Malaysia banking system

2. 3.0 Definition of commercial banks

In the early days, commercial banks were commonly known as exchange banks because their business was concentrated mainly in the financing of external trade. This involved primary transactions in foreign exchange, such as remitting and receiving funds to and from abroad, and trading in commercial bills, including the short- term financing of foreign trade. Commercial banks are defined as “any person who carries on bank business”, under the Banking Act, 1973. Banking business means the business of receiving money on current or deposit account, paying and collecting checks drawn by or paid by customers, and making advances to customers, and include such other business as the Central Bank, with the approval of the Finance Minister, may prescribe.

However, definition under the Banking and Finance Institution Act, 1989 (BAFIA) is almost the same as the definition under Banking Act, 1973 in which a bank can be defined as “individual or organizations”  whom operates the business of banking such as receiving deposits for current account, saving account, making payment and receiving customers’  checks and other financing. Today, all the operations in the banking industry are governed by BAFIA, 1989. It is developed to replace the Finance Company Act, 1969 as well as the Banking Act, 1973. The introduction of the BAFIA is intended to provide an integrated supervision of the Malaysian financial system and to modernize and streamline the laws relating to banking and banking institutions.

2.2.1 History of Commercial Banks

Commercial banks worldwide are mostly owned by private sectors. They are formed as a business organization with the objective to make profits. In their early establishment in Malaysia, commercial banks have played an important role in the transaction and development in the industry of commerce. The business was mainly focused in financing the overseas business transactions such as foreign exchange (in term of sending and receiving money to and from other countries) and also financing in the short- term markets.

The main focus on external transaction was due to the development of economy sector especially in the import and export. Moreover, the business operations at that time were run by the branches with the supervision of their head office in overseas. The first bank branch in Malaysia was Charted Mechantile Bank, in 1959. The bank’s head office was initially in India, and then shifted to London and lastly China. Later, when the economy has developed drastically, there were more foreign bank branches. Today, the traditional practice of the banking industry in Malaysia has progressed. An important feature in the development of banking is the growing of locally incorporated foreign and domestic banks.

BAFIA came into force on October 1, 1989 the domestic bank were required to formally exchange their licenses for new ones issued under BAFIA. The foreign banks, however, were given a time period of five years (up to October, 1994) to exchange their licenses in view of the provision requiring them to incorporate locally. The growth of locally incorporated banks marked a significant change in commercial banking in the country which prior to the 1970’s was dominated by foreign banks. As at the end of 1959, there were then only 8 domestic as compared to 18 foreign banks. After 1982, foreign banks had been restricted from opening new branches in Malaysia in line with the policy to encourage the growth and development of domestic banks, particularly the expansion of the branch network into the rural areas. As at December 1996, there are a total of 37 commercial banks with a total branch network of 1569. The regulated expansion of banks has contributed towards a wider and better spread of banking facilities.

3. 0 Introduction

After the Enron, WorldCom, and Xerox scandals, there has been increasing demand for more disclosures, especially in non- financial segment of the annual report. The need of greater transparency to disclosure the information in the financial statement has increasing more important over the year.

Philip (2005), Transparency is defined as ‘ the public disclosure of reliable and timely information that enables users of that information to make an accurate assessment of a bank’s financial condition and performance, business profile, risk profile and risk management’. Reliable and timely information mean that information disclosure in the annual report is reliable and can help the investors or any interested parties to make the decision in the timely manner. As for, relevance implies that the risk information meets the decision-making needs of the user of that information and timeliness is necessary to ensure the information is received at appropriate intervals and while it is still relevant.

The same author states that reliable information tends to be information about past events, while information about future events is inherently unreliable. However the most relevant information for decision-making is future information and therefore a tension arises between relevance and reliability. Central to this is the issue of forward – looking risk information which is potentially of great relevance, but which is also inherently unreliable.

Risk management

3.1 Disclosure Regulation Debate

Patrice Gelinas (2007), the information firms disclose through regulatory filings and voluntary communication bring into being a complex array of costs and benefits. For example, publicly disclosed information can attract investors as well as qualified employees, increase public profile, and permit benchmarking when competitors must similarly disclose. At the same time, producing information is costly because firms must, among other things, hire and equip information producers and release intelligence that can harm their competitive position.

Hua Hwa Au Yong (2005), the disclosure of proprietary risk management information can put banks at a competitive disadvantage as valuable information is available to their rivals. Additionally, the cost of producing and providing information may be a significant burden for some banks. The prescriptive accounting treatments could bias banks’ decision- making towards the activity and instruments with the least costly regulatory outcome. For example, banks may simply decide to reduce the use of risk management instruments given the detailed disclosure requirements.

Extent theory on voluntary disclosure shows that, absent market imperfections or externalities, firm managers have incentives to optimally trade off the costs and benefits of voluntary disclosure, and to provide the efficient level of information to investors in the economy (Healy and Palepu, 2001).

A single efficient amount of disclosure exists when disclosure costs increase at an increasing pace and benefits increase at a decreasing pace as the amount of disclosure a firm releases augments. Similar assumptions are widespread (e.g. refer to Admati and Pfleiderer, 2000) and seem reasonable. For example, if regulators mandated public disclosure of detailed itemized inventory up to, say, the number of paper clips at every employee’s desk, this extra disclosure would probably generate minimal incremental benefits because of its limited value for investors. However, the costs associated with preparing this information in terms of labor hours, additional pages of printed information, and loss of intelligence to competitors, to name but a few, would certainly be exponential.

Philip (2005), state that it is important to note that disclosure itself will not create transparency unless it is disclosure of ‘useful’  information. Immaterial risk information need not be published as, by definition, this is information that would not influence the user’s decision.

Three theoretical arguments support disclosure regulation in favor of investors and any interested parties. First, Leftwich (1980) and Beaver (1998) note that regulation increases economic efficiency because market failures in disclosure could lead to underproduction of information. Failures arise because existing shareholders pay for the production of information disclosure, but cannot charge potential shareholders who free-ride on the information. Second, the same authors note that it can reduce the information gap between informed and uninformed investors, a purpose that simply redistribute wealth between different shareholder strata. Linsmeier (2002), information gap refers to information asymmetry that exists between a firm’s insiders and outsiders. An information gap reduces firm value due to high monitoring and bonding costs. Managers can increase firm value by narrowing the information gap between banks, investors and other stakeholders via disclosure of value information. Third, Coffee (1984) and Mahoney (1995) argue that it leads to efficient and liquid securities markets because it reduces information asymmetry between investors and managers to solve the agency problem. Keryn Chalmers (2005), derivative disclosures can reduce agency costs. Bank managers, as agents, may act in their own interest, with regulators and shareholders needing to restrict and monitor their behavior. Restriction and monitoring is achievable through the imposition of higher capital adequacy requirements, strict disclosure regulations, or higher expected returns to debt and equity capital providers. By disclosing derivative – related information, bank managers are able to reduce agency costs.

In contrast, Admati and Pfleiderer (2000, p. 479) summarize well the viewpoint of researchers who do not believe that disclosure regulation favors investors:

If disclosure is good, why don’t firms do it voluntarily? Regulation should not be necessary if disclosure is in the firm’s best interest. The need for disclosure regulation is further brought into question by the well-known ‘‘unraveling’’ results of Ross (1979), Grossman (1981), and Milgrom (1981), whereby lack of disclosure is taken to be bad news, forcing the informed party to reveal its information in equilibrium. If this is the case, again, regulation that requires that certain information be disclosed seems to be redundant.

In short, the debate between proponents and opponents to disclosure regulation demonstrates that there is no consensus on its desirability for investors or on whether it increases economic efficiency. To the opposing, disclosure regulation is costly for investor it supposedly helps and, to the extent that managers’ pay is linked to the performance of the firm, it impacts managers’ pay negatively.

Conclusion

Disclosure debate

Banks need to disclose minimum information as required by the regulator. In other words, banks are giving their right to choose not to disclose additional information. As thus, this may lead to complex array of costs and benefits. Although public disclosed additional information can attract more investors, but banks may choose to not disclose it as the cost of disclosure might be greater than it benefit. This why lead to complex of interest.

Three theoretical arguments support disclosure regulation in favor of investors. First, the regulation increases economic efficiency. Second, it helps to reduce information gap between informed and uninformed investors. Lastly, it reduces information asymmetry between investors and managers.

3.2 Risk Disclosure Requirements

Among the many new areas of interest that require disclosure in the annual report are matters relating to social and environmental obligations and the intellectual property of the company. Currently, such disclosures are still left to the discretion of the company in many countries and under varying guidelines issued by the authorities and accounting bodies. (Azlan Amran, Abdul Manaf Rosli Bin and Bin Che Haat Mohd Hassan, 2009) Below are some guideline and standards that which is issue for the banking sector.

Basel II

According to Bank Negara Malaysia, Malaysia will adopt the new capital accord- Basel II set by Basel committee. This Basel II is the revised international capital framework. The Basel II Framework describes a more comprehensive measure and minimum standard for capital adequacy that national supervisory authorities are now working to implement through domestic rule-making and adoption procedures. It seeks to improve on the existing rules by aligning regulatory capital requirements more closely to the underlying risks that banks face. The objective of this new framework is to emphasize on the need for refined measurement of risks, more efficient capital management and the adoption of sound risk management practices that will ultimately contribute to greater financial stability. This will to enhance the corporate governance framework, the robustness of the internal control systems, and to introduce greater transparency and market discipline.

Currently bank in Malaysia is still follow the current accord issued in 1988, this Basel I has served as the international benchmark for capital adequacy assessment for banking institutions. Although this can achieved the desired results in terms of developing more well- capitalized banking institutions globally, however the rapidly change in the developments in financial market over the years, the existing accord may less effective.

The new Basel Accord comprises three pillars. The first pillar provides a minimum capital measurement framework for credit and operational risks. In essence, the regulatory capital requirement is aligned more closely with the actual degree of underlying risk that the banking institution faces. It provides the capital measurement that has three options with different levels of complexities for both credit and operational risks to better reflect actual risk. The second pillar focuses on strengthening the supervisory process, particularly in assessing the quality of risk management in the banking institutions. The supervisory process aims to provide the mechanism to ensure that other risks such as concentration risks and market risks in the banking books being managed. Under such an environment, prudent lending such as that characterized by a high degree of portfolio diversification, could justify lower capital requirements. The third pillar specifies minimum disclosure requirements on capital adequacy to enhance market discipline. (Evidence from Bank Negara Malaysia, 2009)

The adoption of the new accord is consistent with strengthening risk management capability. This not only can result in greater capital savings but the domestic banking system also can become more competitive and integrated with the global marketplace. However, Malaysia will adopt a two- phased approach for Basel II. Which mean that, the first phase will begin in January 2008 all the banks will adopt the standardized approach for credit risks and basic indicator approach for operational risk. The second phase will adopt by year 2010.

IAS 30- Disclosures in the Financial Statements of Banks and Similar Financial Institutions

The financial statements of banks and similar financial institutions are complying with all Financial Reporting Standards. According to Financial Reporting Standards, IAS 30 recognizes the uniqueness of bank and their different accounting and reporting needs. IAS 30 also encourages the presentation of a disclosure of a commentary on management and control of liquidity and risk.

The objective of the IAS 30 is to prescribe appropriate presentation and disclosures for banks. The purpose of this is to provide users with appropriate information to assist them to evaluate the financial position and performance of banks and to enable them to obtain a better understanding of the special characteristics of operations of banks. Users of financial statement of banks will be interested in the liquidity and solvency and the risk related to the assets and liabilities recognized in the balance sheet including off balance sheet items.

The objective of this chapter is to describe the methodology to be used in conducting this study. This included the explanation on sample selected, data collection, method of analysis and hypothesis.

From the total number of twenty - two licensed commercial banks in Malaysia only out of nine banks are locally own. Thus, only nine banks have been chosen as the sample size for this study. As this study only focus on risk management disclosure from Malaysia perspective.

Source of information can be generally categorised into 2 categories namely the primary and secondary data. Primary data come from the original source and are collected especially to answer the particular research question. The method of collecting primary data normally is through observation, questionnaires, and interview. In the other hand secondary data are collected from various sources such as thesis, journals from library and internet, government sources, textbooks and various articles that are related to this study. As for this study, secondary data will be used as the sources of information and data for analysis.

Choosing annual reports to examine to what extent the banks disclosed their risk due to (1) the annual reports is the main source for the investors to make investment decision, (2) easier to make comparison among banks by study their annual reports, (3) annual reports also is the secondary data that can gather from internet. Thus, this method is very useful for the purpose of this study.

Annual reports for every single bank as listed on the Table 4 will be used to analysis the information on risks disclosed by the banks in their financial statements.

Bank 

Annual Report 2007 

Annual Report 2008 

Annual Report 2009

In reference to Table 4 above, total nine banks annual reports were able to downloaded from Bursa Malaysia for the period between 2007 and 2008. However, as for year 2009 only five of these reports were available in Bursa Malaysia’s website. The other four banks annual reports were not able to obtained due to the banks financial year end date is on 31 December (i.e. their financial reports for the year ended 2009 are still in the process of being audited). These banks are Affin Bank, CIMB Bank, EON Bank and RHB Bank. Nonetheless, for Public Bank even though its financial year ends date is on 31 December, the bank’s annual report was available in Bursa Malaysia’s website due to the fact that the company’s annual general meeting was scheduled to be held on March 2, 2010.

 

Among the banks, they have difference financial year-end. For example, RHB Bank Berhad has their financial year-end on 31 Dec, while Malayan Banking Berhad has their financial year-end 30 Jun, and Alliance Bank Malaysia Berhad has their financial year ended 31 March. As so, for the purpose of this study, three years time period taken as the reasonableness time period for this study.

In reference to Table 5, out of the total of nine local commercial banks, two banks having financial year-end on 31 March. Whilst another two banks having financial year- end 30 Jun and the rest having financial year- end on 31 December.

Information that was disclosed in the bank’s annual report can be qualitative (non – financial) and quantitative (financial). Hue Hwa Au Yong (2005), point out that qualitative information consists of management objectives and strategies, discussion of risks and management method, while as for quantitative information consists of notional amount, market value data, risk – weighted asset computation, gross current credit risk, and liquidity risk and others risks . For the purpose of this study, it is focuses on the qualitative part of annual reports, as Amran (2006), indicated that from an earlier study have shown that most of the disclosures are qualitative in nature and concentrated in the chairman’s statement.

Information to be disclosed is a matter of judgments. Hence, guideline from Financial Reporting Standards in Malaysia will take as guidance to examine the level of compliance among commercial banks in Malaysia.

Descriptive analysis is use for this study. The bank annual report will downloaded from Bursa Malaysia website. To locate the a bank disclosure of risk, the “ Find” option in Adobe PDF was used to search key word such as “risk”, “credit risk”, “interest rate risk”, “liquidity risk”, “foreign risk”  and “operation risk”. Then I will seize the content of risk in a statement from the bank’s annual reports and study the type of risk they disclosure examine whether it is voluntary disclosure or mandatory disclosure. I believe that with used of take the “content”  and put in a “statement” and examine the level of compliance, I will be able to gather accrual result from the study.

 

The risk management disclosure level categorize into few type of risk; credit risk, interest rate risk, foreign exchange risk, liquidity risk, and operating risk. Among those types of risks some banks disclosed in their annual reports while some of the banks do not disclose it. Out of twenty – two commercial banks in Malaysia only nine banks have been chosen for this study, as this study only focused on risk management disclosed from Malaysia perspective.

This project will be conduct by descriptive analysis, study the note to account that disclose in the annual reports for the banks, and to examine the level of compliance to FRS 132. Nevertheless, the study only focuses on the non- financial section or the narrative part of the annual report.

 

STATISTICS

Purchasing power parity

$23,57 billion (2012 est.)

$24,11 billion (2011 est.)

$23,99 billion (2010 est.)

Official exchange rate

$22,45 billion (2012 est.)

Real growth rate

-2,3% (2012 est.)

0,5% (2011 est.)

1,1% (2010 est.)

Per capita

$26,900 (2012 est.)

$28,000 (2011 est.)

$28,600 (2010 est.)

 

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