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CHAPTER 1
Introduction & Overview of
Financial System
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Financial stability
• financial system plays a critical role for
intermediation process to function efficiently
• It facilitates the flow of funds between savers and
borrowers  efficient allocation of financial
resources for economic growth and development
• Financial stability: a condition where financial
intermediation process functions smoothly and
there is confidence in the operation of financial
institutions and financial markets
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Importance of financial stability

• to support efficient allocation of resources and
distribution of risks across the economy
• Instability of a financial system  a costly spillover
effects to the economy and lead to financial crisis with
adverse economic consequences
• BNM’s  to promote a sound and efficient financial
system by preserving the soundness of financial
institutions and strong financial infrastructure
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… continue
BNM’s role and responsibilities in the financial
system therefore is:
•To regulate and supervise financial institutions
•To ensure a reliable major payment and
settlement system
•To contribute to the development of efficient
financial markets
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Financial System
• a mechanism where funds can flow effectively
from the surplus units to the deficit units
• monitored closely by a supervisory authority to
ensure rules and regulations are followed
• needs three important components that
complement each other:
a) the financial institutions
b) the financial instruments
c) the provider and user of funds.
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Flow of Funds – Financial System

Cash Cash

USER
Financial PROVIDER
of funds Institutions of funds

Financial Instruments Financial Instruments

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… continue
• Fin. Institutions  provide the location, acts as
an intermediary
• Fin. Instruments  the vehicles/tools
• Providers and users of funds  determine the
amount available and needed
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FINANCIAL SYSTEM
Financial Institution Financial Market
Banking System Money & Forex Market
 BNM Capital Market
 Banking Institutions  Equity Market
 Other Institutions  Bond Market
Non-bank Fin Intermediaries Derivatives Market
 Dev. Fin. Inst. (DFIs) Offshore market
 Provident Pension Fund
 Insurance Companies
 Savings Institutions
 Other Institutions
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The banking system

a) Central banker – BNM
 acts as regulator and supervisor
 objectives:
 Issue currency/keep reserves
 Banker and adviser
 Promote monetary stability
 Influence credit situation
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… continue
b) Banking Institutions
i) Commercial bank (Conventional)
ii) Islamic banks
iii) Investment Banks
 provide banking facilities and services to
meet financial needs of participants
 main contributors of assets in the financial
system
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… continue
 BNM encourage merger – leads to lesser
but stronger banks being established
 in 2003 - 23 banks (local and foreign), 2
Islamic full fledged banks, 11 finance
companies and 10 merchant banks
 BNM made significant changes in
financial structure
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significant changes in financial structure:

(a) the merger of finance companies with

commercial banks
(b) the formation of investment banks
(c) the issuing of more licenses by BNM
(including to foreign institutions) to establish
Islamic banks
Thus, in June 2010, there are 23 commercial
conventional banks, 18 Islamic banks and 15
investment banks
Now 2020 – 26 conventional,
- 16 Islamic,
- 11 investment bank
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Effect of significant changes

• the concept of one-stop center banking system
- all services (banking/insurance/investment) in
one place (including retail services)
• Creating a stronger and more focus investment
banks to compete internationally; to better
service the capital market
• Towards becoming an Islamic financial hub in
the region
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Non-Bank Financial institutions (nbfis)

• NBFIs are part of the financial institutions in the
intermediation process; the movement of funds
from the surplus to the deficits units
• Their roles are specialized in nature such as
pension fund, providing insurance business,
promoting economic activities for economic
development, credit institution, and others
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Examples of NBFIs
• Development Finance Institutions (DFIs)
• Savings Institutions (Bank Simpanan Nasional)
• Provident and Pension Funds (EPF)
• Insurance Companies
• Housing Credit Institutions
• Cagamas Berhad
• Pilgrims Fund Board (Lembaga Tabung Haji)
• Leasing, Factoring and Venture Capital
Companies
• Unit trust funds
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Development Finance Institutions (Dfis)

• Bank Pembangunan Malaysia Berhad
• Bank Perusahaan Kecil & Sederhana Malaysia
Berhad (SME Bank)
• Export-Import Bank of Malaysia Berhad
• Bank Kerjasama Rakyat Malaysia Berhad
• Agrobank (Bank Pertanian Malaysia)
Savings Institutions:
• Bank Simpanan Nasional
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Other NBFIs
• Malaysian Industrial Development Finance
Berhad
• Credit Guarantee Corporation Malaysia Berhad
(CGC)
• Lembaga Tabung Haji
• Sabah Development Bank Berhad
• Sabah Credit Corporation Berhad
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Provident and Pension fund

• An institution to safeguard savings of members and
provide future benefits upon retirement, death or
disabilities
• Examples EPF, Pension Trust Fund, Social
Security Organization, Armed Forces Fund,
Malaysian Estates Staff Provident Fund and
Teachers Provident Fund
• Main source of fund  deductions from
employees/employers; return on investment
• Main use investment in securities, withdrawals
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Insurance companies
• institutions that provide financial coverage to
policyholders in the event of death or loss of
property
• Main source of fund: a sum of money (or
premium) paid by policyholders
• Main use: invest in securities, claims, financing
to corporations
• 2 types: life and general insurance
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Dev. Fin. Institutions (DFIs)

• Institutions that provide capital for industrial, agriculture,
commercial or other economic development (specialized in
nature)
• to support development in strategic and new growth area,
complement the financial service in meeting the national
policies
• Examples:
Bank Pembangunan, SME Bank, Agrobank, Bank Rakyat
• Besides financing, DFIs provide managerial and technical
assistance
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Sources of funds of DFIs

• Sources mainly comprised of borrowings and
shareholders funds
• Borrowings include deposits from public,
government, BNM, foreign institutions; specific
funds from government to finance shipping
industry (Bk Industri) or funds for ECR scheme
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Uses of funds of DFIs

• Loans and investment
• Loans increased due to active participation in
government policy to finance the priority sectors
• Sectors – agriculture, manufacturing, real estate,
construction, transport
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Financial intermediation
• The ‘middlemen’ in the exchange of financial
assets
• To facilitate the movement of funds among users
and demanders of funds
• Basic function – obtain funds from surplus unit
and allocate to deficit units
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Financial intermediation
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Benefits of financial intermediation

• well diversified portfolio of depository or investment
instruments
• more options of borrowing, financing or advances at
lowest possible prices
• reliable information of instruments - such as level of
safeties or liquidity
• act as advisor to participants to utilize the instruments
• offer products/services through virtual banking or
internet banking
• identify the actual provider and users of funds through
effective banking network
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Commercial bank
• ‘an institution that carries on the business of banking’
• the business of banking is defined as ‘the business of:
▫ Receiving deposits;
▫ Paying or collecting cheques;
▫ Provision of finance; and
▫ Such other business as BNM, with the approval of the
Minister, may prescribe’
(BAFIA 1989)
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Banking functions of commercial banks

• Retail banking services

• Trade finance facilities
• Treasury services
• Cross border payment services
• Custody services
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Bank’s balance sheet

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Investment banks
• Providing services for the corporate sector – corporate
advisory, management services and ’wholesale’ lending:
- loan syndication
- management of consortium loans
- corporate advisory services
- underwriting services
- portfolio management
- stock-broking services
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Islamic banks
• Provide services that conform to the shariah
• Establishment of Bank Islam (1983) under the
Islamic Banking Act 1983
• Similar types of products and services with
conventional except that these products are
according to shariah  (i) operations not based
riba and (ii) fairness in the distribution of wealth
• Significant increase in number of Islamic banks
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Money Market
 a market for the movement of short term funds
 to meet the liquidity requirements of market
participants
 2 categories:
(i) direct placement of funds and
(ii) the sale and purchase of securities (financial
instruments)
 participants  BNM, commercial banks,
investment banks and offshore banks
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Examples of Money Market financial

instruments
• Bankers Acceptances (BAs)
• Negotiable Instruments of Deposits (NIDs)
• Treasury Bills (TBs)
• Cagamas Bonds/Notes
• government investment certificates (GICs)
• other short-dated government securities
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Foreign Exchange market

• a market for the buying and selling of foreign
currencies to meet the foreign currency
requirements of corporations which can either
be exporters and/or importers
Participants  BNM, commercial banks, Islamic
banks, multinational corporations and money
brokers (as the intermediaries)
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Capital market
• consist of (i) equity market and (ii) bond market
where the focus is more on the long term basis of
trading of instruments
• Equity market provide means of raising of funds
by corporations by issuing stocks and shares
(Initial Public Offerings - IPOs) and also the
trading of shares in the secondary markets
• Bursa Malaysia  Main Market & ACE market
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… continue
• Bond Market - a place where private and public
sectors can raise funds by issuing private and
government debt securities
• Divided into two:
i) Government bonds – MGS, TB, GII, BNB,
commercial papers, MTN
ii) Corporate bonds (private debt securities –
PDS)
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Offshore market
• establishment of Labuan International Offshore
Financial Centre in 1980
• Provides a wide range of offshore products in
foreign currencies such as banking, insurance,
trust business, fund management, Islamic
financing and company management services
• Deals in currencies other than Malaysian
ringgit
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Derivatives market
• the trading of instruments such as futures,
options, swaps and forwards
• instruments that derived its value from the
movement of price/rate of some underlying
assets such as interest rates, foreign exchange,
commodity and index
• use to hedge against price and interest rates
volatility and for speculative purposes