Act II: Following a successful master plan, a new sector blueprint aims high

The Financial Sector Master plan 2001-10 for Malaysia, written in the wake of 1997-98 crisis and focusing on stability, achieved almost all its goals. The banking sector was consolidated and the country was left with eight sound and solid institutions. Corporate governance and prudent controls were emphasised so Malaysia would not again face the dangerous mismatch of currencies and maturities that had threatened it before. Bond markets were overhauled so the banks would no longer be involved in financings that were better left to the capital markets. The master plan was tested during the 2008 financial crisis and the sector emerged relatively unscathed. Under the master plan, the sector evolved, improved and most of all thrived, growing an average of 7.3% a year.

THE NEXT LEVEL: The Financial Sector Blueprint 2011-20, released by Bank Negara Malaysia, the central bank, on December 21, 2011, seeks to build off this foundation and take the banking system to the next level. The document approaches banking, and all financial activities, in less of a sector-based manner and instead has a more integrated view. In seeking to facilitate greater market participation, liberalisation, regional trade and finance, the blueprint acknowledges banking and finance do not operate in a vacuum and are very much part of the real economy. The recommendations are made not only to improve banks, brokerages and exchanges, but to do so with an eye to achieving the country’s larger goal under the Economic Transformation Programme (ETP), inaugurated in 2010, of making Malaysia into a high-income economy by 2020.

In calling for liberalisation, the blueprint does not set hard limits, but recommends a case-by-case approach. It calls for the country to be able to adjust policy to maximise the benefit to the local banks and finance industry, allowing more foreign participation when that would provide competition and technology useful to the domestic market, and less foreign involvement when that participation from abroad could be potentially harmful for domestic industry players within Malaysia.

A report on the blueprint by the country’s central bank has nine focus areas and makes a total of 69 recommendations. They run the gamut from highly granular – the development of mobile “public key” infrastructure – to a general call to “introduce greater operational flexibility for financial institutions subject to appropriate safeguards”. The recommendations cover all points along the value chain, from retail branches to wholesale banking needs.

STABILITY: Stability remains an area of focus, much as it was in the old master plan. The blueprint calls for a codification of standards with respect to boards and directors, so that their responsibilities to all stakeholders are clearly defined, and calls for the clarification of some roles, including company secretary. It also envisions creating a pool of independent directors formally trained to take positions on the boards of financial companies. The blueprint also suggests that retail deposits should be ring fenced so they cannot be harmed by bad bets made elsewhere in an institution.

Importantly, the central bank is to be given increased powers to request and access information.

The central bank’s report delves into the cross-border elements of risk, and recommends developing the industry mindful of the dangers of capital flows and contagion. It also calls for the establishment of market information systems to evaluate the strengths and weaknesses of counterparties and for a common platform for information exchange with other jurisdictions regarding products and services.

One move the plan contemplates is the creation of common standards with other regulators and the possibility of new regional supervisory networks for banks across ASEAN. Cross-border collateral and liquidity (specifically currency swaps with other central banks) are among the document’s other subjects.

INNOVATION: Compared to the master plan, the blueprint calls for increased risk taking. To help the market continue to develop, the central bank hopes to permit speculative (and, admittedly, potentially dangerous) products, instruments and activities. While hedge funds are not currently being discussed, “funds of funds” are, as is direct access to the wholesale financial markets for corporations. A broadening of securities borrowing and lending and short selling are recommended, and foreign participation on the onshore foreign exchange derivatives market by non-residents without underlying trades or investments is one of the main points. Other types of currency-related innovations are on the list of recommendations, including the development of Malaysia as a regional centre for both foreign and domestic treasury operations.

The blueprint also devotes significant attention to discussing the needs and interests of the retail consumer. It notes that their financial health is key to the overall stability of the system, and conversely that their participation in the market is key to the liquidity and health of the financial system itself. Education and training are among the highlighted areas of focus, and finance-related coursework in the school curriculum is now being contemplated. Plans also include the expansion and improvement of credit reporting and sharing, as well as the creation of a more powerful ombudsman for the sector. While in Malaysia banking penetration is already high, the central bank is now placing new priority on convenience, efficiency and cost effectiveness. This includes more banking channels, at post offices, retail outlets and gas stations, and the increased used of electronic devices for finance. The plan is to quadruple the number of electronic transactions made by the average Malaysian, while cutting the number of cheques used in the system by 50%.

CONSUMER LEADERSHIP: The Malaysian consumer is seen as the new driver of growth. It is hoped that their spending will reduce the country's dependence on exports and oil revenues and drive the re-balancing the economy. To that end, the central bank will encourage the banks to help in the development of more advanced industries. The thinking is that these industries will provide higher-paying jobs, which will result more consumer spending. The blueprint emphasises these connections and the relationship between finance and the rest of the country’s economy.

As in the master plan, the development of Islamic finance is important in the blueprint. The central bank wants to see it go from 29% of the financial sector to 40%. As with conventional banking and capital markets, the emphasis is on more sophisticated products and services. Bank Negara is encouraging the development of sharia-compliant hedging instruments, sharia-compliant repo transaction products, sharia-compliant real estate investment trusts and sharia-compliant insurance as risk-management tools.

The central bank would also like to see the introduction of socially responsible investment principles as part of the Islamic product mix. With these innovations, and with a continued push for common international standards, the central bank is hoping Malaysia will become an undisputed global reference centre for Islamic finance, confirming its status as the apex hub for sharia-complaint banking in the region.

REGIONAL & GLOBAL: The blueprint continues the international agenda established by the master plan and takes it a step further. It talks of the creation of cross-border payment and settlement networks and the development of cross-border liquidity arrangements. Liberalisation is also discussed.

The blueprint envisions more joint ventures with foreign financial institutions, in particular with firms experienced in areas such as project finance. It also further recommends allowing foreign locally incorporated banks the right to open more branches, more non-banking outlets and to engage in more non-banking businesses, such as hire purchase. The plan argues for allowing foreign banks in to the extent that their expertise or resources directly benefit Malaysia or its banks.

In that sense, the blueprint runs the risk of stopping short. Liberalisation is central to the plan but in the end may be somewhat half-hearted and cosmetic. While equity limits might be lifted and branch restrictions might be increased, all of the mentions of these things in the report remain both speculative and conditional, with no blanket support offered for open markets.