Bank Negara Malaysia

G E N E R A L

I N F O R M AT I O N

Bank NegaraMalaysia

A consumer education programme by:

1 Introduction

2 Formation of Bank Negara Malaysia

Objectives of Bank Negara Malaysia

3 Monetary stability

7 Financial stability

10 Developmental role

13 Payments system

14 Other responsibilities of Bank Negara Malaysia

16 The organisation of Bank Negara Malaysia

con

ten

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Disclaimer

This document is intended for your general informationonly. It does not contain exhaustive advice or information relating to the subject matter nor should it be used as a substitute for legal advice.

Date: 21 January 2003

The role of a

central bank is entrusted with

Bank Negara Malaysia

Introduction

Most countries have established central banks as the monetary authority to oversee the financial system and the economy. While central banks maydiffer in terms of structure and modus operandi, they share the commonresponsibility of maintaining monetary and financial stability. For others,its responsibility extends to the development of the financial infrastructureand participating in the overall economic development of the nation.In Malaysia, the role of the central bank is entrusted with Bank NegaraMalaysia.

The role and function of Bank Negara Malaysia, its operations and activitiesare described in this booklet.

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FORMATION OF BANK NEGARA MALAYSIA

The Central Bank of Malaya Ordinance1958 (CBO) (Central Bank of Malaya untilthe formation of Malaysia in 1963) wasenacted on 23 October 1958, while theCentral Bank of Malaysia was establishedon 24 January 1959. At the same time, theBanking Ordinance, 1958, which providedfor the licensing and regulation of thebusiness of banking in the Federation ofMalaya also came into force. The CBO wasrevised in 1994 and is now the CentralBank of Malaysia Act 1958 (CBA).

OBJECTIVES OF BANK NEGARA MALAYSIA

The objectives of Bank Negara Malaysia asoutlined in the CBA are:

• To promote monetary stability and a soundfinancial structure

• To act as a banker and financial adviser tothe Government

• To issue currency and keep reservessafeguarding the value of the currency

• To influence the credit situation to theadvantage of the country

Over the years, the roles and responsibilitiesof Bank Negara Malaysia have evolved and expanded. Today, Bank NegaraMalaysia focuses on the three pillars ofcentral banking, namely monetary stability,financial stability and the payments system.In addition, importance is given to thedevelopmental role of Bank NegaraMalaysia, in respect to economicmanagement, institutional building andthe development of the financial system.

Monetarystability

refers to the stabilityof the value of the

Malaysian currency,the ringgit

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MONETARY STABILITY

As the country's monetary authority, BankNegara Malaysia is responsible to maintainmonetary stability. Monetary stability refers to the stability of the value of theMalaysian currency, the ringgit. The bestway to ensure that the value of the ringgit ispreserved is by ensuring price stability, thatis, to ensure that inflation in the countryremains low and stable. By maintainingmonetary stability through appropriatechanges in monetary policy, Bank NegaraMalaysia ensures that inflation is kept lowand that the purchasing power of theringgit is not diminished.

Why is monetary stability so important?

It is important because when there ismonetary instability, prices are either rising(inflation) or falling (deflation) and this canresult in distortions and undermine thelong-term economic growth prospects ofthe country.

If inflation is too high, people will beconcerned about the purchasing power oftheir money balances. This would result ina greater demand for real assets likehouses and properties, which are thoughtto be more "inflation-proof". There wouldbe less interest to invest in productivecapacity of the economy. Similarly, saverswould be less inclined to hold savings inthe financial system if they expect that thevalue of their savings would be diminished.Fixed income earners will find that they areable to buy less goods and services and willexperience a reduction in their standard ofliving. High inflation would also makeexports more expensive to foreigners andthis would reduce the competitiveness ofthe exports. Persistently high inflation wouldtherefore reduce the growth potential ofthe economy.

Similarly, when the rate of inflation isnegative, prices are falling and businessesfind their profits shrinking. They mayreduce their costs by cutting expenditure

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and laying off staff. Workers in turn wouldhave less money to spend and thus reducespending, resulting in a further reduction inthe demand for goods and services. Thiscreates a vicious circle of falling prices andcontracting demand resulting in a contractionin the level of overall economic activity.

When there is price stability, the futurevalue of savings and the future returns oninvestments are preserved. This gives saversthe incentive to save while investors havegreater confidence to undertakeproductive activities. Increased investmentleads to an increase in the productivecapacity of the economy and increasedeconomic activity leads to new job creation.Therefore, by maintaining monetary orprice stability, it creates a conduciveenvironment that allows the economy toexpand in a sustainable manner at close toits potential.

Bank Negara Malaysia conducts itsmonetary policy by influencing the level ofinterest rates that borrowers have to pay ontheir loans and that depositors earn on their

deposits. When the economy is overheatingand the threat of inflation is high, monetarypolicy will be tightened by withdrawingfunds from the banking system and raisinginterest rates. The higher interest rates willencourage people to save more and spendless. It would also make it more expensivefor people to borrow money. This will causeconsumption and investment to slow downto a level that is more sustainable andreduce the prospect for high inflation.Conversely, when economic conditions areweak, funds will be injected into thebanking system to reduce interest rates.With lower interest rates, spending andborrowing would increase. The resultingincrease in consumption and investmentwould stimulate further economic activity,leading to higher income, employment andeconomic growth.

Bank Negara Malaysia has a number ofmonetary instruments at its disposal toinject and withdraw funds to influence the level of interest rates in the financialsystem. Examples of these instrumentswould include the purchase and sale of

When there is

pricestability

the future value ofsavings and the

future returns on investments

are preserved

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Bank Negara Malaysia and MalaysianGovernment papers, changes in the statutoryreserve requirements and direct lendingand borrowing in the interbank market.

Malaysia is one of the most open economiesin the world. This means that theperformance of the Malaysian economy issignificantly influenced by developmentsoutside its borders. The economicperformance of Malaysia's trading partnerswould affect the demand for Malaysia'sexports. By maintaining a low inflation raterelative to our trading partners, monetarypolicy contributes to making Malaysiangoods competitive internationally.

Bank Negara Malaysia also manages theforeign exchange reserves of the country to ensure that Malaysia is able to meet itsinternational obligations, therebycushioning any temporary shifts in inflowsand outflows in Malaysia's balance ofpayments and thus promote a stable andfundamentally sound ringgit exchange rate.The exchange control policies in Malaysiaare directed at ensuring the stability of the

BANK NEGARA MALAYSIA

Economic Growth/Inflation

Bank Reserves(Liquidity)Money SupplyConsumer &

Business Spending

Interest Rates

Exchange Rate

How Bank Negara Malaysia’s Monetary Policy Affects the Economyand Inflation

MonetaryOperations

When Bank Negara Malaysia wants to STIMULATE the economy

When Bank Negara Malaysia wants to CONSTRAIN the economy

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ringgit as well as encouraging the use of thecountry's financial resources for productivepurposes. There is generally free movementof funds into and out of the country subjectto certain prudential regulationsadministered by Bank Negara Malaysiaunder the Exchange Control Act 1953.

To effectively manage the financial andeconomic conditions, Bank NegaraMalaysia collects data and informationabout the domestic economy, the financialsystem and the international environment.Economists at Bank Negara Malaysiaanalyse these developments to provide the assessment which becomes the basis for the policy making process. The sourcesof information are diverse and includepublications of a wide range of domesticand international agencies and regulardialogues with various groups from theprivate sector. An important source ofinformation is also from the financial sector.Being able to monitor closely the activitiesof the financial institutions allow BankNegara Malaysia to monitor efficiently theimpact of its policy measures.

BankReserves

BankReserves

EconomicActivity

EconomicActivity

EconomicGrowthBelow

Potential

InflationToo High

InflationVery Low

EconomicGrowth

ExceedingPotential

Short-termInterest Rates

Short-termInterest Rates

Loans

Loans

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FINANCIAL STABILITY

Financial stability refers to an environmentwhere institutions in a financial system arestrong and can continue to meet theircontractual obligations without interruptionor without any external assistance. Marketparticipants can also confidently enter intotransactions at prices that do not changesubstantially over short periods when therehas not been any changes in marketfundamentals.

Why is financial stability important?

Financial stability creates a conduciveenvironment for businesses to undertaketheir activities and for savers and investorsto enter into short-term or long termcontracts.

As the financial sector has a central role in promoting economic growth, it isimportant that the financial system isstrong, resilient and efficient in mobilisingsavings and undertaking lending activities.It is vital that this intermediation process

continues uninterrupted even in periodsof economic difficulties.

As the nation's regulatory authority, one of the fundamental roles of BankNegara Malaysia is to develop a soundbanking system that responds to thechanging needs of the economy andsociety, a system that is made up ofstrong and resilient financial players andwell-functioning financial markets. In the context of preserving financialstability, Bank Negara Malaysia has alsobeen entrusted to regulate and developthe insurance sector to be an effectivemobiliser of long term savings andprovide wide range of insurance productswhile protecting the interest of policyowners. The overall objective of financialstability has been achieved not onlythrough the formulation of strong legal,regulatory and supervisory framework,but also through the development andstrengthening of new institutions andsystem infrastructure.

Financialstabilitycreates a conduciveenvironment for businesses toundertake theiractivities and forsavers and investorsto enter intocontracts

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Developing the

institutions and market

infrastructure are part of Bank

Negara Malaysia’sdevelopmental role

Bank Negara Malaysia's regulatory andsupervisory role was extended in 1988when the insurance industry was broughtunder the supervision of Bank NegaraMalaysia. Recently, this regulatoryoversight was further extended to sixdevelopment financial institutions withthe enactment of the DevelopmentFinancial Institutions Act in 2001. Inaddition, a separate legislation wasenacted to protect the financial sectorfrom being used as a conduit for moneylaundering activities. The Anti-MoneyLaundering Act (AMLA) came into force inJanuary 2002 and Bank Negara Malaysiawas appointed as the competent authorityto implement the national anti-moneylaundering programme.

Regulatory rules are complemented withregular examinations of financialinstitutions and their close monitoring.The on-site and off-site supervision of allfinancial institutions under the purview ofBank Negara Malaysia is a vital process in

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Regulatory rules have been continuouslyenhanced with the adoption ofinternational standards to instil appropriaterisk management system to enablefinancial institutions to undertake theirintermediation function effectively. Theenactment of new laws such as the Bankingand Financial Institutions Act in 1989 andthe Insurance Act in 1996 has enhancedBank Negara Malaysia's regulatory authorityover the financial system. Similarly, theenactment of the Islamic Banking Act in1983 has given Bank Negara Malaysiaadditional mandate to supervise new typesof institutions, namely the Islamic banks. Inaddition, to avoid widespread failure andmaintain public confidence in the financialsystem, particularly the banking system,Bank Negara Malaysia also extends thelender of last resort facility (wherebybanking institutions in need of funds couldcome to Bank Negara Malaysia to sell theirsecurities) to assist banking institutions indealing with short-term liquidity problems.

DEVELOPMENTAL ROLE

As a central bank in an emerging economy,Bank Negara Malaysia has an importantdevelopmental role. This role ranges fromdeveloping the necessary institutions andmarket infrastructure for the developmentof a modern and strong financial system tocontributing to the strengthening of thefoundation of the economy. In strengtheningthe financial market infrastructure, Bank Negara Malaysia has built a strongpayment systems. These systems areregularly "upgraded" to address the impactof technology on the banking system. To promote a good credit culture amongbanking institutions, Bank Negara Malaysiaalso operates the Central Credit ReferenceInformation System. The first of its kind inthis region, this system collects anddisseminates credit information on allborrowers. This allows banking institutionsto make informed decisions on loanapplications.

ensuring financial stability. Bank NegaraMalaysia adopts the risk-based supervisionapproach, whereby financial institutionsare assessed and monitored based on riskprofiles and adequacy of risk managementsystems. Pre-emptive strategies areformulated to address any adverse trendor weakness that could threaten thestability of an individual financialinstitution or the financial system as awhole. The supervisory framework iscontinuously enhanced in line withchanges in the economic environment.

Bank Negara Malaysia also maintains close relationship with supervisors in othercountries to ensure that developmentsabroad, especially in countries whereMalaysia has a banking presence andcountries of foreign banks in Malaysia,would not threaten the stability of theMalaysian financial system.

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On the institutional front, Bank NegaraMalaysia plays a significant role inestablishing new institutions. Specialisedinstitutions that were set up to fill gaps inthe financial system were the CreditGuarantee Corporation Malaysia Berhad(CGC) and the National Savings Bank (to meet the needs of small borrowers) andBank Industri dan Teknologi MalaysiaBerhad (to provide financing for capitalgoods exports and development of theshipping industry). In developing thecapital market, Bank Negara Malaysianurtured the group of brokers into theNational Malayan Stock Exchange and laterthe Kuala Lumpur Stock Exchange.Deepening the capital market wasachieved through the setting up of theNational Mortgage Corporation (Cagamas),and later the Securities Commission toregulate capital market activities. BankNegara Malaysia played an instrumentalrole in setting up the Labuan OffshoreFinancial Services Authority (LOFSA) tosupervise the offshore financial sector and

Bank NegaraMalaysia is entrusted with therole of ensuring that the paymentssystem of thecountry is

stable andoperatessmoothly

today, plays a catalytic role in expandingthe scope of its activities.

Bank Negara Malaysia had also played anactive role in designing the mechanism todeal with the impact of the Asian financialcrisis in 1997-98 involving the setting up of Pengurusan Danaharta Nasional Berhadto purchase bad loans from financialinstitutions, Danamodal Nasional Berhad torecapitalise banking institutions, and theCorporate Debt Restructuring Committeeto restructure large corporate debts. BankNegara Malaysia was also instrumental indesigning and implementing the selectiveexchange control measures introduced in September 1998. The aim of the controlswas to insulate the Malaysian economyfrom the instability in the internationalfinancial markets and restore stability in the ringgit exchange rate. The stabilityaccorded by the controls allowed forsuccessful implementation of various pro-growth measures and accelerated thefinancial sector restructuring process.

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Moving forward, the task of maintainingfinancial stability would become morechallenging. Bank Negara Malaysiarecognises the need to be well positionedto manage the forces of change broughtabout by globalisation, liberalisation, morevolatile global financial markets and therapid advances in information technology.All of these are expected to have majorimpact on the financial system. The key is totake early actions in solving any emergingproblems, keeping the right balancebetween the multiple functions of ensuringmonetary stability and the regulatory anddevelopmental role. A clear vision anddirection for the development of financialsector is necessary for this purpose. It is forthis reason that Bank Negara Malaysia haslaid down a 10-year masterplan in 2001 forthe development of financial sector thatprovides the blue print for the futurelandscape for the sector and recommendsmeasures to be undertaken to develop anefficient, dynamic and resilient financialsector that would be able to meet therequirements of the changing economy.

As the financial system becomesincreasingly diversified and integratedwith the international financial systemsover recent years, the task of maintainingfinancial stability has also called for thecontinuation of the role of Bank NegaraMalaysia in economic development.In the more recent period, greater attentionis being accorded to the development ofsmall-and medium-sized enterprises (SMEs).To enhance the contribution of SMEs, Bank Negara Malaysia produced acomprehensive report on strategies fordevelopment of SMEs to the Governmentin 2002. In addition, various funds havebeen established by Bank Negara Malaysiato promote the development of selectedsectors of the economy. Alternative modes of financing such as venture capitalare being developed to support thedevelopment of new growth areas. The need to maintain financial stability,therefore, goes hand-in-hand with theneed to have balanced economic growthand development.

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PAYMENTS SYSTEM

The payments system is an importantpart of the financial system. It providesa means of transferring funds betweenparties and for commercial transactionsto be conducted effectively andefficiently. Bank Negara Malaysia isentrusted with the role of ensuring thatthe payments system of the country isstable and operates smoothly.

Why is the smooth functioning of thepayments system important?

Any failure of a financial institution tosettle its obligations in a timely mannerwould result in spillover effects, resultingin other financial institutions not beingable to settle their financial obligations.

Bank Negara Malaysia has the importantrole of ensuring the safety and efficiency of the payments system. Bank NegaraMalaysia therefore:

• Oversees the payments system. Thisincludes formulating policies andguidelines to regulate the paymentssystem

• Operates the payments system. BankNegara Malaysia operates the real timegross settlement system (RENTAS) andthe cheque clearing system (SPICK)

• Facilitates further development of thepayments system. Bank Negara Malaysiaencourages the payments industry toadopt best practices, internationalstandards and cutting edge technologiesin enhancing the payments system

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of the country. Based on these assessments,Bank Negara Malaysia presents policyrecommendations at regular briefings tothe Minister of Finance as well as atvarious economic policy making forums atthe national level.

Role of financial adviser

Bank Negara Malaysia does not providefinancing to the Government. However, as the financial adviser to the Government,Bank Negara Malaysia gives regular adviceto the Government on the management of its domestic and external debts and theterms and timing of Government loanprogrammes. Bank Negara Malaysia alsoact as the agent for the Government innegotiations and concluding of loanagreements. Bank Negara Malaysia is alsoresponsible for trading, registering,settlement and redemption of Governmentsecurities through its computerised systems(RENTAS, FAST and BIDS).

OTHER RESPONSIBILITIES OF BANK NEGARA MALAYSIA

Bank Negara Malaysia serves as theeconomic and financial adviser to theGovernment and also participates ininternational meetings to strengthen co-operation with other countries as wellas to discuss the important issues from the perspective of emerging marketeconomies.

Role of economic adviser

In its role as the economic and financialadviser to the Government, Bank NegaraMalaysia analyses and assesses thedevelopments in the international anddomestic economy and highlights theareas that need to be addressed. BankNegara Malaysia undertakes economicintelligence and surveillance and carriesout forecasts on the economic condition

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International Relations

Bank Negara Malaysia also participates in a number of international meetings.Amongst them are the meetings of theSouth-East Asian Nations (ASEAN). ASEAN +3 (which includes China, Koreaand Japan), South-East Asian CentralBanks (SEACEN), Executive Meeting ofEast Asia and Pacific (EMEAP), the Asia-Pacific Economic Co-operation (APEC)and the international agencies includingthe Bank for International Settlements.

The participation in the meetings are to strengthen co-operation with theinternational and financial community in key areas such as surveillance,macroeconomic management andmeasures to enhance financial stability. It is to bring key issues which areimportant from a national or regionalperspective to the forefront in order thatMalaysian interests and interests ofemerging market economies are givendue consideration.

Bank Negara Malaysia

serves as the economicand financial adviserto the Government

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THE ORGANISATION OF BANK NEGARA MALAYSIA

Bank Negara Malaysia is a statutory bodywhich is wholly owned by the FederalGovernment. It started operations in1959 with a paid-up capital of RM20million which has since increased to itspresent level of RM100 million in 1977.

The constitution, functions, duties andpowers of Bank Negara Malaysia are setout in the CBA. The administration ofBank Negara Malaysia is organised tomeet its principal objectives, with clearlines of responsibility. The Governor ofBank Negara Malaysia is also the chiefexecutive officer and the Governor isassisted by two Deputy Governors andfive Assistant Governors. The CBAprovides that the Governor shall beappointed by the Yang di-Pertuan Agongand the Deputy Governors by theMinister of Finance.

Bank Negara Malaysia is required to have a Board of Directors under the CBA. Like

any other board of directors of a privateorganisation, the Board is entrusted withthe responsibilities of setting the policydirection of Bank Negara Malaysia andthe general administration of the affairsof the Bank. The CBA requires the Boardof Directors to inform the Minister ofFinance of the monetary and bankingpolicies pursued or intended to bepursued by it.

There are eight members on the Boardof Directors. The ex-officio members ofthe Board are the Governor, the DeputyGovernors and the Secretary-General to the Treasury. The other directors arepersons of standing and experience inbanking and economic affairs. Allmembers except the Deputy Governorsare appointed by His Majesty, the Yangdi-Pertuan Agong and hold office for a maximum term of three years but areeligible for reappointment. TheGovernor is the chairman of the Boardand the Board is required to meet atleast once a month.

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