Malaysian Banks and the Current Meltdown - (Based on findings till 24 January 2009)
Initially I was planning to start another blog to post all the MBA reports and essay as well as all the best practices, and learnings I've experienced through my RMIT - MIMS Inti MBA Executive (Part Time) MBA. But then life is always busy busy, and if I procastinate too long, the topics I wrote about might even get out-dated. :p . Furthermore some of the work below e.g. as the one below, is very much related to Penang and Malaysia, so it deserves a post in fyi-penang.blogspot.com wouldn't you say? Anyway, below is my individual report for the Core Course, Global Business Context (GBC). Hope you find this useful, and do leave any comments of what you think of this report. Note I submitted this report on 24 January 2009, so information would be only latest till around that time. This is my personal understanding and study of the recession and its impact, and is in no way a recommendation or advice. -Lukman
HOW THE FINANCIAL MELTDOWN IS GOING TO IMPACT FINANCIAL INSTITUTIONS IN MALAYSIA
TABLE OF CONTENTS
Executive Summary
1. Introduction
1.1. Aim of the Report
1.2. Overview of the Financial Sector, specifically in Malaysia
2. Globalization and the Financial Meltdown
2.1. Understanding the Financial Meltdown
2.2. The ASEAN 1997 Financial Crisis
3. Country Analysis
3.1. Trade Interdependence: Commodity Exporter & Manufacturing Dependent
3.2. The Financial Sector: Over-leveraged?
4. The Regulatory Environment 10
5. Scenario Analysis (Anticipating Change)
5.1. The Average Case
5.2. The Worst Case
5.3. The Best Case
6. Strategy - Foreign Banks Strategizing in Malaysia
7. Innovation - Islamic Banking
8. Conclusion
9. APPENDIX
9.1. Appendix 1: Malaysia Monthly Trade Performance 2007-November 2008.
10. REFERENCE
FIGURES
Figure 1: Malaysia Exports by Destinations, January – November 2008
Figure 2: Malaysia Federal Government Finance, 1985-2008.
Figure 3: Malaysia Financial and the Scenarios 2015
Figure 4: Islamic Banking as % of total Banking Assets by Country
Executive Summary
Malaysian financial institutions, both local and locally incorporated foreign banks managed to come out of the ASEAN (Association of South East Asian Courtiers) 1997 crisis, alive but battered. Lessons were learnt, steps taken and regulations setup to avoid a recurrence. Now the financial meltdown spurred by the banks in USA, has put this institutions through their toughest test yet.
The Malaysia economy is highly dependent on exports and many of its trading partners have entered or nearing recession. Besides the already existing pressure on the financial institutions due to the meltdown, the potential fall of the economy and exports will further strain the financial institutions. The strong reserves and manageable debt of Malaysia will be vital to the survival of the country and institutions.
Regulations in place by Bank Negara Malaysia (BNM) ensuring all banks are locally incorporated and execute prudent financial practices will play an important role in ensuring the financial stability locally. These regulations have also been a factor in determining the strategy implemented by foreign banks to operate in Malaysia, giving it benefits of both worlds, having its strong brand and network while insulating itself from the quandary of its parent company.
The scenario analysis concludes three possible scenarios, an average scenario is expected to be most plausible where Malaysian financial institutions manage to weather the turmoil with strong support from BNM and the government, in time for the world economies and banks to slowly recover.
There exists innovation opportunities in the sector to implement key principles from the Islamic finance in the conventional banking, renewing the eroded credibility of institutions world wide.
Finally it is concluded that Malaysia and its financial sector will suffer from the meltdown however to a lesser effect considering the strong fundamentals and prudent financial practices.
1. Introduction
1.1. Aim of the Report
This report will look into the financial institutions in Malaysia and evaluate how they will fare in the current financial meltdown. A global business context view is discussed to assess the above statement.
1.2. Overview of the Financial Sector, specifically in Malaysia
Crane (1995) states from the most aggregated level, six core functions are performed by the financial system:
Clearing and settling payments to facilitate trade
Provide a mechanism for the pooling of resources and for the subdividing of shares
Transfer economic resources through time, across borders, and among industries.
Provide ways of managing risk.
Provide price information to help coordinate decentralized decision-making in various sectors of the economy
Provide ways of dealing with the incentive problems
Bank Negara Malaysia (BNM), the central bank for Malaysia was established on 26 January 1969. The local banking sector comprises of commercial banks, finance companies, merchant banks, discount houses and money brokers which are licensed under the Banking and Financial Institutions Act 1989 (BAFIA) and supervised by BNM (Bank Negara Malaysia 2008a).
Meyer (1999) summarizes central banks as having two core missions; pursuit of monetary policy to achieve broad macroeconomic objectives as well as the maintenance of financial stability, including the management of financial crisis, where the latter is closely connected to regulation and supervision of the banking system.
In 1997 the 36 banks went through a merging process, and as of 2004, the domestic banking institutions were reduced to 25 (Dr. Zeti 12 November 2007).
2. Globalization and the Financial Meltdown
Nayyar (2006) comments there are three manifestation of the globalization phenomenon; international trade, international investment and international finance. It is these factors that will play a major part in deciding its impact to the financial institutions in Malaysia.
2.1. Understanding the Financial Meltdown
Summarizing the financial meltdown into 3 stages, firstly with creditors fleeing from the sub-prime debt in summer 2007 due to large losses, secondly with the Bear Stearns Securities crisis in March and extended through the bailout of mortgage giants caused mainly due to investment banks evolving into proprietary trading houses with large illiquid securities, and given sufficient panic, it becomes impossible to roll over their short term loans. The third stage, with the bankruptcy filing on Lehman Brothers Holdings Inc and the ‘rescue’ of AIG, further eroded confidence. Combined with lax reaction from the Fed and inconsistency, fuelled a run from all entities that might fail, even if they appear solvent. Subsequently the collapse of a fund market and pending lapse of others sent the U.S Treasury into crisis mode. Now the shock waves have spread quickly throughout the world (Johnson 2009).
2.2. The ASEAN 1997 Financial Crisis
Abdelal & Alfaro (2003) argue that Malaysia’s success in applying capital controls during the ASEAN 1997 recession is due to 3 critical factors, being Bank Negara had a high level of foreign exchange reserves, Malaysia had relatively little external debt and finally the links between public authorities and the financial system were deeply institutionalized. These factors will be used as a basis to evaluate the financial sector’s current standing against the meltdown.
3. Country Analysis
Two major points need to be studied in the Malaysia analysis with reference to interdependent and integrated world economy. Firstly is the trade with the world and secondly is the interdependence and integration of the financial sector itself with external forces.
Johnson (2009) observes that while wealthy nations like USA can use their wealthy balance sheets to shore up banks many countries will find this impossible, as happened in the emerging markets after 1997-1998, the withdrawal of credit can lead to steep recessions and major internal disruptions. He further argues that four set of countries stand to lose the most;
• The over-leveraged; i.e. banks and countries that over-borrowed heavily.
• The commodity-dependent exporters especially oil and other major commodities that have dropped in price.
• The extremely poor, e.g. Sub Saharan Africa.
• China, being heavily dependent on manufacturing.
3.1. Trade Interdependence: Commodity Exporter & Manufacturing Dependent
Based on Figure 1 Singapore, USA, Japan and China are Malaysia’s largest customers. USA has already gone into recession, followed by Singapore. China is seeing a slowdown in growth. It short, most of Malaysia’s main trading partners are going through a rough time, and will definitely impact exports and business.
Figure 1: Malaysia Exports by Destinations, January – November 2008
Source : (Ministry of International Trade and Industry Malaysia 2009)
Referring to Appendix 1, Malaysia’s monthly trade performance has started to dip since Sep 2008 and is not expected to recover in the near future. A drop in exports translates into a number of issues, including local business making losses due to lower exports and revenue, thus potentially leading some to default on loans, turning into Non Performing Loans (NPL) and finally go into bankruptcy. This will impact financial institutions due to a higher NPL ratio, and lower liquidity. Consequently, banks will be more stringent in disbursing loans, making credit availability tighter.
3.2. The Financial Sector: Over-leveraged?
Hendrickson (2008) mentions Dr. Zeti, the governor of BNM explains that in the current crisis, the impact on Asian countries is volatility in financial markets—in the stock market and the foreign exchange market as there is a deleveraging process by the international financial institutions going on and as a result, they are liquidating assets all over the world because of their increased demand for dollars.
Hendrickson (2008) further comments that Thailand which was the flashpoint for the ASEAN 1997 crisis, has improved NPL ratios, and are shielded against liquidity strain in the international market, with local deposits funding accounting for about 86% of total liabilities. In other countries like Indonesia, concerns begin to exist; where Dollar liquidity is under strain after the Rupiah fell to a 10 year low in late November 2008. This is just the beginning of the meltdown, and it would be expected that the strain will continue to grow.
Malaysia’s Official Reserve Assets as of January 2009, was RM317.2 billion, equivalent to USD91.5 billion (Bank Negara Malaysia 2008b). Compared to between RM56 - 59 billion in February 1998, six months before the capital controls were put in place (Abdelal & Alfaro 2003). Next the external debt; in the 1997-99 crisis, more than 50 percent of Korea’s and Thailand’s external debt had been short-term before the crisis began, only one quarter of Malaysia’s had been (Abdelal & Alfaro 2003). At end of 2007, Malaysia’s short term debts were still less then 30%, i.e. RM54.4 Billion out of a total external debt of RM187.4 billion (Economic Planning Unit Prime Minister's Department Malaysia 2008).
Figure 2: Malaysia Federal Government Finance, 1985-2008.
Source : Economic Planning Unit Prime Minister's Department Malaysia (2008)
However an important distinction this time round, (Figure 2) is Malaysia has an overall budget deficit estimated at RM21.6 Billion in 2008 verses during the 1997 crisis, Malaysia had a small budget surplus.
Country analysis shows a mix of positive and negative events.
4. The Regulatory Environment
The regulatory environment will either help or worsen Malaysia’s capability to cope with the meltdown. A number of important regulatory requirements for financial institutions in Malaysia were induced by the recessions it had gone through previously. Malaysia is a member of the World Trade Organization (WTO) which has called for the liberalization of the financial sectors from 2003 (Shanmugam & Nair 2004).
Daquila (2007) summarizes that following the ASEAN crisis, BNM implemented various controls aimed at strengthening prudential regulation and supervision, including greater transparency in monetary operations, increased requirements for capital adequacy ratios, and re-classification of NPL from six to three months.
Another important regulation enforced in 1994 for foreign banks in Malaysia, is the revoked authorization of foreign banks to operate in Malaysia unless they are locally incorporated (United States Trade Representative 2006). An interesting positive impact of this regulation is now evident; with major losses reported by parent foreign banks yet the locally incorporated banks did not suffer. Citibank Berhad (the locally incorporated Citibank) issued circulars to its customers stating that the bank is locally incorporated and regulated by BNM and as such is subject to all prudential and other requirements applicable to commercial banks in Malaysia (Nanavati 2008).
After understanding the causes of the economic meltdown propagated by USA in 2.1, it is clear that the rules and regulation set in the USA were too loose and was not well regulated. The discussion above highlights the regulations that have been placed by BNM which would potentially prevent or at least minimize similar issues or faults in the local institutions.
5. Scenario Analysis (Anticipating Change)
A short-medium term scenario analysis is conducted based on two focal questions that have the ability to impact the outlook of Financial Institutions in Malaysia. The focal questions are relevant to both the external implications especially happenings in ASEAN and in Malaysia in particular. :
• Will the Malaysian government, BNM and local institutions be able to govern effectively, spur the local economy and financial sector with appropriate but wise fiscal and lending policies?
• Will the economic meltdown continue to worsen or head towards improvements? Also how this will impact the ASEAN nations in specific. The domino effect during the 1997 crisis points towards significant dependence on these neighbouring countries.
Baig & Goldfajn (1998) conclude that their correlations on the Asian crises suggest during a period of financial market instability, shocks originating from one market readily get transmitted to other markets, thus becoming a source of substantial instability.
Three different paths for the Malaysian financial institutions are depicted in Figure 3, represented by progress through the defined focal questions.
Figure 3: Malaysia Financial and the Scenarios 2015
5.1. The Average Case
(a) 2009-2012: In a continued downturn of world economies and further bailouts of financial institutions in USA and Europe, the region’s economy is shaky. Lessons learnt and steps taken from the 1997 crisis prove to be useful in minimizing the impact to Malaysian banks to a certain extent. BNM policies and close collaboration with banks keeps the financial sector alive. Continued government spending helps avoid an economic halt.
(b) 2013-2015: Major economies remain stagnant but do not collapse. Weaker ASEAN countries with low reserves and export dependent begin to go further into recession. Trade between world economies and ASEAN countries continue to decline. Prudent spending by the Malaysian government helps keep the economy moving while maintaining acceptable levels of reserve. Smaller banks are forced to file for bankruptcy due to low financial reserves and further deleveraging. A number of banks merge to increase capital and the government takes over NPLs to avoid a further collapse of the institution. BNM maintains it policy of low interest rates. The economy survives but at a slow rate.
5.2. The Worst Case
(a) 2009-2012: The government’s efforts to inject capital and increase fiscal spending help sustain the economy. However this is not enough to spur growth and counter the world wide economic recessions. ASEAN economies start to tumble leading to higher default on loans, forcing banks to declare losses. The government continues to try to maintain the economy by lowering interest rates and increase spending. BNM policies to reduce interest rates and encourage borrowing ends up awry with more NPL loans.
(b) 2013-2015: The world economy and financial sectors continue to collapse, specifically USA, China and India. ASEAN countries are badly hit. Trading within ASEAN and world economies reach an all time low. The government has used up most of its foreign reserves to spur the local economy. Debt has grown, further made worse by a continued trade deficit. Middle term loans mature and put more pressure on the public and private sector, forcing the Malaysian economy to collapse and many banks declare bankruptcy.
5.3. The Best Case
(a) 2009-2012: The government’s fiscal policy to stimulate the economy succeeds. BNM lowering the interest rates spurs spending and borrowing, keeping the momentum going. Banks have enough liquidity and manage to give out loans, with a maintained low ratio of NPL. Public and private institutions having not over-leveraged on short term loans manage to maintain liquidity and a healthy cash flow. In the ASEAN region, even with the continued recession world-wide, intra ASEAN trade is healthy. ASEAN governments, banks and financial institutions have in-place good governance, transparency, and strong financial reserves to weather the turmoil.
(b) 2013-2015: A stable region enhances customer confidence and spending while investments grow. The world economies and financial institutions start to show positive growth with new improved regulations and practices. Trade with non-ASEAN countries specifically USA and China reach new highs.
Based on the research and analysis, the average case is most likely to happen due to governments around the world specifically China, USA, EU and Malaysia have started to implement stimulus packages and bank deposit guarantees avoiding a great depression. Malaysia should be able to sustain itself with the current foreign reserves until the world’s economy starts to pickup.
The best case scenario is deemed unlikely due to even though having prudential measures in place, the Malaysian economy is highly dependent on exports, and the meltdown will impact exports, subsequently the economy and business, which will then cascade to the financial sector. Furthermore the impact of the current meltdown is significant, making it unlikely for all economies to recover by 2013.
The worst case scenario is also not highly plausible as the short term debt is manageable and the foreign reserves are significantly higher then the debt. BNM also has a proven track record to steer the financial institution to survive and succeed in a recession. At least some of the major economies should be able to recover by 2013, helping improve exports and raise the economy to sustainable levels.
6. Strategy - Foreign Banks Strategizing in Malaysia
Considerations are made to identify strategies to assist in global expansion, mainly to lower costs of value creation, differentiate the firm’s product or service offering and / or penetrate new markets. Four main strategies can be considered, being International, Global, Transnational and Multi-Domestic.
It is making best of these strategies that for example enabled Citibank to make significant profits in Malaysia even though losing money in USA. However in the same notion of global expansion some Malaysian banks, namely Maybank made losses while trying to expand into Indonesia due to inadequate research on the regulations there.
Generally most banks expanding globally are transnational (Lovelock 1999), but then due to Malaysian law requiring banks to be locally incorporated, banks would need to consider the multi-domestic strategy. In similar considerations, Ennew & White (2006) argue that it is difficult for financial service providers to be truly global because regulatory regimes vary across countries and limit the extent of true standardization. Perhaps HSBC’s motto itself provides an explanation to their strategy, i.e. ‘The World’s Local Bank’. Simply put, foreign banks operating in Malaysia try to maintain their global brand name and network benefits, but localize the company setup and tailor the services to the given market.
Gunasegaram (2008) points out foreign banks that strongly resisted the local incorporation regulation by Bank Negara, are now benefiting during the current meltdown as they must maintain capital funds here thus avoiding capital flight from local investors as well as enjoying Bank Negara’s blanket guarantee of deposits on all banks operating in Malaysia.
In short, the ‘forced’ regulation by Bank Negara, has helped foreign banks to strategize optimally in the Malaysian market, benefiting from existing experience and brand name, yet being insulated from its parent company to a certain extent, as well as not having to fear local customers’ reaction to its parent company’s predicament.
7. Innovation - Islamic Banking
An incremental innovation for the conventional banking sector would be to take a deep look into the principals of Islamic banking. Currently both have distinct different rules, regulations and ethics. It could be said that Islamic banking provides financial services while maintaining compliance with Sharia, the Islamic legal code and maintains lower risks therefore presumably lower returns.
Per Figure 4, Islamic banking is already growing in Malaysia on two bases, one is conventional banks offering an Islamic banking window e.g. HSBC Amanah, and the other is full fledged Islamic banks for example Bank Islam Malaysia Bhd.
Figure 4: Islamic Banking as % of total Banking Assets by Country
Source : Benaissa, Jopart & Tanrikulu (2007)
Presumably Islamic Banking emerged due to the ‘demand-pull’, spurring entrepreneurship to tap this segment while providing a social obligation to the growing desire of many Muslim to conform to Sharia in their day-to-day activities.
In a fresh perspective, maybe it is time to innovate. Conventional banking can innovatively study the benefits and basics of Islamic banking which can be a check and balance to avoid banks from over leveraging and taking high risks as witnessed in the current meltdown. One important point for innovation in conventional banks would be to consider a key requirement in Islamic banking for the creation of a large number of products is that financial instruments must be founded on a physical transaction, such as the underlying sale and purchase of a commodity (Benaissa, Jopart & Tanrikulu 2007). Some might argue this is the basis of any prudent financial management, but due to lack of specific regulations calling this out in conventional banking; banks tend to be over exposed in expectations of higher returns. It has been discussed that this was one of the factors of the meltdown.
Customers who prefer conventional banking but expect a new set of assurance can be targeted, likened to Hamel’s ‘concept innovation’ where companies create different business models compared to previous practices (Hamel 2002). It is interesting to note that even though many international banks including Citibank have started Islamic banking operations, the notion is still new in many countries including its parent country, USA.
Recently a tiny Michigan Bank is getting attention in the industry by turning profit on loans without even charging interest, its specialty being financial products that comply with Islamic law. That means no collecting interest, no short selling and no contracts that are considered exceedingly risky. Mentioned also is that it rules out some of the activity that got Western finance in trouble – subprime mortgages, credit default swaps and the like. It further goes to clarify though, that there is no guarantee that banks will find immunity in Islamic finance from a severe global downturn quoting Afaq Khan the head of Saadiq, the Islamic banking arm of Standard Chartered Bank “I am not doing banking on Mars” (Karoub & Abbot 2009)
In short, there is clearly room for innovating in the conventional banking sector, as well as growing the existing Islamic finance to cater to a larger market.
8. Conclusion
It is clear that the economical and financial challenges will keep on growing as globalization continues. Interdependence and integration will be the norm of the day, and it will depend on how well Malaysia prepares itself with strong fundamentals and diversification to avoid catching a flu when the world sneezes. Robert Shiller, a leading finance professor at Yale University, proposed for a super cross-country macro-hedge, suggesting that government and its agencies should diversify GDP growth, state welfare and state pension internationally (Poon 1999). This would reduce regional dependence and diversify funds. While there exists opportunities for innovation, prudent regulations are necessary to guarantee a healthy structure of financial institutions. Finally it is expected that Malaysia and its financial sector will suffer from the meltdown due to its interdependence on world and ASEAN economies, however to a lesser effect considering the strong fundamentals and prudent financial practices.
9. APPENDIX
9.1. Appendix 1: Malaysia Monthly Trade Performance 2007-November 2008.
Source : Ministry of International Trade and Industry Malaysia (2009)
10. REFERENCE
Abdelal, R & Alfaro, L 2003, 'Capital and Control: Lessons from Malaysia', Challenge, vol. 46, no. 4, pp. 36-53.
Baig, T & Goldfajn, I 1998, 'Financial Market Contagion in the Asian Crisis', International Monetary Fund Working Paper, vol. 98, no. 155.
Bank Negara Malaysia 2008a, The Financial Sector Masterplan, Bank Negara Malaysia, Publication Sales Center, BNM.
---- 2008b, International Reserves and Foreign Currency Liquidity, BNM, viewed 19 Jan 2009,
.
Benaissa, N-E, Jopart, X & Tanrikulu, O 2007, 'Rethinking regulation for Islamic banking', The McKinsey Quarterly: The Online Journal of McKinsey & Co.
Crane, DB, Bodie, Z, Froot, KA, Mason, SP, Perold, AF & Merton, RC 1995, The Global Financial System, Harvard Business Press.
Daquila, TC 2007, The Transformation of Southeast Asian Economies, Nova Publishers.
Dr. Zeti, AA 12 November 2007, 'Governor's speech at the Sir Purshotamdas Thakurdas Memorial Lecture - "Managing Financial Liberalisation and its Challenges: Implications for Emerging Economies"', paper presented to Sir Purshotamdas Thakurdas Memorial Lecture, Mumbai, India, 12 November 2007.
Economic Planning Unit Prime Minister's Department Malaysia 2008, The Malaysian Economy in Figures - 2008, EPU, viewed 15 January 2009, .
Ennew, C & Waite, N 2006, Financial Services Marketing: An International Guide to Principles and Practice, Butterworth-Heinemann.
Gunasegaram, P 2008, 'When local banks are safer', The Star, 20 December 2008.
Hamel, G 2002, Leading the Revolution, Harvard Business Press.
Hendrickson, D 2008, 'Revamping regulators', Asian Banker Journal, no. 84.
Johnson, S 2009, 'Confidence, Tricked', MIT Sloan Management Review, vol. Winter Issue 2009, viewed 20 January 2009, .
Karoub, J & Abbot, S 2009, 'Finance the Islamic way at Michigan Bank', The Joplin Globe, 13 January 2009.
Lovelock, CH 1999, 'Developing marketing strategies for transnational service operations', Journal of Services Marketing, vol. 13, no. 4/5, pp. 278-95.
Meyer, LH 1999, 'Lessons from the Asian Crisis: A Central Banker's Perspective', paper presented to Ninth Annual Hyman P. Minsky Conference on Financial Structure, Instability, and the World Economy, April 1999.
Ministry of International Trade and Industry Malaysia 2009, 2008 Trade Statistics, MITI, viewed 22 January 2009, .
Nanavati, S 2008, viewed 22 January 2009, .
Nayyar, D 2006, 'Globalisation, history and development: a tale of two centuries', Cambridge Journal of Economics, vol. 30, pp. 137-59.
Poon, S-H 1999, 'Malaysia and Asian Financial Crisis; A View from the Finance Perspective', African Finance Journal, Special Issue.
Shanmugam, B & Nair, M 2004, 'Mergers and Acquisitions of Banks in Malaysia', Managerial Finance, vol. 30, no. 4, pp. 1-18.
United States Trade Representative 2006, Malaysia Trade Summary, USTR, 2009, .
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