An extract from The Banking Regulation Review, 11th Edition

Prudential regulation

i Relationship with the prudential regulator

From a corporate governance perspective, the Acts codify the duties of the directors of financial institutions, and place stringent requirements for transparency on the directors of financial institutions and their holding companies. Directors are required to disclose to the board of directors the nature and extent of any direct or indirect interest in a material transaction or material arrangement with the financial institution where they hold office. Further, under the Acts, the approval of the BNM is required for the appointment, election, reappointment and re-election of the chairperson, directors and chief executive officer of a financial institution.

In addition, the Acts provide that the BNM has the power to specify fit and proper requirements to be complied with by the chairperson, directors, chief executive officer and senior officers of a financial institution and, in the case of Islamic financial institutions, members of the shariah committee. The requirements may include minimum criteria relating to probity, personal integrity and reputation; competency and capability; and financial integrity. The BNM has complete discretion in determining whether the fit and proper requirements specified have been complied with.

The aforementioned RBS approach is primarily implemented by the BNM through the adoption of risk profiles, best practices, sound governance and proper risk management systems within the internal oversight process of each institution with the objective of anticipating and managing future risks; and identifying and resolving weaknesses within the processes of each institution. The BNM further facilitates the RBS approach by ensuring the quality of the membership of directors and senior management of financial institutions, inculcating a culture of workforce risk management and ethics, and reliance on the opinion of independent audit and actuarial professionals appointed by financial institutions.

To further ensure the proper division and coordination of their respective legislative responsibilities in respect of investment banks in particular, the BNM and the SC jointly issued the Guidelines of Investment Banks pursuant to Section 126 of the BAFIA (now repealed) and Section 158 of the SCA. The Guidelines specifically provide that the BNM will be responsible for the prudential regulation of investment banks to ensure safety and soundness in the interests of depositors, and that the SC will be responsible for the business and market conduct of investment banks to promote market integrity and investor protection in the capital market.

The BNM also has stringent fit and proper tests, which are set out in further guidelines contained in the Fit and Proper Criteria of June 2013 issued under the FSA, which should be read together with the Corporate Governance guidelines issued in August 2016 (the CG Guidelines). The BNM also issued Fit and Proper Criteria in June 2017 for the DFIs, as prescribed under the DFIA.

The CG Guidelines are applicable to, inter alia, banks, investment banks, Islamic banks and financial holding companies (i.e., companies approved by the BNM to hold more than 50 per cent of the shares of a licensed financial institution), and set out the minimum standards of corporate governance that the BNM expects local financial institutions to adopt, which are consistent with the long-term viability of the aforesaid institutions.

Based on the fundamental concepts of responsibility, accountability and transparency, the CG Guidelines contain provisions that set out management and audit oversight, accountability and transparency together with key responsibilities of the board of directors and senior management of financial institutions. Overall, the CG Guidelines seek to encourage a corporate culture that reinforces ethical, prudent and professional behaviour, beginning with the example to be set by the board and senior management of the core values of a financial institution. Similar guidelines have been issued that are applicable to DFIs.

ii Management of banks

Further to the foregoing, the CG Guidelines require boards of directors of banking institutions to establish specialised board committees to oversee critical or major functional areas, to address matters requiring detailed review or in-depth consideration, and to be responsible for the decisions of those committees. These specialised committees help to discharge the functions of the board and comprise the following, as set out in the CG Guidelines:

  1. a nominations committee responsible for the following matters concerning the board of directors, senior management and company secretaries:
    • board appointments and removals;
    • the overall composition of each group;
    • measures for evaluation of the performance and development of directors, senior managers and company secretaries; and
    • fit and proper assessments and evaluations;
  2. a remuneration committee responsible for reviewing the remuneration of directors, and actively overseeing the design and operation of remuneration systems of financial institutions;
  3. a risk management committee responsible for formulating risk management strategies that include identification of the nature of and exposure to risks involved in banking, and methods used to identify, monitor, manage and control each risk, and the nature and frequency of evaluation procedures of risk management systems;
  4. an audit committee to provide independent oversight of the internal and external audit functions and internal controls, and ensuring checks and balances within the financial institution; and
  5. in the case of Islamic financial institutions, a shariah committee to provide oversight on shariah compliance.

In addition, the aim of the CG Guidelines is to ensure that risk-taking activities and business prudence are appropriately balanced so as to maximise shareholders’ returns and protect the interests of all stakeholders, and they contain principles dealing with board matters, management oversight, accountability and audit and transparency.

The CG Guidelines should be read together with the Acts, the CA and other relevant regulations, guidelines and circulars relating to corporate governance that the BNM may issue from time to time.

iii Regulatory capital and liquidity

The Acts provide that the BNM has the power to prescribe standards on prudential matters (including liquidity and capital adequacy) to be complied with by financial institutions to promote the sound financial position of an institution, and the integrity, professionalism and expertise in the conduct of the business, affairs and activities of an institution. Pursuant to such powers, the BNM issued the liquidity coverage ratio (LCR) framework in August 2016 as per Basel III requirements (see below), which provides that banking institutions must maintain sufficient stock of high-quality liquid assets (HQLA) to withstand an acute liquidity stress scenario for a 30-day horizon at both the entity and consolidated levels. The LCR framework, which took effect on 25 August 2016, supersedes the LCR guidelines issued on 31 March 2015 and the Liquidity Framework and Liquidity Framework issued in July 1998, and provides that banking institutions shall hold, at all times, an adequate stock of HQLA such that it maintains a minimum LCR of 70 per cent, achieved by January 2016, rising to 100 per cent by January 2019 and thereafter. In addition, banking institutions are required to comply with the framework at: (1) their respective entity and global operational level on a stand-alone basis; and (2) a consolidated level, which includes both (1) and the consolidation of all subsidiaries, except for insurance and takaful subsidiaries. As at the end of 2019, all banking institutions reported LCR levels of above the 100 per cent minimum ratio.

In addition to the Acts, the CBA provides that for the purpose of conducting monetary operations, the BNM may require financial institutions to deposit a reserve with it, and prescribe the principles and method for the determination of that reserve. Pursuant thereto, in January 2016, the BNM issued the Statutory Reserve Requirement Guidelines, which came into effect in February 2016 for the purpose of liquidity management, whereby financial institutions (conventional and Islamic) are required to maintain a statutory reserve requirement (SRR) balance in their statutory reserve accounts equivalent to a certain proportion of their eligible liabilities, this proportion being the SRR rate (currently 2 per cent). In this case, eligible liabilities comprise ringgit-denominated deposits and non-deposit liabilities, net of interbank assets and placements with the BNM, subject to the adjustments, exclusions and deductions prescribed under the SRR rules. In the past, and in addition to the SRR, Malaysian financial institutions were required to set aside a percentage of their profits as buffers under the repealed Banking and Financial Institutions Act 1989. The BNM announced in May 2017 that these buffers were no longer needed with the phasing-in of the Basel capital conservation buffer. Instead, financial institutions must maintain a set minimum amount of capital funds at all times. It is now possible for the existing reserve funds to be distributed as dividends, which was not possible previously. On 19 March 2020, the BNM announced that the SRR ratio will be lowered by 10 basis points from 3 per cent to 2 per cent, effective from 20 March 2020. In addition, each principal dealer is able to recognise Malaysian Government Securities and Malaysian Government Investment Issues of up to 1 billion ringgit as part of the SRR compliance. This flexibility to the principal dealers is available until 31 March 2021. These combined measures will release approximately 30 billion ringgits’ worth of liquidity into the banking system. The BNM also updated the policy document on Statutory Reserve Requirement on 27 March 2020.

The Acts also provide that a financial institution may only be licensed if its capital funds are equal to or exceed the minimum amount prescribed by the Minister. Pursuant thereto, the BNM issued the Guidelines on Capital Funds and the Guidelines on Capital Funds for Islamic Banks in 2013 (updated in 2017) to ensure that financial institutions maintain a minimum amount of capital to operate and perform their functions.

The Guidelines on Capital Funds provide that the minimum capital funds that must be maintained by commercial banks and investment banks are as follows: for a domestic bank (by itself or in aggregation with its related corporation that is a licensed investment bank), 2 billion ringgit; for a locally incorporated foreign bank, 300 million ringgit; and for a stand-alone investment bank, 500 million ringgit. Under the Guidelines on Capital Funds for Islamic Banks, banking entities are required to maintain 300 million ringgit as a minimum capital fund.

In December 2010, the Basel Committee on Banking Supervision (Basel Committee) finalised a package of measures to strengthen global capital and liquidity rules with the goal of strengthening the resilience of the global banking system. The rules are detailed in the documents Basel III: A global regulatory framework for more resilient banks and banking systems (revised) and Basel III: International framework for liquidity risk measurement, standards and monitoring (collectively, Basel III).

The BNM issued a circular implementing Basel III in 2010 that set out its approach to incorporating elements of each reform into Malaysia’s domestic regulatory and supervisory framework, with the regulator’s expectations of banking institutions in managing the transition to the new regime. The circular provides that the BNM supports the implementation of these reforms, and will strengthen the existing capital and liquidity standards for banking institutions in Malaysia to be in line with Basel III, and that the BNM aims to implement Basel III reforms in Malaysia in accordance with globally agreed levels and is working on an implementation timeline for the gradual phasing-in of the reforms between 2013 and 2019.

In addition to the foregoing, and to facilitate the monitoring of Basel III reform implementation, identification of transitioning issues and assessment of potential impact on the financial system, the following requirements were imposed on financial institutions by the BNM:

  1. minimum regulatory capital requirements imposed under the Capital Adequacy Framework (Capital Components) and the Capital Adequacy Framework for Islamic Banks (Capital Components) issued by the BNM, which basically fulfil Basel III capital adequacy requirements. The guidelines require banking institutions to maintain a minimum risk-weighted total capital ratio of 8 per cent at all times at entity, global and consolidated levels; and
  2. reporting requirements on financial institutions with regard to their Basel III leverage and liquidity prior to formal implementation of the new standards.

In November 2012, the BNM issued its regulatory capital adequacy framework (Capital Adequacy Framework (Capital Components) (2012 Framework)), implementing the Basel III reforms. The capital requirements promulgated by the BNM provided that banking institutions were required to maintain the following minimum capital ratios for the calendar years stated: a Common Equity Tier 1 (CET1) capital ratio of 3.5 per cent in 2013, 4 per cent in 2014 and 4.5 per cent in 2015; a Tier 1 capital ratio of 4.5 per cent in 2013, 5.5 per cent in 2014 and 6 per cent in 2015; and a total capital ratio of 8 per cent from 1 January 2013 onwards. The 2012 Framework provided that these capital requirements would be supplemented by a leverage ratio, an LCR and a net stable funding ratio (NSFR). Further, banking institutions were required to maintain additional capital buffers above the minimum CET1, Tier 1 and total capital ratios set out above in the form of a capital conservation buffer and a countercyclical capital buffer based on a percentage of total risk-weighted assets.

The BNM then issued its guidelines on the Capital Adequacy Framework (Capital Components) in October 2015 (2015 Framework) for banking and financial institutions, which superseded the 2012 Framework. The provisions of the 2015 Framework do not differ greatly from the 2012 Framework, but seek to enhance it so that Malaysian regulations can better conform with Basel III. The 2015 Framework provides detailed formulae for calculating the capital conservation buffers and countercyclical buffers, determined from an operational perspective, and provides that banking institutions and their holding companies are required to comply with the provisions of the 2015 Framework both at the entity and consolidated levels.

The BNM subsequently issued its guidelines on the Capital Adequacy Framework (Capital Components) in August 2017 (2017 Framework) for banking and financial institutions. The aim of the 2017 Framework is to incorporate loss absorption mechanisms via write-off for Additional Tier 1 and Tier 2 Islamic capital instruments that are structured using equity-based shariah contracts such as wakalah, musyarakah or mudarabah. The BNM issued fresh guidelines on the Capital Adequacy Framework (Capital Components) in February 2018 (2018 Framework) for banking institutions, to be read together with the Capital Adequacy Framework (Basel II – Risk-Weighted Assets) Guidelines. The 2018 Framework supersedes the 2017 Framework. On 5 February 2020, the BNM issued the Capital Adequacy Framework (Capital Components) and Capital Adequacy Framework for Islamic Banks (Capital Components), which supersede the 2018 Framework.

The implementation of Basel III standards remained a key focus of banks’ regulatory and supervisory activities in 2018. The leverage ratio requirement took effect on 1 January 2018 with a minimum ratio of 3 per cent. The NSFR requires banks to maintain sufficient stable funding in relation to their asset profile and off-balance sheet obligations over a one-year horizon. While most banking institutions are expected to be well-positioned to meet the NSFR minimum requirement of 100 per cent, the BNM is conducting further work on the liquidity risk management practices of banking institutions as additional input to the finalisation of the NSFR requirements. Although progress in the implementation of NSFR globally remains uneven, the Bank remains committed to its implementation in Malaysia. In July 2019, the BNM issued the Net Stable Funding Ratio Guidelines, which will come into effect on 1 July 2020. However, the minimum NSFR will initially be lowered to 80 per cent and banking institutions will be required to comply with the 100 per cent requirement from 30 September 2021.

On 5 February 2020, the BNM issued a policy document on the Domestic Systemically Important Banks (D-SIBs) Framework for D-SIBs, which sets out BNM’s assessment methodology to identify D-SIBs in Malaysia, and the inaugural list of D-SIBs. D-SIBs refer to banks whose distress or failure have the potential to cause considerable disruption to the domestic financial system and the wider economy. Higher capital requirements introduced for such banks will complement the regulatory framework in place to mitigate the risks posed by D-SIBs to the stability of the Malaysian financial system and the wider economy. A D-SIB is required to maintain higher capital buffers to meet regulatory capital requirements that include a higher loss absorbency requirement. This serves to increase a D-SIB’s capacity to absorb losses, thereby reducing its probability of distress or failure during periods of stress. In turn, this will contribute to a safer and more resilient Malaysian financial system. As at April 2020, the banking groups identified as D-SIBs are Public Bank Berhad, CIMB Group Holdings Berhad and Malayan Banking Berhad.

iv Recovery and resolution

The CA was introduced in early 2017, repealing and superseding the Companies Act 1965 for the most part. As with corporations, financial institutions are subject to general legislation for corporate insolvency, now contained within Part IV of the CA. The modes of winding-up proceedings under the CA include compulsory and voluntary winding up and the appointment of receivers and managers over a corporation. The Act also contains provisions relating to corporate voluntary arrangements and judicial management in Part VIII (corporate rescue mechanisms), which came into force on 1 March 2018, together with the Companies (Corporate Rescue Mechanism) Rules 2018. However, specialised frameworks for addressing the failure of financial institutions to pay their debts as they fall due exist separately under the Acts and the Malaysia Deposit Insurance Corporation Act 2011 (MDICA).

Consumers who make deposits into financial institutions in Malaysia are protected by an insurance scheme known as the Perbadanan Insurans Deposit Malaysia (PIDM) (or the Malaysia Deposit Insurance Corporation (Corporation)) pursuant to the provisions of the MDICA. As a measure that promotes financial stability within the financial system, the PIDM ensures that depositors are insured against the loss of their deposits (subject to a threshold of 250,000 ringgit per depositor per financial institution) in the event of loss caused by the failure of a financial institution holding their deposits.

The provisions of the MDICA empower the Corporation to assume control of a non-viable financial institution, and to acquire and take control of non-performing loans that are outstanding between financial institutions, borrowers and security providers through the appointment of a conservator.

The MDICA further provides that upon the appointment of a conservator, a moratorium shall take effect during which, inter alia, no action, suit or proceeding may be commenced or continued against the Corporation, the conservator or the financial institution, any petition for the winding up of the financial institution shall be dismissed, no receiver, receiver manager or liquidator may be appointed over the financial institution, and no steps may be taken to enforce any security over the assets of the financial institution.

The MDICA also provides that the BNM may provide written notice to the Corporation if the BNM is of the opinion that a financial institution has ceased to be viable or is likely to cease to be viable, whereupon the Corporation is empowered to, inter alia:

  1. require the financial institution to take any step or action or refrain from any act or thing, in relation to itself, its businesses or its officers, to cease soliciting, taking or repaying deposits, or carry on its business or such part of its business as the Corporation may direct, or to restructure the whole or part of its business as may be specified by the Corporation;
  2. acquire or subscribe to the shares of the financial institution;
  3. assume control over the member institution, carry on the whole or part of its businesses, and manage the whole or part of its assets, liabilities and affairs, including disposal of its assets or businesses or any part thereof, or appoint any person to do so on behalf of the Corporation;
  4. apply for the appointment of a receiver, a manager or a receiver manager, to manage the whole or part of the assets, liabilities, businesses and affairs of the financial institution;
  5. subject to the approval of the Minister, present a petition for the winding up of the financial institution;
  6. with the approval of the Minister, designate one of its subsidiaries as a bridge institution; or
  7. transfer such assets and liabilities of the non-viable financial institution to the bridge institution on terms as the Corporation shall determine.

The Acts themselves provide measures for addressing the insolvency of financial institutions that distinguish between conventional and Islamic banks whereby the BNM itself acts as a resolution authority, and with the prior approval of the Minister by an order in writing, is empowered to assume control of the whole or part of the business, affairs or property of a financial institution, manage the same, or appoint any person to do so on behalf of the BNM in the event that the BNM is of the opinion that certain circumstances exist in relation to the financial institution concerned, including the following:

  1. the assets of the institution are not sufficient to give adequate protection to its depositors, policy owners, participants, users or creditors, as the case may be;
  2. the capital of the institution has reached a detrimental level or is eroding in a manner that may detrimentally affect its depositors, policy owners, participants, users, creditors or the public generally; and
  3. the financial institution has become or is likely to become insolvent, or is likely to become unable to meet all or any of its obligations.

The Acts provide the BNM with further powers in the event of insolvency whereby it may:

  1. make an application to appoint a receiver and manager over the whole or part of the business, affairs or property of the financial institution;
  2. with the prior approval of the Minister, by an order in writing, vest in a bridge institution or any other person the whole or part of the business, assets or liabilities of the financial institution;
  3. with the prior approval of the Minister, provide financial assistance to another institution or any other person to purchase any shares, or the whole or any part of the business, assets or liabilities, of the financial institution; and
  4. recommend to the Minister, and the Minister may, upon such recommendation, authorise the BNM to file an application for the winding up of a financial institution.

The Acts generally provide that the provisions of the CA shall apply to the winding up of an institution, unless specifically provided otherwise. However, no application for the winding up of a financial institution may be presented by any person without the prior written approval of the BNM.

In conclusion, the Acts provide that in the winding up of investment banks and Islamic banks, the assets of a banking institution shall be available to meet all liabilities of that licensed investment bank in respect of all deposits in Malaysia as a priority over all other unsecured liabilities of those banking institutions in Malaysia, other than preferential debts set out in the CA and debts due and claims owing to the government under the Government Proceedings Act 1956.



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