme that protects consumers who deposit money into financial institutions in

Malaysia in accordance with the MDICA35. In order to promote financial stability

throughout the financial system, the PIDM ensures that customers have protection

against the loss of their money in the case of loss caused by the bankruptcy of a

financial institution carrying their deposits.

The Acts themselves outline procedures for resolving the bankruptcy of banking

organizations, distinguishing among conventional and Islamic banks. The BNM

serves as the resolution authority and, with the Minister's prior written approval, has

the authority to take over all or a portion of a financial institution's operations,

manage them, or choose a third party to do so on the BNM's behalf:

1. The institution's assets are insufficient to adequately safeguard its depositors,

policy owners, participants, users, or creditors, as applicable;

35
"What is the Deposit Insurance System (DIS)?" PIDM. Accessed June 9, 2023.
https://www.pidm.gov.my/en/how-we-protect-you/deposit-insurance-system/what-is-the-deposit-
insurance-system-dis.

49
 2. The institution's capital has reached a risky level or is deteriorating in a way

that might have a negative impact on its depositors, policy owners,

participants, users, creditors, or the general public; and

3. The financial institution is now, or soon will be, bankrupt, or soon won't be

able to fulfil any of its commitments.

The Acts typically provide that, unless otherwise specified, the CA's provisions shall

apply to the wound up of an institution. But no application for the closure of an

insurance company may be made by anybody without the BNM's prior written

consent.

On July 28, 2021, the BNM and the PIDM issued the policy framework for

undertaking recovery and resolution strategy for the banking industry in Malaysia. It

specifies the policies and expectations of the BNM for the development and

maintenance of rehabilitation strategies for the banking sector. Every banking

institution is going to be required, under the framework, to design and prepare for the

execution of a number of recovery alternatives in order to restore its long-term

sustainability as a result of an assortment of distinct and system-wide stress events.

Last but not least, the Acts mandate that, in the unlikely scenario of the

bankruptcy of investment companies and Islamic banks, the funds of a financial

institution must be made accessible to satisfy every debt of that licensed investment

company in respect of all contributions in Malaysia as the highest priority over the

50
other unprotected obligations of those financial institutions in the nation of Malaysia,

alongside the possible exception of more beneficial liabilities stipulated by the CA

and responsibilities due and his claims owing.

Eight.4.5 Conduct of Business

A number of activities, among others as well, would require licencing under the

FSA's provisions:

1. The banking industry, which includes the business of receiving deposits on

current accounts, bank accounts, savings accounts, and other types of

accounts, as well as the payment or collection of customer-drawn or

customer-paid checks; and supplying financing;

2. Investment banking business, which includes receiving deposits on deposit

accounts and providing financing, as well as any regulated activity carried out

in accordance with a CMSA-issued licence for capital markets services.; and

3. any further practises that the BNM, with the Minister's agreement, may

mandate.

51
The IFSA states that, among other things, the following actions would require a

licence in accordance with its regulations:

1. An Islamic banking business is one that accepts Islamic deposits on current

accounts, deposit accounts, savings accounts, or other similar accounts,

whether or not it also pays or collects customer checks, accepts funds for

investment accounts, or provides financing;

2. international Islamic banking, which entails conducting Islamic banking

operations in currency other than the ringgit or the other types of operations

listed in point (3); and

3. any further practises that the BNM, under the Minister's agreement, may

mandate.

Other than the Malaysian ringgit, international Islamic banks conduct Islamic

banking operations. Regulations on International Islamic Bank published by the

BNM in 2008, Malaysian commercial banking, investment banking, and other

banking activities are all included in the definition of Islamic banking activity in

foreign currencies.

The Labuan FSA may, in accordance with the LFSSA and the LIFSSA, grant a

Labuan banking licence, Labuan financial services licence, Labuan Islamic banking

licence, Labuan Islamic investment financial services licence, or such kind of

company licence as the Labuan FSA, via the Minister's consent, may define. To do

52
trade in currencies that are not in Malaysian ringgit in, or from, or through the

Labuan IBFC, only Labuan banks holding one of the abovementioned licenses would

be allowed, always subject to the appropriate exchange control restrictions prescribed

by the Acts.

The BNM released the Rules on Prohibited Business Conduct in 2016 in

accordance with the Acts' provisions, which forbid financial services providers from

acting in a way that is intrinsically unfair to financial customers.

By using the following methods, these regulations strengthen the BNM's already-

existing codes of conduct for businesses and consumer protection:

1. Making sure customers are not given information that is false or misleading

in relation to a financial service or product;

2. prohibiting irrational corporate practises that threaten or take advantage of

financial consumers;

3. avoiding commercial practises that limit financial customers' flexibility to

select from a range of financial services and products.; and

4. avoiding business collusion that might have a negative impact on financial

consumers.

53
 The Financial Services (Financial Ombudsman Scheme) Regulations 2015 and

Islamic Financial Services (Financial Ombudsman Scheme) Regulations 2015

(Regulations) were released in September 2015 in addition to the aforementioned 36.

The Financial Ombudsman Scheme was established by the Regulations in

accordance with the FSB's vision to ensure the efficient and impartial managing of

complaints and the resolution of disputes against participating institutions of banking

for direct financial damage within the prescribed monetary ceilings, which are

250,000 ringgit for financial service disputes and 25,000 ringgit for conflicts on

unauthorized transactions involving debit or credit card payment channels, or

cheques.

In June 2015, the SC announced the Lodge and Launch (LOLA) Framework for

all of the wholesale sales that unlisted in all the capital market goods, which

represented a significant modification to its capital markets product authorisation

regulations. The SC has also been actively engaged in regulatory reform37. After

required information has been given to the SC via a web-based submission system,

the LOLA provides a method for wealthy investors (certified investors, extremely

wealthy companies, and high net value individuals) to acquire unlisted capital market

goods, significantly decreasing the time to market.

36
"Financial Services Regulations and Requirements." CFP Board Financial Planning Competency
Handbook, 2019, 25-34. doi:10.1002/9781119642473.ch3.
37
"Lodge and Launch Framework - Guidelines." Securities Commission Malaysia. Accessed June 9,
2023. https://www.sc.com.my/regulation/guidelines/lodge-and-launch-framework.

54
 Close-out netting for financial transactions in Malaysia is covered by the Netting

of Financial Agreements Act 2015 (NFAA), which went into effect in March 2015.

Financial institutions and other players in the financial market employ close-out

netting as a significant risk-management tool in financial derivative transactions and

repurchase transactions. The enforceable nature of close-out netting provides

advantages for credit risk mitigation and mitigation by allowing counterparties to net

out exposures to credit risk rather than having gross risks. This boosts operational

effectiveness and lowers systemic risk to all of the financial system.

The NFAA is also expected to improve Malaysia's financial markets' efficiency

through allowing banking institutions to conduct more aggressive international trade

with foreign counterparties, develop novel banking products and hedging devices,

and encourage the expansion of a vibrant and comparable financial sector.

Furthermore, maintaining remittance systems' high levels of safety, efficiency,

dependability, and integrity is one of the BNM's top responsibilities. The 2011

Money Services Business Act (also known as the Money Services Act 2011) went

into effect that year. While promoting the development of a more vibrant,

competitive, and professional market for money services businesses, which includes

currency-changing, money transfer, and retail currency enterprises, this Act improves

safeguards against laundering money, terrorist funding, and illegal activities. To

guarantee the correct functioning of the money services industry, licensees are

required by this Act to adhere to legal standards such transparency and operational

55
and governance frameworks. According to reports, the Finance Ministry is amending

the 2011 Money Services Act to better monitor and stop unlawful remittance activity.

The BNM released two policy papers for companies with licences under the Money

Services Act 2011 on June 30, 2022. These were the Governance, Risk Management,

and Operations for Money Services Business (MSB), and these replaced 13 of the

current regulations, announcements, and messages and strengthened and laid out the

fundamental requirements to be observed by an MSB to implement sound

governance, appropriate risk management, and strong internal contingencies. The

Agent Oversight Framework for Money Services Business replaced the guideline

previously issued to the Money Services Business.

The BNM published the Guidelines on Electronic Money (the E-Money

Guidelines) in 2008, and these rules will apply to all e-money transactions in

Malaysia38. The BNM must get authorisation before someone can start operating if

they want to issue a specified payment instrument like e-money, according to the

FSA. In order to improve the security and dependability of e-money issuers (EMIs)

and to maintain the public's trust in using e-money, the BNM released a new policy

statement on electronic money (E-Money) on December 30, 2022. This was to be

accomplished by strengthening requirements on several key areas under the new

policy document, including (1) reclassifying EMIs based on the nature of their

business model and risk profile, (2) modifying minimum capital fund requirements to

strengthen the business resilience of the EMIs, and (3) strengthening prudential

38
"Malaysian Payment system" Human Verification. Accessed June 9, 2023.
https://www.bnm.gov.my/overview-on-malaysian-payment-systems.

56
standards on safeguarding of customers' funds, governance, and other management

of operational risks proportionate to the category of EMIs and the potential risk.

Existing E-Money Guidelines were mainly replaced by the new policy, and any

remaining sections will be repealed by 30 December 2023. The new policy reflects

the BNM's recognition of e-money's rising importance in the financial landscape,

which necessitates improvements to the regulatory framework for e-money to

guarantee that it continues to be a secure and reliable payment mechanism.

An individual who wants to offer merchant-acquiring services must also register

with the BNM, according to the FSA. Merchant-acquiring services enable retailers to

accept payment methods for the sale of goods and services to their customers,

whereas acquirers provide the link between consumers of payment mechanisms and

shopkeepers to enable the acquisition of goods or services. When customers use

payment instruments to pay for goods or services, acquirers make sure that the

money is quickly paid to the merchants. rapid developments in the electronic

payment landscape have led to the availability of merchant-acquiring services for

fresh forms of payment such as secure online banking and rapid response (QR)

codes. To regulate this, the BNM published the Merchant Acquiring Services

Guidelines in 2021. The Guidelines describe the effective governance, tracking,

operational risk administration, and technological management that the BNM expects

from registered merchant acquirers.

57
Eight.5 Fraudulent Cases of Financial Reporting

Eight.5.1 Fraudulent classification

In past examinations, several fraud categories have been found from a

number of perspectives. For instance, fraud may be external, when it is done by a

customer or other third parties, or internal, when it is committed by employees or

management. The Malaysian Approved Standards on Accountancy define two

categories of fraud: fraudulent reporting of finances and asset theft 39. Fraud may also

be categorized based on the type of fraud. In a joint report, the Association of

Internal Auditors recognized three types of fraud: accounting and reporting fraud,

property theft, and corruption40.

Financial reporting fraud, which includes the deliberate distortion or omission

of critical information from the company's financial report, is an important type of

fraud. Just 9% of fraud cases. With the average loss of US$1 million, those cases

contained financial statement fraud but also had the most severe financial effects. To

prevent further damage to the company, it is crucial to develop methods for spotting

financial statement fraud at an early stage.

39
Rizkiana Iskandar, Muh. Syahru Ramadhan, M. Ikhwan Mansyuri, and Rizky Ramadhan.
"Determinants of Auditor's Ability to Detect Fraud: Internal and External Factors." International
Journal of Science, Technology & Management 3, no. 1 (2022), 179-195.
doi:10.46729/ijstm.v3i1.452.
40
"COSO Releases Fraud Risk Management Guide: 2nd Edition." Home. Accessed June 9, 2023.
https://www.coso.org/SitePages/COSO-Releases-Fraud-Risk-Management-Guide-2nd-Edition.aspx.

58
Eight.5.2 Fraudulent cases statistic

Significant financial losses as a consequence of fraud might put a company's

viability in jeopardy. Fraud causes organisations to lose 6% of their annual sales. The

numbers below show how frequently and how much money was lost due to three

forms of fraud that ACFE identified between 2015 and 2019. This data shows that

employee fraud and asset theft have been less common over the past few years.

Contrarily, unless severe steps are taken to stop them, corruption and financial

statement fraud have both significantly grown recently and are expected to

continue41.

Like other nations, Malaysia is not immune to the incidence of fraud. During

that period, more documented incidences of fraud had occurred. For the years 2006

and 2007, according to statistics provided by the Securities Commission (SC),

Malaysia, there were 10 and 14 enforcement actions, respectively. According to this

commission's findings for the years 2009 and 2010, there were 18 and 26 incidents of

fraud, respectively42. Fraud caused Malaysian firms' financial performance to decline

by more than 60% (66%) overall. According to KPMG (2013), 89% of respondents

said that the number of fraud instances has increased during the previous three years.

Additionally, data shows that 42% of the recorded fraud occurrences occurred

between RM10,000 and RM100,000. The examined data indicate that fraud is still a

41
Association of Certified Fraud Examiners. "Report to the Nations Archive." Association of Certified
Fraud Examiners. Accessed June 9, 2023. https://www.acfe.com/fraud-resources/report-to-the-
nations-archive.
42
Hasnan, Suhaily, Rashidah A. Rahman, and Sakthi Mahenthiran. "Management Motive, Weak
Governance, Earnings Management, and Fraudulent Financial Reporting: Malaysian Evidence."
Journal of International Accounting Research 12, no. 1 (2012), 1-27. doi:10.2308/jiar-50353.

59
significant problem in Malaysia. To overcome this issue, a practical and relevant

instrument is required43.

Eight.5.3 Fraudulent cases detection

Following the demise of once-reputable businesses like Enron and

WorldCom, financial reporting fraud has become a major concern on a global scale.

Financial reporting fraud falls within the occupational fraud category, along with

asset theft and corruption. It is a fraud scheme in which the perpetrator purposefully

incorporates a significant false statement or absence into the organization's financial

statements. According to the 2020 worldwide study on industrial fraud and abuse,

which looked at 2,504 incidents during January 2018 and September 2019, forged

financial reporting is the least common method (5% of incidences), but the most

costliest category of professional crime. The average loss per case is USD 954,000

(ACFE, 2020). It is described as the first tier of massive losses, in other words. The

great majority of fraud schemes (86% of them) include asset misappropriation, in

which an employee steals or improperly uses the resources of the employing

organisation. Despite this, these schemes result in the lowest median loss of USD

100,000 per instance. The third type of corruption, which includes offenses like

corrupt practices, conflicts of interest, and bribery, lies in the center in terms of

frequency and financial impact. In 43% of cases, this fraud results in a loss of

43
PricewaterhouseCoopers. "PwC’s Global Economic Crime and Fraud Survey 2022." PwC. Accessed
June 9, 2023. https://www.pwc.com/gx/en/services/forensics/economic-crime-survey.html.

60
$200,000 or more. Since all three types of fraud are often overlooked and usually

never reported, it is difficult to determine the exact level of global losses.44.

Before Enron's bankruptcy, incidents of fake financial reporting began to

emerge in Malaysia. The director of Ganad Corporation Bhd committed the first

instance of providing misleading information in 1995. A few additional instances of

this kind emerged in businesses like Kiara Emas Asia Industries Bhd and Chase

Perdana Bhd towards the end of the 1990s. The biggest incidence of this type of

fraud happened between 2004 and 2007 and involved businesses like Transmile

Group Bhd, Welli Multi Corporation Bhd, and MEMS Technology Bhd. Prior to

2007, the Securities Industry Act of 1983 applied to the offences of misleading

financial reporting. When the new Act went into effect on September 28, 2007, the

cases were later charged under the Capital Market and Services Act 2007 (CMSA).

So far, no research has been explicitly undertaken in Malaysia to investigate

the history of the businesses involved in false financial reporting and all of the

effects on both the offenders and the businesses after the fraud was discovered by the

regulator. If this research is not conducted, it will be unknown how the firms

involved in dishonest financial reporting came to be, what effects the fraud had on

the companies once it was discovered, and how the offenders were affected.

Therefore, the purpose of this study is to investigate the history of the firms that

44
Curwen, Lesley. "The Collapse of Enron and the Dark Side of Business." BBC News. Last modified
August 3, 2021. https://www.bbc.com/news/business-58026162.

61
engaged in false financial reporting and the effects on both the offenders and the

companies after the regulator discovered the fraud.

According to the ACFE's definition of fraudulent financial reporting, this

happens when there is a purposeful, intentional misstatement or neglect of material

facts or data from accounting with the intent to deceive and, when taken into account

with all the information provided, would cause the reader to change his or her

judgment in making a decision, typically regarding investments. In other words, false

financial reporting is usually understood to mean that someone intentionally misleads

or deceives someone else. False sales, wrong expenditure recognition, inaccurate

asset valuation, concealed liabilities, and inappropriate disclosures are the five

fundamental components of financial statement fraud45.

Fraudulent financial reporting has drawn increased attention throughout the

general public and global regulators since crime may occur everywhere and is

committed by individuals from all walks of life46. Financial statement fraud,

according to research by Reinstein and others, is a result of internal financial and

morale issues and a weak control environment that favours ineffective auditing

practises47. False financial reporting hurts organisations the most on average, even

45
Zin, Siti F., Marziana M. Marzuki, and Nik K. Abdulatiff. "The Likelihood of Fraudulent Financial
Reporting: The New Implementation of Malaysian Code of Corporate Governance (MCCG) 2017."
International Journal of Financial Research 11, no. 3 (2020), 84. doi:10.5430/ijfr.v11n3p84.
46
Carcello, Joseph V., and Albert L. Nagy. "Audit Firm Tenure and Fraudulent Financial Reporting."
AUDITING: A Journal of Practice & Theory 23, no. 2 (2004), 55-69. doi:10.2308/aud.2004.23.2.55.
47
Reinstein, Alan, Stephen R. Moehrle, and Jennifer Reynolds‐Moehrle. "Crime and punishment in
the marketplace." Managerial Auditing Journal 21, no. 4 (2006), 420-435.
doi:10.1108/02686900610661423.

62
though it happens less frequently than other forms of fraud48. As a result, the public,

the financial sector, and regulatory organisations have given misleading financial

reporting a lot of attention.

The Capital Market and Services Act 2007 (CMSA) is the primary law

governing Malaysia's securities market. According to the CMSA, the Securities

Commission is empowered to bring criminal and civil legal actions as well as

administrative punishments without going through the courts for violations of the

securities laws. A consolidating law known as the CMSA currently includes the

previous Securities Industry Act of 1983, the Futures Industry Act of 1993, and Part

IV of the Securities Commission Act of 1993, which regulates fundraising

operations. The Capital Markets and Services Regulations of 2007, the Licencing

Handbook, and the Guidelines on Regulation of Markets all provide support for the

CMSA. On September 28, 2007, the CMSA, which was approved by Parliament in

May 2007, went into effect. As a result, the CMSA will now be used to prosecute

any publicly traded corporations that engage in deceptive financial reporting.

Eight.5.4 Fraud cases reporting in Malaysia – Bank Sector

Due to the high susceptibility and wide-ranging nature of financial institution

fraud, all banking operations must adhere to the highest standards and recommended

procedures for risk control and internal auditing. Complete compliance within Bank

Negara Malaysia's standards for managing fraud risk is necessary to guarantee that
48
Dalnial, Hawariah, Amrizah Kamaluddin, Zuraidah M. Sanusi, and Khairun S. Khairuddin. "Detecting
Fraudulent Financial Reporting through Financial Statement Analysis." Journal of Advanced
Management Science 2, no. 1 (2014), 17-22. doi:10.12720/joams.2.1.17-22.

63
the possibility of fraud in the banking sector is kept to a minimum. It requires

coordinated efforts from all staff levels, including those of front-line workers and

upper management. Internal control weaknesses in the banking sector are the root

cause of fraud; hence, coordinated efforts to address these weaknesses should be

improved to embrace recent developments in information technology programs, such

as the usage of computerized risk screening systems. In order to combat the

frequency of fraud, banking institutions must always stay one step ahead of

fraudsters since their techniques are becoming more complex.

Due to the underlying nature of banking activities, it is challenging to achieve

zero fraudulent activity in financial organizations. While fraudsters are always going

to discover a way, even the most sophisticated technological solutions cannot

guarantee that fraud is going to be eliminated. Employees of financial institutions

should have their primary duties clearly defined to make them more obvious and

important in combating fraud. To take into consideration the lessons learned from

earlier fraud incidents, financial institution staff members should include

preventative measures into their daily job. Upper management must push for the

requirement that workers do an accurate evaluation of the fraud risk before the risk is

taken on by the financial institutions. Even while each scam is unique in its own way,

the offenders are always clever enough to use the same technique over and over

again.

64
Table 8.1
Examples Of Fraud In Malaysia
Name of Company/ person
Jassie Y Gadong & James R
Connie (Fraud Involving
Remittances)
A Japanese Guy (Fraud
Involving Exchange of
Notes)
Circumstances of the Case
 Two US Treasury Cheques were
accepted by one of the banks, and the
money was deposited into two external
savings accounts.
 The majority of the funds were
removed from both external accounts
via ATM (RM2,000 daily withdrawal
cap). It was determined that the
aforementioned US Treasury Cheques
had been changed.
 Jassie Y Gadong original cheque
amount will be USD 282.50 instead of
US Treasury cheque collected USD
47,282.50
 James R Connie original cheque
amount will be USD 89.50 instead of US
Treasury cheque collected USD
46,589.50
 A Japanese guy who was a walk-in
customer arrived at the bank's counter
and claimed to want to exchange
RM2,900 in cash for RM50 bills.
 After collecting the cash, he made an
attempt to mislead the teller by
claiming that he needed RM50 bills
instead of USD50 bills.
 The client returned back the amount of
cash (which was insufficient) to the
teller after learning that the branch
wasn't accepting transactions in US
dollars. The cash amount of RM2,900
was subsequently given to him by the
teller. When the teller began counting
the returned money, the fraudster
intervened and asked to change RM100
into RM2 and RM100 into RM5
denominations.
65
  He then hurried out of the bank. The
final tally by the teller revealed that
there was RM1,450.00 insufficient.

 The Bersatu Jaya Branch reported a

second instance of a fraudulent
withdrawal using an ATM using the
identical method.
 Information on the event according to
Bersatu Jaya Branch:
o A client complained to the
branch that a guy posing as
bank employee helped him to
Bersatu Jaya Branch report cancel the debit card by phoning
(Fraud Involving ATM) the ATM center on his hand
phone while it was stuck inside
the ATM at the Bersatu Jaya
Branch.
o After requesting that her
passbook be updated after seeing
the strange behavior, they found
out that RM4,000 had been
withdrawn through MEPS four
times.
(Fraudulent Alterations of Modus Operandi of the Scam
Cheques)  Our clients' cheque were either
intercepted or taken. After then, the
payee's name was either deleted by:
 1. removing the cheques' surface using
a scraper, or
 2. These cheques should be soaked in
chemical solutions to remove the ink,
with the exception of the signature area,
to do so. The faces of the cheques were
then updated with new information.
The forged cheques were subsequently
transferred into the fraudster's account
for SPICK clearance.
 The fraudster often deposits the cheque

66
 using CQM or online branches.

Findings
 It is believed that the criminals were
aware of the SPICK clearing method
and had used it to get past the clearing
system's defenses.
 Since the culprits are aware of the
procedure, they often deposit these
cheques using banker's clearing, which
means that depending on where the
cheque was drawn, they may use one
bank to deposit it or another. They
won't deposit a home cheque to avoid
being immediately discovered by the
branch officer who is checking these
cheque.
 When the drawer inquired as to why
the payee had not received money, the
bank first learned about the scam. The
fraudster had already taken away the
money and fled by that point.
(Fraud Involving Housing  A mention is made of the message
Loan) warning bank branches about the rise
in mortgage fraud including falsified
value reports.
 Bank Negara Malaysia advised all
financial institutions to be especially
watchful against fraud perpetration,
underscoring the gravity of the
situation.
 The following home loan scams were
addressed in a Bank Negara Malaysia
circular:
o Borrowers providing incorrect
information and submitting fake
papers, such as fake bank
statements and pay stubs.
o Borrowers who exaggerate the

67
 value of real estate (often condos
and apartments in another
state).
o Direct sales agents hired from
within financial institution staff
were thought to have assisted in
the scams.

68
 CHAPTER NINE
RESULTS AND DISCUSSION

Nine.1 Statistic on awareness of different fraud

In this study, 15 questionnaires were distributed to the respondents, which

contain 5 academician, 5 lawyers and 5 Bankers and there have 12 respondents had

respond to the questionnaires.

Table 9.2

Shows The Most Common Fraud That Occur In Banking Sector.

Fraud
Money Onlin Phon
Respondent financial Signatur
launderin e e
s Industry statemen e forging
g Scam scam
t
Lawyer 1 0 1 1 0
Banker 1 3 1 0 0
Academicia
0 3 0 0 1
n

From Table 9.1, it shows that banker have more aware of Online Scam

compare to lawyer and academician. This might due to nowadays there have a lot of

news that related to online scam. And high security requirements must be adopted by

Malaysian banks, in particular for Internet and mobile banking services, according to

Bank Negara. Other than that, Bank Negara also request those financial institutions

have been told to take additional precautions like switching SMS one-time passwords

(OTP) to a more secure authentication method, tightening detection rules and triggers

69
to block scam-related transactions, requiring a cooling-off period before enrolling

customers in online banking services and secure devices for the first time, and

limiting customers to using a single mobile device or secure device to authenticate

online banking transactions.

Nine.2 Main causes of fraud

From the questionnaire, most of the respondent are pointing out the main

cause of fraud due to lack of awareness, lack of knowledge, lack of competent

security system and bad economic.

Table 9.2

Shows The Main Cause Of Fraud

Securit Bad
Respondent Awarenes Knowledg
y Economi
s Industry s e
system c
Lawyer 2 0 1 0
Banker 0 2 3 0
Academician 0 0 3 1

70
Nine.3 Impact of the fraud

From the questionnaire, it shows that most of the respondents mention that

bank sector fraud will affect the Malaysia Economic directly, and some of the

respondent point out the reasons that will affect the Malaysia Economic due to lack

of confidence from Malaysian and also foreigners.

Table 9.3

Shows Main Impact Of Bank Sector Fraud

Loss of
Respondent Economi
confidenc
s Industry c impact
e to bank
Lawyer 1 2
Banker 1 4
Academicia
4 0
n

71
Nine.4 What is the strategic to compact the financial fraud? And current anti-
fraud measures and strategies employed by Malaysian banks

From the questionnaire, it shows that most of the banker suggest to enhance

the awareness and policy and most of the lawyers suggest to enhance the existing law

to cater the financial fraud issue.

Table 9.4

Shows The Strategic To Compact The Bank Sector Fraud

Enhance
Respondents Enhance Enhance
existing
Industry awareness policy
law
Lawyer 0 0 3
Banker 3 2 0
Academician 2 2 0

One of the respondent from academician, suggest to have frequently send

reminders and educate the users to avoid being scammed and also remove the SMS

PIN function replace with the 6 numbers pin upon online transaction. This will be a

good suggestion for enhance the awareness of the financial fraud.

72
 Current anti-fraud measures and
strategies employed by Malaysian
banks (Sale 1 to 10)
7 3
17% 8% 4
8%

6 5
33% 33%

3 4 5 6 7

Figure 9.1 Current anti-fraud measures and strategies employed by Malaysian

banks

From Figure 9.1, it shows that, there have 16% of the respondents feel that

current anti-fraud measures and strategies employed by Malaysian banks are not

qualified. There have 67% of the respondents feel that the current anti-fraud

measures and strategies employed by Malaysian banks are just passed the qualified

border line. And there have only 17% of the respondents feel that current anti-fraud

measures and strategies employed by Malaysian banks are qualified.

73
Nine.5 Main challenge to help bank sector to combat fraud

From the questionnaire, it shows that main challenge that facing to help on

bank sector to combat fraud are lack of transparency, lack of accountability, lack of

government support, and due to high cost to bank sector on implement a new system

to combat the fraud.

Table 9.5

Shows The Challenges On Bank Sector To Combat Fraud

Lack of
Lack of High cost to
Respondent transparency
government implement new
s Industry and
support system
accountability
Lawyer 2 1 0
Banker 0 5 0
Academician 0 1 3

From table 9.5, it shows that, there all of the bankers feel that, government

must support the bank sector to combat the fraud.

74
Nine.6 Any innovative solutions to help bank sector to combat fraud?

From the questionnaire, there have few suggestion to help bank sector to

combat fraud. Which are implementing higher sentences, enhance the law, creating

AI system to help, enhance policy or system and etc.

Table 9.6

Shows The Innovative Solutions To Help Bank Sector To Combat Fraud

Implementin Enhance Using
Respondents Enhance
g higher policy or AI to
Industry awareness
sentences law track
Lawyer 1 1 0 1
Banker 0 2 3 0
Academician 0 0 4 0

75
Nine.7 Important of establish specialized courts or legal mechanisms dedicated
to handling financial fraud cases in the Malaysian banking sector

From the questionnaire, it shows that it’s important to establish a specialized

courts or legal mechanisms in order to effectively on handling financial fraud cases.

Important to establish specialized courts or legal

mechanisms (Sale 1 to 10)

4
8%
7
17%
10
50%

8
17%
9
8%

4 7 8 9 10

Figure 9.2 Important to establish specialized courts or legal mechanisms

From Figure 2, it shows there have 92% of the respondent suggest to have

specialized courts or legal mechanisms to handling financial fraud cases.

76
77
 CHAPTER TEN

CONCLUSION

Ten.1 Conclusion

The objectives of this study is to find out the most common types of financial

fraud that prevalent in Malaysian banking sector, analysis the causes and

contributing factors, and any policy or legal or any innovative solution to implement

in order to combat financial fraud in Malaysia banking sector effectively.

From previous study, it shows that most of the fraud are physically done by

the criminal. Such as, fraud cheques, fraud at ATM and etc. Nowadays, financial

fraud had started to grow rapidly through online, which is online scam. Besides that

online scam, there still have some traditional financial fraud which are Money

laundering and fraud financial statement for bank loan.

From the questionnaire shows the causes of financial fraud in banking sector.

The main causes of the online scam is because of lack of knowledge and weak

security system. Malaysia have to improve our system and increase Malaysian

knowledge in order to avoid the scam. In other country, they started to have Artificial

intelligent to assist them on banking sector in order to track all the transaction and

investigate the financial fraud from the transaction.

78
 On the other hands, from the questionnaire, it shows that there have there

have only 17% of the respondents feel that current anti-fraud measures and strategies

employed by Malaysian banks are qualified. It proved that, current anti-fraud

measures and strategies are not enough to cater the financial fraud. So, anti-fraud

measures and strategies must be improve from time to time, else our anti-fraud

measures and strategies will eliminate by the generation. Furthermore, financial

fraud will have bad impact to Malaysia’s economic and it will cause loss of confident

from foreign investor. Not only bank sector have to improve their system and

awareness of financial fraud. Government also play the important roles on supporting

bank sector to achieve the goal. Government can support on research and

development in order to get a new system to track the banking fraud.

Due to rapid grow of financial fraud in bank sector. Malaysian bank also have

to catch up the technology. Artificial intelligent should be one of the effective way to

help to detect those financial fraud. Even though there have some people will think

that, artificial intelligent will replace their position and cause they loss of job. But,

artificial intelligent might be one of the innovative way to track all the financial

fraud.

Lastly, many people know that artificial intelligent still have long way to

investigate and it still in research stage. Before artificial intelligent can establish in

Malaysian Banking sector, government have to implement specialized courts or legal

79
mechanisms dedicated to handling financial fraud cases in the Malaysian banking

sector.

80
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84
 APPENDICES

Appendix A
Questionnaire

1. Which background are you come from?

2. How familiar are you with the existing measures and strategies implemented

by Malaysian banks to combat financial fraud (Scale: Not familiar, somehow

familiar, Very familiar)?

3. What are the most common types of financial fraud that you have

encountered or observed in the Malaysian banking sector?

4. In your opinion, what are the primary causes and contributing factors to

financial fraud in the Malaysian banking sector?

5. From your perspective, what are the potential impacts of financial fraud on

the stability and reputation of the Malaysian banking sector?

6. Please provide specific examples of anti-fraud measures or strategies that you

are aware of in the Malaysian banking sector.

7. In your experience, how effective do you believe the current anti-fraud

measures and strategies employed by Malaysian banks are in preventing and

detecting financial fraud? (Scale: 1-10, with 1 being not effective at all and

10 being highly effective)

85
8. What innovative solutions do you think can be adopted to enhance the

prevention and detection of financial fraud in the Malaysian banking sector?

9. From your perspective, what are the main challenges or limitations faced by

Malaysian banks in effectively combating financial fraud?

10. How important do you believe it is to establish specialized courts or legal

mechanisms dedicated to handling financial fraud cases in the Malaysian

banking sector? (Scale: 1-10, with 1 being not important at all and 10 being

highly important)

86
 Appendix B
Data of questionnaire

1. Which background are you come from?

Respondents No.
Industry Respondent
Lawyer 3
Banker 5
Academician 4

2. How familiar are you with the existing measures and strategies implemented

by Malaysian banks to combat financial fraud (Scale: Not familiar, somehow

familiar, Very familiar)?

Respondent Not Very

Familiar
s Industry familiar Familiar
Lawyer 0 1 2
Banker 0 0 5
Academician 0 1 3

87
 3. What are the most common types of financial fraud that you have

encountered or observed in the Malaysian banking sector?

Securit Bad
Respondent Awarenes Knowledg
y Economi
s Industry s e
system c
Lawyer 2 0 1 0
Banker 0 2 3 0
Academician 0 0 4 1

4. In your opinion, what are the primary causes and contributing factors to

financial fraud in the Malaysian banking sector?

Securit Bad
Respondent Awarenes Knowledg
y Economi
s Industry s e
system c
Lawyer 2 0 1 0
Banker 0 2 3 0
Academician 0 0 3 1

5. From your perspective, what are the potential impacts of financial fraud on

the stability and reputation of the Malaysian banking sector?

Loss of
Respondent Economi
confidenc
s Industry c impact
e to bank
Lawyer 1 2
Banker 1 4
Academicia 4 0

88
n

6. Please provide specific examples of anti-fraud measures or strategies that you

are aware of in the Malaysian banking sector.

Enhance
Respondents Enhance Enhance
existing
Industry awareness policy
law
Lawyer 0 0 3
Banker 3 2 0
Academician 2 2 0

7. In your experience, how effective do you believe the current anti-fraud

measures and strategies employed by Malaysian banks are in preventing and

detecting financial fraud? (Scale: 1-10, with 1 being not effective at all and

10 being highly effective)

Current anti-fraud measures and

strategies employed by Malaysian
banks (Sale 1 to 10)
7 3
17% 8% 4
8%

6 5
33% 33%

3 4 5 6 7

89
 8. What innovative solutions do you think can be adopted to enhance the

prevention and detection of financial fraud in the Malaysian banking sector?

Implementin Enhance Using

Respondents Enhance
g higher policy or AI to
Industry awareness
sentences law track
Lawyer 1 1 0 1
Banker 0 2 3 0
Academician 0 0 4 0

9. From your perspective, what are the main challenges or limitations faced by

Malaysian banks in effectively combating financial fraud?

Lack of
Lack of High cost to
Respondent transparency
government implement new
s Industry and
support system
accountability
Lawyer 2 1 0
Banker 0 5 0
Academician 0 1 3

90
10. How important do you believe it is to establish specialized courts or legal

mechanisms dedicated to handling financial fraud cases in the Malaysian

banking sector? (Scale: 1-10, with 1 being not important at all and 10 being

highly important)

Important to establish specialized courts or legal

mechanisms (Sale 1 to 10)

4
8%
7
17%
10
50%

8
17%
9
8%

4 7 8 9 10

91