Harvard Institute for
International Development
HARVARD UNIVERSITY
Development Discussion Papers
Financing Capital Market Activities
of Capital Market Intermediaries in Malaysia
Alison Harwood
Development Discussion Paper No. 470
September 1993
© Copyright 1993 Alison Harwood and President and Fellows of Harvard College
HIID Development Discussion Paper no. 470
Financing Capital Market Activities of Capital Market Intermediaries in Malaysia
Alison Harwood
Abstract
In many Western countries, such as the U.S., the involvement of capital market intermediaries (brokers, dealers, and underwriters) in the local capital markets contributes significantly to the
level of market transactions, liquidity, and hence overall growth. These capital market intermediaries (CMIs) need access to sufficient financing or their market involvement will be curtailed, with potentially negative ramifications for market development. This study sought to determine if the absence of financing constrained the activities of CMIs in Malaysia and therefore constrained market growth. The paper concluded that financing for CMIs is not a constraint on market development. CMIs, which are predominantly banks, take few capital market positions so that their need for financing is limited. Sufficient financing is available through the banking system, funded
largely with bank deposits, to support intermediation done by the banks themselves and by the non-bank intermediaries which rely on bank loans for financing. However, the need for financing by CMIs may rise in the future along with the risks of capital market transactions. In the interest of bank safety and soundness, Malaysia might consider efforts to reduce the banking system's direct (intermediation) and indirect (lending) exposure to the capital markets and to develop alternative financing sources for all CMIs, including the banks. This paper was prepared as part of a study of eight Asian countries sponsored by the Program for International Financial Systems at Harvard Law School and the Japan Center for International Studies.
This paper is prepared as part of a joint research study between the Japan Center for International Finance and the Harvard Law School Program for International Financial Systems.
Alison Harwood is a Research Associate with the Program for Financial Policy Studies and Training at the Harvard Institute for International Development.
HIID Development Discussion Paper no. 470
Financing Capital Market Activities of Capital Market Intermediaries in Malaysia
Alison Harwood
I. Introduction
The Malaysian capital markets have grown over the past several years, providing a broader range of funding and investment vehicles to a financial system otherwise dominated by bank loans and bank deposits. The Malaysian government is committed to the future growth of the capital markets, as an important step to assuring that the private sector obtains sufficient financial resources to act as the country's engine of economic growth and for mobilizing more domestic funds and thereby closing a growing savings-investment gap.
This paper reviews the current structure of Malaysia's capital markets and the way in which capital market intermediaries finance their activities. It concludes that today, Malaysia's banking sector directly and indirectly finances almost all capital market intermediation. Commercial and
merchant banks combined underwrite almost all debt and equity issues. Together they comprise the bulk of principal dealers in the one active secondary debt market -- for government securities. They are the predominant funding source for the country's stockbrokers who intermediate the secondary market for equity. The Malaysian banking system likely could support the continued growth of the domestic capital markets, but it might do so by exposing the country's bank deposits and payment system to greater capital market risk. To date, capital market risks in Malaysia are limited by practices such as underpricing of new securities issues. But such measures may change over time as the capital markets develop and become more sophisticated.
Given these concerns, the government should encourage banks to diversify their funding sources beyond deposits and to distance themselves from their stockbroking affiliates. It might also prohibit banks from doing direct capital market intermediation.
See Money and Banking in Malaysia, Bank Negara (Third Edition, 1989), page 24.1
II. Macroeconomic and General Overview
The Malaysian economy grew rapidly during the 1980s, particularly toward the decade's end, driven largely by domestic demand which in turn was driven by growing private sector consumption and investment. GNP, which rose by an annual average of almost 5.5 percent from the early part of the decade until 1987, rose by an annual average of 13 percent from 1987 through 1991 (Table 1).
Underlying this rapid expansion of the 1980s was a shift in government policy to promote the private sector as the engine of Malaysia's economic growth. Although the theme of private sector development was important during the 1960s and 1970s, it was intensified after the global recession of the early 1980s highlighted many problems with Malaysia's economic structure, among them its strong dependence on primary, non-oil commodities and narrow manufacturing base. The government set out to encourage private sector activity, particularly in manufacturing, through tax incentives,
liberalization of restrictive laws and practices, and deregulation of cumbersome rules and
regulations. Further measures were implemented in the latter part of the decade to foster foreign1
investment in local private industry.
Consequently, private investment jumped from 6.2 percent in real terms in 1987 to an average of 25 percent per annum in 1988-1991. Manufacturing as a percentage of GNP rose from 16 percent in 1975 to 20 percent in 1985 to 28 percent in 1991, with an annual average growth of 15 percent from 1987 through 1991. The services (9.6 percent) and construction (12 percent) sectors expanded considerably as well (Table 2).
At the same time, the government began downsizing its operations, to reduce its involvement in the economy and allow domestic financial resources to support private sector activities. Government
See 1992 Budget Speech by Anwar Ibrahim, Minister of Finance, to the Malaysian House of Representatives.2 emphasis will be on providing physical, educational, and other public infrastructure in accordance with Malaysia's increasingly higher standard of living. Toward these ends, a process of privatization2
was started in 1983. Several companies have been privatized and more are planned for the future. Growth in new issuance of government securities has slowed, given the slow down in government expenditures (Table 3).
To date, Malaysia's economic expansion has been financed largely by the banking system. Outstanding bank loans rose from M$26.1 billion at year-end 1980 to M$114 billion at year-end 1990. Strong national savings helped fund these loans mainly through banks deposits. Gross national savings averaged about 30 percent of GNP in the second half of the 1980s, while outstanding bank deposits grew from M$29.4 billion at year-end 1980 to M$95.2 billion by year-end 1990. For the future, the
government is intent on developing a more diversified financial system to support a more diversified, industrialized economy. The capital markets are viewed as key to that end. Although the corporate capital markets remain small relative to the banking system, they have been growing in absolute terms and efforts are underway to encourage their further development (Tables 3 and 4).
III. General Overview of the Markets
A. Basic Market Structure
The Malaysian capital markets consist of markets for government bills and bonds, corporate debt, equities, and derivative products.
Bank Negara, the Malaysian central bank, also issues Government Investment Certificates (GICs), dividend-bearing3
instruments issued annually on behalf of the government to meet the needs of Bank Islam and other Islamic institutions, with maturities from 1 to 5 years. The central bank also issues Registered Certificates, interest bearing instruments with a semi-annual coupon. These are not offered to the public. Applications can be made only on invitation from Bank Negara.
MGS typically have maturities of 5, 10, and 15 years while Treasury bills have maturities of 91 days, 182 days, and4
364 days.
Underwriters submit bids to purchase paper with particular yields rather than a particular price or quantity of paper.5
1. Government Debt
Malaysia's government bond market is made up of Malaysian Government Securities (MGS), which are issued several times each year to finance long-term government expenditures, and Treasury bills, which are issued weekly, bi-weekly, and monthly also to finance government expenditures. The MGS34
primary market is by far the largest, with total outstandings reaching M$65 billion in December 1991, followed by Treasury bills with M$4 billion.
Government paper with maturities of 10 years or less is issued through a yield auction5
underwritten by 23 principal dealers, with the dealership community comprised of 9 commercial banks, 7 merchant banks, and 7 discount houses. These dealers are the only parties allowed to bid in the
auctions. Investors must submit bids through a dealer or purchase paper in the secondary market. Government paper with maturities of 11 and 21 years are issued via advance subscription to the country's Employee Provident Fund and National Savings Bank.
Although outstandings of MGS are the largest of all three categories, they show the lowest level of secondary market activity. Treasury bills have been the most active -- M$8.1 billion were traded in 1991 against outstandings of M$4 billion.
Bonds with equity options such as conversions and warrants are attractive to investors because they offer the6
possibility of purchasing stock at below the prevailing market price at the time the option is exercised. They are attractive to issuers because the equity option allows the issuer to pay a lower coupon rate on the bonds.
No Cagamas bonds were issued in 1991 due to an increase in interest rates and general uncertainty about economic7
conditions.
These are notes issued by corporate securities based on one of two Islamic principles: deferred payment sale or joint8
participation.
2. Corporate Debt Market and Cagamas Bonds
Corporate debt securities in Malaysia are either publicly offered and listed on the KLSE or privately placed. Approximately M$2.2 billion of debt was offered on the KLSE between 1987 through 1991, the bulk of which was issued in the form of equity-linked bonds such as convertible bonds and bonds with detachable warrants to take advantage of the rising stock prices on the KLSE (Table 4). 6 Issuers of equity-linked bonds typically have been large, listed companies including financial houses such as Rashid Hussein and large manufacturers such as UMW and Time Engineering.
Most of the remaining funds were raised through private placements. About M$6.5 billion in unlisted paper was issued since 1987. This includes several commercial paper facilities which have been arranged with total drawdowns allotted ranging from $25 to $50 million and structured as note issuance facilities (NIFS) or revolving underwriting facilities (RUFs) with 3 to 5 year maturities and 1 to 3 month repricing periods. Several large, well-known corporations such as Shell Malaysia also have offered longer term promissory notes, which are essentially straight bonds with minimum maturities of 3 years and minimum issue size of M$50 million. In addition, the national mortgage corporation, Cagamas Berhad, launched M$3 billion worth of bonds from 1987 through 1991 which are repackaged paper issued against mortgage loans purchased from banks (Table 4). Finally, new Islamic7
See KLSE speech entitled, "Recent Developments on the Kuala Lumpur Stock Exchange," presented in the Spring9
of 1991.
In 1980, 250 companies were listed in total, which included 56 Singaporean companies and 12 of other nations.10
As discussed in the text below, all Singaporean companies were delisted from the KLSE in 1990. In 1991, only three non-Malaysian companies were listed.
Malaysia also has a small stock exchange for Bumiputera (i.e. indigenous Malaysian) companies. At present, only11
seven companies are listed and the government is considering folding the exchange into the KLSE.
The 1980 market capitalization figure includes Singaporean stocks that were delisted in 1990.12
While Malaysia's debt markets are small, they have been growing since the mid-1980s. Total issuance of both listed and unlisted debt offerings rose 400 percent from 1987 through 1991 (Table 4). Secondary market trading of listed and unlisted corporate debt securities is small. In April 1991, listed debt securities equalled roughly 2.5 percent of listed equity but debt turnover (M$22 million) equalled only .75 percent of equity turnover (M$3 billion). As is common in most countries, trading of9 privately placed corporate issues is limited, which the Malaysian government encourages by allowing at most ten investors (excluding financial institutions) to hold the bonds at any one time. Cagamas
bonds, however, have traded actively at times; in 1990, $12.5 billion were traded against outstandings of M$3 billion.
3. Equity
Like so many other Asian countries, Malaysia's equity market activity has grown significantly in the past several years. In 1980, 182 Malaysian companies were listed on the Kuala Lumpur Stock
Exchange compared to 321 at the end of 1991. Market capitalization grew from M$43.1 billion in 19801011
to M$161.4 billion at the end of 1991, despite the delisting of 53 Singaporean companies in 1990 (Table 5). The market has become a more important source of fund raising over the years. New equity12 offerings totaled only M$137 million in 1980 and peaked at M$8.5 billion in 1990 before falling back to M$2.7 billion in 1991 (Table 5a). At the secondary market level, annual trading value for 1991 totaled
See Investing in the Stock Market in Malaysia, Kuala Lumpur Stock Exchange, 1991.13
M$30.1 billion (12.3 billion shares), compared to M$5.6 billion (1.5 billion shares) in 1980, again despite the Singapore company delistings.
Statistics on the investor base for 1991 show that the vast majority of shareholders were individuals, who represented 95.2 percent of all shareholders. Institutions (44%) and nominees (36%) were the dominant shareholders in terms of the value of equity held *(individuals held 16 percent), while shareholders with over 10,000 shares combined held almost 90% of total outstanding shares. Approximately 83% of the 1.5 million investors were Malaysians, who held roughly M$33.7 billion or 75 percent of the market's capitalization.13
4. Derivative Products
Until 1992, Malaysian derivative products consisted of embedded equity options on listed
convertible and warrant bonds. In November 1990, a new options and futures exchange, called KLOFFE for the Kuala Lumpur Options and Financial Futures Exchange, was given approval in principal to begin
operations. As of early 1993, KLOFFE had not begun trading yet.
B. The Importance of the Capital Markets to the Financial System
In theory, capital markets are intended to provide borrowers and investors with a wider range of funding and investment vehicles and so better mobilize and allocate a country's financial resources and support more diversified, dynamic economic growth. For borrowers, the capital markets
"disintermediate" borrowing away from bank loans, reducing borrowing costs and providing access to funds which can support broader economic activities than that supported by the banking system, given
Approximately 26 percent of the M$10.6 billion in new equity raised in 1990 was for a privatization issue.14
The bulk of these loans were to corporate, private sector entities.15
Development of capital markets also can introduce new means by which financial institutions can manage their16
liquidity outside the interbank market, and the government can manage the money supply without setting credit controls on banks. The Malaysian Treasury bill and MGS markets have increasingly been used as a tool by both Bank Negara and the country's financial institutions for these purposes.
bank concerns about prudential regulations and credit risk. For investors, capital markets provide new and more varied savings vehicles as alternatives to bank deposits, offering higher risk/return tradeoff, longer maturities, and more specialized cash flows. One way to judge the importance of the capital markets is to compare their size to that of bank loans and deposits. On the whole, banking products still dominate Malaysian finance. For borrowers, bank loans predominantly financed the Malaysian economic expansion of the 1980s. New funds raised in the capital markets by corporate borrowers totalled M$27 billion from 1987 through 1991 compared to M$68 billion for new bank loans (Tables 1 and 3). New equity issuance alone was just M$4.4 billion in 1991 (Table 4) compared to M$251415
billion for new bank loans. On the investor side, because of the government debt market, the Malaysian capital markets provide more diversity of instruments to investors compared to borrowers, so that the distance between the size of bank deposits and capital market investments is narrower than that of bank loans and capital market borrowings. Over M$60 billion in new deposits were raised from 1987 through 1991 while almost the same amount of gross new capital market paper was issued over that period, half that amount accountable to the government (Tables 1 and 3). Investors can purchase government securities in the government securities market and they place a considerable amount of funds in Malaysia's Employee Provident Fund, which in turn invests overwhelmingly in government securities (discussed below).16
As noted, Malaysia's corporate capital markets have been growing and, as discussed more below, are expected to grow in the future to help assure that the private sector can obtain the funding
necessary to generate overall economic growth. Issuance of corporate securities rose from M$1.8 billion in 1987 to a high of M$11.4 billion in 1990. However, the banking sector has grown considerably faster. Issuance of new government securities has fallen, in line with the policy to reduce the
government's role in the economy (Table 3).
C. Important Market Characteristics
The Malaysian capital markets have several notable features regarding market operations, investors, and intermediators.
1. Important Characteristics of the Capital Market
Four characteristics to highlight are: (a) the sizable but captive government debt market; (2) the small corporate bond market; (3) the equity linkage with Singapore; and (4) the minimal secondary market trading in all Malaysian capital markets.
a. Sizable But Captive Government Debt Market
Malaysia is somewhat unusual in Asia because of its sizable government debt market. However, the market's rapid growth over the years is largely due to its captive investor base. The Employees Provident Fund, with total investments of M$52 billion at end-1991, is by far the single largest holder of Government securities. It has been required by law to hold at least 70 percent of its total
investible funds in government securities, and in practice has held considerably higher than that
In addition to a reserve requirement, banks and finance companies must hold 17 percent of their total liquid assets17
in "eligible liabilities" -- equal to "primary liquid assets" plus time deposits, net amounts due other banks, negotiable certificates of deposit, and repurchase agreements. In addition, 5 percent of these "eligible liabilities" must be in the form of "primary liquid assets" -- consisting of cash, clearing balances with Bank Negara, money at call in Malaysia, Federal Government Treasury Bills, Federal and State Government securities, and Cagamas bonds with one year or less to maturity.
"The Malaysian Capital Market: Current Situation and Perspective," by Lin See-Yan, 1986 pages 15 through 18.18 specified amounts of government securities (70 percent for the Bank), and hold significant portions of their portfolios in those securities as well. The commercial banks, finance companies, and merchant banks are required to hold a specified amount of liquid assets, and government securities are the main tool for meeting the liquid asset requirements (LAR). 17
This captive investor base has provided an outlet for financing government expenditures. Before introduction of the primary dealer system, it allowed for below market pricing, at the expense of creating an active secondary market and benchmark for corporate bonds. 18
b. The Small Size of the Corporate Debt Market
The second key feature is the small size of Malaysia's primary and secondary corporate debt markets, which is due to several factors. First is the difficulty (confronted in most countries) of encouraging corporations to borrow debt outside the banking system. If the banking system satisfies the needs of corporate borrowers, then the corporate debt market must offer considerably more attractive costs or other features to warrant a shift away from bank loans and the supportive relationship that bank lending can create between banks and their corporate borrowers.
Second is a cumbersome approval process for issuing bonds. Malaysia is just now introducing a unified Securities Exchange Commission. To date, several regulatory bodies have had to be consulted with prior to engaging in many capital markets activities, including debt. Offerings by public
The CIC is a government entity that must approve each public equity issue before it can be launched -- initial public19
offerings as well as rights issues.
The limitation on the number of investors is a standard feature of private placement markets. It is usually20
implemented because the absence of a prospectus means that all buyers other than the initial one have limited means by which to evaluate the investment. The initial buyer can obtain information directly from the issuer, but subsequent buyers do not normally have such access.
Policies regarding issuing private debt securities without a prospectus and their secondary market trading are21
detailed in Section B., "Legal Requirements," of Bank Negara's "Guidelines on the Issue of Private Debt Securities."
listed issues also must obtain KLSE approval. The entire approval process could take four to six19 months. Market conditions may change and become less attractive by the time the paper is ready to be sold to investors, discouraging the issuer from proceeding with the deal. Consequently, corporations have tended to shy away from the market.
Most of the bonds that have been offered are private placements, such as commercial paper and promissory notes, or equity-linked bonds which can be offered at low interest rates because of the embedded stock option. The latter account for most of the bonds offered on the stock exchange. According to some market participants, bond issuers have preferred private placements because public offerings require widespread circulation of a prospectus which is onerous and expensive to complete. Secondary market trading of privately placed paper is restricted, partly because of the absence of a prospectus, so the government limits the investor base to a maximum of 10, excluding financial institutions, at any one time. Often the investor base consists of insurance companies, pension2021
funds, and banks.
Another impediment to market development is that insurance companies are encouraged by Bank Negara to purchase only bank-guaranteed securities, due to central bank concerns about their ability to assess borrower credit quality in the absence of a public rating agency. This means that
In 1961 trading rooms in Singapore and Kuala Lumpur were linked by direct phone lines, which eliminated22
arbitrage between the two markets and allowed them to operate as one. After Singapore seceded from Malaysia in 1965, the common stock exchange continued to function and was known as the Stock Exchange of Malaysia and Singapore. In 1973, the two exchanges split and a separate Malaysian exchange was established. However, stocks from the two countries continued to trade on each other's exchanges. The Malaysian exchange listed several Singapore stocks and vice versa.
Bank Negara Malaysia Annual Report 1991, page 170.23
CLOB also lists stocks from Hong Kong and the Philippines among other countries.24
For a five month period from December 1991 through April 1992, trading volume for the 180 Malaysian25
companies listed on CLOB averaged about 30 percent of total SES trading volume. Trading volume for those 180 companies on the KLSE averaged roughly 60 percent of total KLSE trading volume. The CLOB trading volume for
may be just equal to or below their own, making the bond offering expensive and consequently unattractive.
c. Equity Linkage with Singapore
A third key feature of the Malaysian capital markets is the Kuala Lumpur Stock Exchange's
(KLSE) linkage with the Stock Exchange of Singapore (SES). The KLSE formally split from the Singapore exchange in 1973 but it was not until January 1990 that all Malaysian incorporated companies were22
delisted from the SES and all Singapore stocks were delisted from the KLSE. The 1990 action was done because the Malaysian government wanted "to confine dealings on Malaysian counters to the local exchange, to attract international investors, as well as to reduce the market's vulnerability to unfavorable developments on the SES." 23
The rupture had more effect on the SES than the KLSE because more Malaysian shares were traded in Singapore than vice versa; by 1990, approximately half all shares listed on the Singapore exchange were those of Malaysian companies; only about 11 percent of the KLSE's shares were those of Singapore companies. To compensate for the dramatic decline in SES trading volume, Singapore launched an over the counter (OTC) market called Central Limit Order Booking (CLOB) International which today lists about 118 Malaysian companies. 2425
those 180 companies averaged
57 percent of their KLSE trading volume.
Malaysian stocks trading on CLOB are traded and settled in Singapore dollars. 26
Foreigners can own up to 49 percent of a Malaysian stock brokerage firm, but must obtain government approval27
to invest beyond 30 percent and must show that the above-30 percent capital investment will enhance the firm's business opportunities.
These concerns stem mainly from the problems experienced in 1990 when the KLSE and SES split. As discussed28
below, Malaysia is currently revamping its clearing and settlement system to address these problems.
See Money and Banking in Malaysia, by Bank Negara, (Third edition, 1989), page 372.29
According to Singaporean officials, the bulk of trading on CLOB is done by Singaporeans who prefer to trade in their home market, in their home currency , and who would not likely shift to26
Malaysia if CLOB did not exist. But there is some sense that CLOB's existence also has limited non-Singaporean foreign equity investment on the KLSE. Some foreign brokers have expressed a preference for trading on CLOB because they are prohibited from becoming full-fledged KLSE members and thus have27 to trade through Malaysian brokers, whose competency they sometimes question. They also expressed some concerns about the KLSE's clearing and settlement system.28
d. Minimal Secondary Market Trading
As shown, secondary market trading in most debt and equity Malaysian markets is limited. In the government securities market, this is largely because of the captive investor base caused by the liquid asset requirements of commercial and merchant banks and the investment portfolio requirements of the EPF, the National Savings Bank, and the other insurance and provident and pension funds. Moreover, the low and stable interest rates paid on government securities has been said to discourage development of an active secondary market.29
Interview with Tan Sri Sallehuddin Mohamed, Executive Chairman, EPF. Also see series of articles concerning30
EPF's conservative investment stance in Malaysian Business, August 16-31, 1991, pages 9-16.
There are 38 commercial banks, 12 merchant banks, and 7 discount houses. Discount houses are institutions which31
were designed to absorb excess liquidity in the financial system, particularly from the interbank market, and invest those funds in government paper.
The funneling of so much of the country's investible resources into the EPF with its restricted portfolio structure and its conservatism about non-bank, non-government investments, also restricts30
the flow of funds into other capital market products, and so limits development of an active, trading investor base. In the corporate securities market, the pension and insurance companies that comprise the investors in privately placed issues are long term investors who are not looking to trade their securities.
2. Important Characteristics of Capital Market Intermediaries
In Malaysia, merchant banks, commercial banks, discount houses, and stockbrokers are the major capital market intermediaries. There are three main features to note about these intermediaries. 31
First, except in the government securities market, where commercial banks, merchant banks, and discount houses comprise the underwriting syndicate (i.e. principal dealers), the financial
intermediaries are neatly divided in terms of the markets they intermediate. Merchant banks lead
manage and underwrite most equity issues, commercial banks lead manage and underwrite most corporate debt, and stockbrokers are the predominant brokers and dealers of equity. Stockbrokers are becoming more involved in equity underwriting.
The mix of different institutions as principal dealers in the government sector is due to the fact that the government designated those institutions to act as intermediaries. Until 1990, discount houses were the predominant participants in the market. Today, 7 of the 12 merchant banks, 9 of the 38 commercial banks, and all 7 discount houses intermediate the government market.
In the corporate sector, the division of labor results from institutional-specific reasons.
In corporate debt underwriting, commercial banks dominate in underwriting syndicates because issues are large, underwriters usually operate on a fully committed basis, so capital must be sizable to
support the activity. Commercial banks have the largest capital bases of the capital market
intermediaries (Table 7). Merchant banks participate in the syndicates but are less prominent than commercial banks, given their smaller capital bases. Secondary market trading in bonds is minimal. To the extent it does occur, it is intermediated by commercial banks, as they often have inventory of the paper they underwrite.
Malaysia's 12 merchant banks dominate equity underwriting and are the only institutions which lead manage the offerings. This is because they are the only institution allowed to submit new issue proposals to the CIC and are the main financial advisers for corporations on such matters as timing for new securities and mergers and acquisitions. By the time a firm is ready to offer new shares, the merchant bank has played such an extensive role that the issuing corporation will request the bank to act as lead and co-lead manager and as general underwriters. Commercial banks participate in
underwriting syndicates but, like merchant banks in the corporate debt market, play a subsidiary role. In the secondary market for equity, Malaysia's 55 licensed stockbrokers are the country's brokers and dealers of equity. Independent stockbroking companies must obtain a dealer's license from the Registrar of Companies. Merchant banks can do stockbroking and do not have to obtain a dealer's license. While a merchant banks do stockbroking, most establish separate subsidiaries which are licensed as a dealer by the Registrar of Companies.
Malaysia's licensed stockbroking companies tier into three levels according to size. The top tier consists of companies such as Rashid Hussein Securities and Arab Malaysian Securities, highly
In 1990, the group Rashid Hussein, of which Rashid Hussein Securities is a part, had total capital of M$125 billion.32
Arab Malaysian Banking Group, which owns 97 percent of Arab Malaysian Securities, had a capital of M$266 billion. The institutional clients are split between domestic funds (provident and pension funds) and foreign fund managers33
operating out of Singapore, Hong Kong, and London. About half the total business is with domestic retail investors.
capitalized companies connected to large banks, often part of a large financial conglomerate32
including a merchant bank, commercial bank, and finance house, and which service a mix of institutional and retail clients. The second tier consists of companies in the Kuala Lumpur area with capital33
ranging from M$20 to M$50 million and a predominantly retail customer base but with some domestic institutional clients as well. Last are the family-owned, purely retail companies, many of which are striving to meet the new M$20 million paid-up-capital requirement. They generally operate outside the Kuala Lumpur area.
With the exception of roughly 10 brokers in the first tier, secondary market activity remains the sole source of income for most Malaysian stockbrokers. The emphasis on broking reflects the growth in stock market trading volume and the fixed commissions that have been in place for years. It also reflects the small capital base that most of the Malaysian brokers have, even when the companies meet the M$20 million paid up capital requirement. The growing stock market fluctuations in recent years have encouraged larger capitalized companies to consider entering the underwriting business to both increase and stabilize profits.
The second main feature of Malaysia's capital market intermediaries is the strong role played
by banks. As noted above, merchant banks and commercial banks predominate as underwriters in Malaysia. Both are deposit taking institutions. This topic is discussed more fully in Section III.A in regard to
the way in which activities of capital market intermediaries are financed.
Third is the limited role played by foreign securities companies in the Malaysian capital markets. Most foreign securities firms have only representative offices in Malaysia, which research
If a foreign broker needs additional liquidity in a stock traded on CLOB, it will place an order through to the KLSE34
via a Malaysian broker.
The Social Security Organization (SOCSO), the Armed Forces Fund (AFF), the Teachers Provident Fund (TPF),35
and several other separately constituted private provident and pension funds.
See Money and Banking in Malaysia, op.cit., page 295.36
the local economic and financial situation for advising global investors. This is partly because foreign firms, like domestic firms, are prohibited by law from incorporating a start-up enterprise and must invest in an existing stockbroking company. Foreign investors can only own up to 30 percent of that company's capital (49 percent with the government's approval if the foreign firms can prove they will enhance the business opportunities of the Malaysian firm). These restrictions deter many foreign firms from investing in local stockbroking companies, and only five have made such investments: W.I. Carr, Morgan Grenfell, Asia Equity, Smith Newcourt Far East, and Peregrine Brokerage. Some foreign firms also said that concern about the quality of the Malaysian equity clearing and settlement system deterred them from opening offices in Malaysia. The ability to trade Malaysian shares on CLOB is another reason given. 34
3. Important Characteristics of Investors
A sizable proportion of Malaysia's financial resources are channeled into a few large managed funds. Most important is the EPF, with assets of M$53 billion and total investible funds of M$52 billion in 1991 (Table 6). It is supplemented by a variety of smaller provident and pension funds and several sizable insurance funds. These funds were developed to assure that Malaysian citizens were35 provided with sufficient degrees of social security and retirement funds. The National Savings Bank, developed as an outgrowth of its predecessor the postal savings system, was intended to "promote and mobilize savings, especially of the small man."36
Combined these institutions in 1991 held 19 percent of Malaysia's total financial assets and 44 percent of total private savings. EPF's resources have increased dramatically over time as coverage has expanded from low-to-medium wage earners to all employees and as Malaysian income levels have risen. Investments have multiplied from M$9 billion in 1980 to M$46 billion by 1990 and to M$52 billion in 1991 (Table 6).
As noted, government policy requires that most of these funds be invested in government securities. In the past, this assured that sufficient funds were available to finance government expenditures, which were seen as the driving force of the economy. In 1991, 64 percent of the total M$69 billion assets of all Malaysian provident, pension, and life insurance funds were invested in government securities.
D. Recent Developments
Several changes have been occurring in the Malaysian capital markets to strengthen and broaden the markets, strengthen the intermediaries operating in those markets, and free some of the sizable
fund investors to support development and activity in markets outside government and banking products.
1. Strengthen and Broaden the Markets
a. The Government Debt Market
Government securities issuance will decline in the future as the government continues to downsize its expenditures, allowing more resources to flow to the private sector for investment and thereby enable the private sector to further its role as the country's engine of growth. Consequently, the government in June 1991 implemented the new Employee Provident Fund Act which reduced from 70 percent to 50 percent the proportion of the EPF's annual investible funds which must be invested in
The EPF still must hold 70 percent of its total investible funds in government securities.37
See for example Foreward to Bank Negara's Annual Report 1991. 38
government securities in any one year. The Act also broadens EPF's acceptable investments to include37 immovable properties, promissory notes, and bills of exchange, joint ventures or participation in a privatization program, or any other form of investment with the prior approval of the Minister of Finance.
Improvements in clearing and settlement have been made. In January 1990, a new book-entry, scripless clearing and settlement system called The Scripless Securities Trading System (SSTS) was implemented for trading MGS, treasury bills, Cagamas bonds, and non-listed private debt securities to encourage more active trading in each of those market segments. SSTS is a component of the scripless book-entry trading and funds transfer system known as SPEEDS (System Pemindahan Electronik untuk Dana dan Sekuriti). Various linkages exist between dealers that enable customers to purchase in the primary market and trade in the secondary market with delivery versus payment. Total trading of MTB, MGS, and Cagamas rose 23 percent in 1990 which is partly attributed to the improved clearing and settlement
system.
b. Increasing Activity in The Corporate Debt Market
The government is committed to developing the corporate debt market, both the listed and privately placed segments, partly because it feels that the banking system alone cannot meet the
financing needs of a growing and increasingly industrialized economy. More varied financing tools are needed. 38
Several steps have been taken to improve corporate debt activity. In December 1988, Bank Negara issued guidelines for issuing corporate debt securities to create the basic legal and
administrative structure for the market. In January 1989 corporate debt securities were exempted from stamp duty. In November 1990 a new credit rating agency, The Rating Agency of Malaysia (RAM), became operational and in late 1991 launched its first rating. Finally, the government is at present
finishing plans to create a Securities and Exchange Commission which will consolidate activities of the three agencies that must be consulted for each public debt issue, that is the CIC, Registrar of Companies, and KLSE, and so streamline the approval process.
Bank Negara is considering additional measures to further encourage market activity. One is allowing certain managed funds and institutional investors to purchase debt securities without bank guarantees if the securities are satisfactorily rated by RAM. That would reduce issuing costs and so make the market a more attractive and frequently used funding vehicle. Another is to allow companies with outstanding bonds and hence a fairly recent prospectus to amend that prospectus for additional issues rather than prepare an entirely new one.
The KLSE has implemented measures to encourage more trading of listed corporate debt to help provide liquidity to what is now an illiquid market. One major effort is to reduce the marketable lot to 1,000 units instead of 3 million (the interbank trading lot) to encourage more interest among the general public.
c. Equity: Strengthening Clearing and Settlement
In addition to strengthening securities brokers, discussed below, the main focus of change in the equity markets has been improving the clearing and settlement system. In 1990, when the KLSE split from the Singapore exchange, volume on the KLSE rose dramatically. It was evident that the existing clearing and settlement system -- which was physical delivery-based -- was insufficient for large volume days. Consequently, several efforts were initiated to improve clearing and settlement.
As a first step, in January 1990 the KLSE publicized introduction of a daily netting settlement system for securities to complement the daily netting of cash positions. Brokers now settle only a net rather than gross securities position with the clearing house, SCANS ("Securities Clearing and
Automated Network System"), on any given day which significantly reduces the number of shares which must be physically delivered to SCANS, and hence the chance of failures and complications in the clearing and settlement process.
In February 1990, a Fixed Delivery and Settlement System (FFDS) was introduced by the clearing house. FFDS established a time table for delivery of shares and cash between clearing members and the clearing house and clearing members and their clients and thereby improved the ability of stockbrokers to better manage their related settlement flows (Table 8).
The next step has been introduction of a Central Depository System to enable immobilized book-entry securities settlement. This CDS began operating at the end of 1992 when it immobilized one security. It plans to immobilize all securities listed on the KLSE over the coming 2 to 3 years.
2. Strengthening Capital Market Intermediaries
The government has intensified efforts to strengthen the capital and professionalism of
Malaysian brokers over the past several years. The two major efforts toward that end were both spurred by stock market disturbances that highlighted the inadequacies of existing brokerage standards.
The first such change followed the Pan Electric Crisis of 1985. One year later, corporations were allowed to become stock exchange members while banks, other financial institutions and foreign brokerage firms were permitted to invest in brokerage firms. The second change followed the January 1990 split of the stock exchange into two separate entities, one in Singapore and one in Kuala Lumpur. The massive clearing and settlement difficulties which resulted from that split highlighted the poor
Stock transactions rose tenfold as investors shifted their holdings from Singapore to Kuala Lumpur.39
Compliance extensions were granted to several brokers located outside the Klang Valley. 40
The average paid-up-capital of the stockbroking industry doubled from M$5.5 million at the end of 1989 to M$11.241
million at the end of 1990. See Bank Negara Annual Report 1990, page 170.
Foreign firms, however, still must have special reason to invest beyond the 30 percent level, including some42
indication that their greater capital contribution will enhance the business opportunities of the local company.
capitalization and poor professionalism of Malaysia's brokers. Consequently, the government raised39 minimum paid-up capital requirements to $20 million, a level which had to be met by the end of 1990. 40
Prior to that date, the minimum required capital was just M$2 million. 41
To obtain capital to satisfy the new capital requirements, stockbrokers have been encouraged to "corporatize", to align or merge with other stockbroking firms or institutions and/or to list on the stock exchange. Of the 55 stock broking houses (25 of which are in the Klang Valley), a total of 30 have now aligned with other corporate entities including commercial banks, merchant banks, listed
companies, and established foreign securities houses. Mergers among stockbrokers are being
encouraged, particularly in the Klang valley (Kuala Lumpur) to strengthen the smaller, family owned firms that are located there. The government is limiting the number of stockbrokers that can list to 10. Five firms are currently listed and 5 are approved for and in the process of listing their shares. To promote increased foreign participation in local brokerages, the government raised the ceiling on foreign corporate ownership from 30 to 49 percent in 1990. These alliances will not only improve42
local capital, but technical know-how and professionalism of Malaysian brokerages.
Additionally, the government is fostering greater competition among different types of financial intermediaries. For instance, since 1991, discount houses may invest in and underwrite issues of private debt securities and commercial paper, which increases their competition with both merchant and commercial banks. Generally, the plan is to develop discount houses into full fledged securities firms dealing in a wide range of financial instruments. In other instances, enhanced
competition is developing as a natural outgrowth of market activities; stockbrokers are becoming more interested in underwriting new share offerings as a way to complement income from the volatile
stockbroking business.
III. Current Demand for Capital Market Financing
Financial intermediaries need funding to support either client-related or their own investment activities. Underwriters need funds if they underwrite on a fully committed basis and are unable to place underwritten paper with investors or because they purchase paper for their own account. Brokers, which transact only on behalf of customers, need funds to bridge gaps in the clearing and settlement process, to buy up bits and pieces of a large customer order (called "warehousing") until the entire order can be sold to the customer at once, and for margin lending to clients. Dealers need funds to buy securities for their own investment portfolio and thereby provide the market liquidity needed to
encourage other investors to enter the market. Discussed below are the specific demands for funding by underwriters, brokers (excluding margin lending), dealers, and lenders, including lenders for margin transactions.
A. Debt Markets
1. Underwriting
a. Government Debt
In the government securities market, underwriters--merchant banks, commercial banks, and discount houses--need financing for two main purposes. First, as principal dealers, they must submit bids for at least 5 percent of the entire issue. The banks usually submit reasonable bids in each auction since they must meet their LARs and need government paper for that purpose. Second,
periodically dealers submit bids on behalf of customers but may bid a price below that bid by the customer, on the belief that the market can bear a lower price. If the dealer is wrong, it will fail to obtain enough paper through the auction to meet customer orders and will have to buy the paper in the open market at a price above what the customer agreed to pay. The dealer must absorb that extra cost.
b. Corporate Debt
The total exposure of commercial banks, the lead managers and predominant underwriters, to the corporate debt market may be small due to the market's small overall size, but the combination of
certain market features can lead to sizable exposures with particular deals. Individual deals can be large, the debt is underwritten on a fully committed basis so underwriters must purchase whatever investors will not buy, and the lengthy approval process means that investor interest can wane by the time a deal is ready for issue, leaving the underwriter with a significant sum of paper to absorb. The limited investor base that exists implies that finding investors in a tight situation would be
difficult.
2. Brokerage
Brokerage volume is a function of trading volume. On the corporate side, debt trading is virtually nonexistent and hence so is brokerage activity. Brokerage in the government market may be active, but generates minimal need for funds because of the clearing and settlement system.
Warehousing is not necessary since the market is relatively liquid and the new SSTS eliminates clearing and settlement gaps that might need to be financed.
3. Dealing
There is minimal dealing in Malaysian corporate debt markets as there is limited secondary
market trading. Lead managers are required by Bank Negara to make markets in the corporate securities they underwrite which can generate some need for funds. In the government market, dealers need funds to finance trading for their own accounts, which they do to satisfy LAR, to manage liquidity more generally, and to take interest rate positions.
4. Lending
Lending by financial intermediaries to finance customer transactions is neither as prevalent nor formal in the debt market as in the equity markets in most countries around the world. Malaysia is no exception. There is nothing analogous to "margin" lending for secondary debt market transactions in Malaysia from the standpoint of capital markets per se. Banks may provide investors with funds to purchase government paper. Moreover, a good portion of the investors are managed funds like the EPF, SOCSO, the Armed Forces Fund, and the National Savings Bank which are looking for ways to deploy their financial resources and have no need to borrow funds to finance transactions.
B. Equity
1. Underwriting
Underwriters need minimal funding for initial public offerings in Malaysia (IPOs). The CIC, which approves IPO prices, also sets those prices by following a pre-determined price-earnings
schedule which puts prices below what the market-determined price likely would be. This government policy is intended to enable retail investors to afford new stocks issues. Consequently, new issues are attractive and oversubscribed, often by over 50 times. Moreover, subscribers are required to pay
The underwriter profits because it is paid a commission for underwriting while assuming essentially no risk. The43
investor profits by obtaining stock for low cost.
for the shares before they know whether they will actually receive the shares. So underwriters have few worries about having to buy unwanted shares. The same is generally true with rights offerings, which comprise a sizable proportion of total issued shares (Table 5), although investors reportedly are refraining increasingly from buying an entire rights offerings, forcing the underwriter to
purchase the remainder.
Clearly, stock issuers incur an opportunity cost when their shares are sold at below market prices, but they accept this arrangement since it ingratiates them with new investors and avoids the embarrassment of having a poorly subscribed share offering. Thus, underpricing is a form of insurance which the issuer is willing to buy to avoid undersubscription.43
2. Brokerage
Trading is fairly sizable in Malaysian equities so that brokerage activities are fairly sizable as well. Financing needs for brokerage activities stem from the clearing and settlement process and the need to warehouse large customer orders.
Malaysia's central clearing and settlement system, SCANS, offers physical delivery of
securities on a net basis and net as opposed to gross cash settlement for brokerage houses which are clearing members who can participate directly in the system. (SCANS estimates that net cash settlement reduces payment flows by approximately 30 percent.) Clearing members transact directly with SCANS as opposed to with one another. Although SCANS substitutes itself operationally as the central
counterparty in settling trades, it is not an official guarantor of trade. However, since SCANS calculates and receives cash obligations on a net basis, it in practice operates almost as a guarantor.
This is a cash and carry transaction.44
Normally, the foreign investor's custodian bank will not release any money to the broker until it receives the shares45
from the broker. The broker receives the shares from SCANs on T+6, brings them to the custodian bank on T+7 and receives a check on T+8 that does not clear until T+9. Brokers would like the custodian banks of these foreign clients (i.e. Citibank, Standard Chartered, Hong Kong Shanghai Bank) to provide a credit line to cover the 3-day exposure but the custodian banks are unwilling to do so.
This illiquidity can stem from there being a single large majority shareholder or a family of holders which as a46
group constitutes a large majority shareholder for many listed KLSE companies, so that only a small number of shares are available for public trading is small.
It has a M$45 million overdraft facility so it can offer each clearing member a M$1 million bridging loan per day.
The existing system is depicted in Table 8. Under normal conditions and for domestic investors, there is a 25 hour time period during which clearing members may have to finance the
positions of their clients -- from T+6 at 11:30 a.m. when the clearing member (MC) must pay SCANS until T+7 at 12:30 p.m. when it must be paid money by the buying client. If the buying client fails to deliver funds on T+7, the clearing member is instructed by the clearing and settlement rules to close out the purchase position on T+8 on an immediate delivery basis. 44
Frequently, domestic retail investors are required to pay the broker for their shares before the broker must pay SCANS, which reduces the broker's exposure. However, according to Malaysian brokers, funding needs for clearing and settlement still can be onerous, particularly on high volume days. Clearing and settlement for foreign investors generates a 3 day financing need by the broker. The broker must pay SCANs by 11:30 a.m. on T+6. But the foreign investor's check will not be received until T+8 and will not clear until T+9.45
In addition to clearing and settlement, Malaysian stockbrokers also need funds to purchase shares for clients who want large orders which cannot be obtained in one transaction because of the frequent illiquidity of the KLSE market. To fill large orders, brokers often have to buy the demanded46
Some brokers reported that they will not warehouse for more than seven days.47
Several foreign brokers resident in Malaysia argued that Malaysian brokers are sizable proprietary traders, who48
often claim to be trading on behalf of a client but actually are trading for their own account.
The KLSE has no floor. Since 1989, trading has been done through a semi-automated system known as SCORE49
(System on Computerized Order Routing and Execution), which phased out the traditional open outcry method of trading. SCORE works as follows: Client orders are entered into computer terminals at Member Companies' premises and transmitted to the Exchange. The orders are automatically routed to the Exchange's matching room where matching of buy and sell orders are executed by the Exchange's staff by price and time preference.
allotment. Only then will the broker "sell" the shares to the client. The broker, however, must47 purchase each portion of the total with its own funds. Such warehousing frequently is needed to meet orders from foreign investors, who do not pay in advance, since they buy in sizable allotments.
3. Dealing
Most stockbrokers claim to take few proprietary positions, which they attribute to a variety of reasons. First is market structure. The KLSE is an order-matched, not market maker, system. This48
means that the dealing function, the provision of market liquidity, is not a requirement of any particular intermediary in Malaysia as it is, for example, for specialists on the New York Stock
Exchange. However, many order-matched markets around the world have active, non-designated market49
makers which deal on their own account for a variety of other purposes: buying shares of companies they have underwritten to enhance their attractiveness and as a service to the corporate issuer; selling
shares out of inventory that were obtained when there were not enough investors subscribing to the offering; or to make capital gains from trading to supplement their commission and fee income.
The second reported reason is limited financing. Most stockbrokers regard their brokerage (i.e. customer) business and the fees and commissions it generates as their "bread and butter"
business. Considerable funds can be needed to cover brokerage activities, clearing and settlement as well as warehousing. As discussed more below, access to financing for these activities can be limited,
Although banking regulations restrict any one bank's loans to an affiliate, a bank-affiliated stockbroker may be in50
a better position to borrow and to borrow more from a wider range of banks because it is considered to be backed by its parent or affiliate bank. This financing constraint may be less of a problem today, given improved capital levels. See discussion in Section E below.
Frontrunning refers to the practice of a dealer putting an order for its own account ahead of an order it has received51
for a customer, giving the dealer the more attractive market opportunities at the expense of the client.
particularly for smaller, non-bank affiliated brokerage houses, which have had smaller capital bases and likely less access to other sources of funds. An independent stockbroking firm may be able to50
expand its capital base, but may be unwilling to do so because the stockbroking business fluctuates considerably. During quiet times, the company's return on capital can be low, which can impair its perceived standing and hence cost of capital in other markets.
A third set of reasons given are certain rules concerning the market. Some dealers claimed that the Bank Negara rule against frontrunning on client positions inhibits their proprietary trading,
causing brokers to trade only with other brokers. Dealers also allege that the KLSE requires51
cumbersome reporting for trades in which the broker is a principal, and hence a deterrent to the trade itself or to admitting that the broker trades frequently (if it is not submitting the reports as
required).
Finally, dealers expressed concern about their ability to manage risk. Malaysia does not allow short selling (the Securities Industry Act of 1983) and no derivative equity products exist for
covering exposures. Dealers also note that due to recent stock market scandals, Bank Negara is wary of risk-taking by dealers and discourages the dealers from taking positions. This may cause firms to restrict their dealing operations or just to report that they do little dealing.
Intermediaries other than stockbrokers might be expected to deal in the stock market, such as merchant banks, but their position taking is small because they can only hold stock absorbed during underwriting for up to one year and they can only hold trustee shares, which are shares quoted on the
This may reflect the growing affiliations between stockbrokers and banks that has followed the "corporatization"52
of stockbrokers.
stock exchange and which have paid dividends for the past five years. Commercial banks face similar investment portfolio restrictions on their equity investments.
4. Margin Lending
Until 1989, margin lending was unregulated by any official entity and was based on the
customer/broker relationship. It now is covered by KLSE as well as Bank Negara rules. The major rule, KLSE Rule 20, states that the collateral (cash plus the market value of securities) plus the securities purchased in a customer's margin account must be at least 150 percent of the total amount owed by the customer for securities transactions. If the percentage falls below that level, the customer must
provide additional collateral to replenish the account.
The providers of margin loans in Malaysia are stockbrokers and commercial and merchant banks. Most customers borrow on margin from their broker rather than from a bank, which many stockbrokers prefer as it gives them more control over the margin lending and equity trading processes. A bank usually will provide 60 percent of the transaction's value to the stockbroker who on-lends the funds to the customer and who pledges the customer's stock as collateral. Stockbrokers typically lend between 50 and 70 percent of the value of the transaction to the customer.
Stockbroker customers are increasingly borrowing directly from a bank, and stockbrokers in some cases put their customers in touch with a particular bank. Most direct bank lending to customers52 is done by commercial banks since merchant banks do little consumer lending in general. These
commercial bank loans can be formally for buying on margin but usually the bank will just extend a line of credit to a customer which can be used for any purpose. If the borrower chooses to provide
To some extent, the RP market resembles the interbank market: instead of selling excess reserves, merchant banks53
sell excess liquid assets. However, most of the buyers are not other banks.
collateral for the loan in the form of stock, the bank will accept 50 to 70 percent of the total value of the stock being offered. Many banks prefer "trustee" shares as collateral from either stockbrokers or the clients directly.
V. Methods for Financing Capital Market Activities
Several mechanisms are available in Malaysia for financing capital market positions of
financial intermediaries. These mechanisms vary, depending on whether the intermediary is a merchant or commercial bank, a discount house, or a stockbroker.
A. Merchant Banks
Merchant banks fund their capital market activities (underwriting and dealing in government paper and underwriting equity) with their regular funding sources. They raise funds for general operating purposes, not specifically for capital market activities, and then internally allocate those funds as necessary.
The bulk of merchant bank funding is from deposits (Table 9a), which accounted for 60 percent of total funds in 1991. Most of these deposits are from institutions and wealthier individuals rather
than the general public; Bank Negara requires that the deposits be for denominations of at least M$200,000 and with maturities of not less than one month. Repurchase agreements based largely on Treasury paper comprised almost 10 percent of the total deposit base in 1991. Merchant banks sell MGS, TBs, and Cagamas bonds that are not needed for liquid asset requirements to cash-rich corporations looking for short term investments. Transactions are also done with banks but the bulk involve RPs53
with corporations. NCDs constitute another element of deposits. At present only merchant banks with over M$30 million in capital are allowed to issue NCDs. In 1991, 10 merchant banks passed that test.
Following deposits, the next largest funding category is amounts due to other financial
institutions -- primarily commercial banks but other merchant banks and discount houses as well, which account for 24 percent of all liabilities. Next are capital and reserves (6 percent), bankers
acceptances (3 percent), and other sources (7 percent).
As can also be seen in Table 9a, the total funds raised by merchant banks has grown considerably in recent years, almost doubling in size from the end of 1988 to the end of 1991 (from M$7 billion to over M$13 billion). At the same time, the percentage of activity funded by deposits has fallen -- from 69 percent to 60 percent over the same period, with the slack largely picked up by amounts due to other institutions -- which rose from 6 percent to 24 percent.
To rectify this situation, the Malaysian government in October 1991 liberalized deposit-taking rules for merchant banks and allowed them to accept one-month fixed deposits from any party other than an individual, proprietorship, or partnership with a minimum of M$200,000. This broadened the deposit base and dropped the floor for several depositors as well: previously, corporations, associations,
clubs, and foundations required a M$500,000 minimum and banking and approved financial institutions a M$250,000 minimum.
While this change may impact the reliance on deposits by merchant banks, it is not likely to alter the maturity structure of those deposits, which has been very short term for quite some time (Table 9a). Almost 55 percent of merchant banks deposits were in maturities of 6 months or less in 1991, with almost 70 percent in maturities of up to 1 year. Generally, the deposit base has become shorter over the years, partly due to the increased reliance on and shorter maturities of NCDs and RPs. NCDs almost tripled in absolute amounts from 1987 to 1991, though their importance as a funding tool
Commercials banks have lower funding costs than merchant banks because they can raise demand and retail54
deposits.
has fallen since 1988. Almost 85 percent of these NCDs had maturities of one year or less in 1991, up from almost 70 percent one year earlier and a significant change from 1988 when 73 percent had maturities of at least one year.
The importance of RPs as a funding source dropped in absolute and relative terms in 1991, likely because the government changed the rules for repurchase agreements to allow only principal dealers in the government securities market to transact RPs with interbank and non-interbank participants for all maturities. The access of non-principal dealers to the non-interbank repos was restricted for
maturities of one month or longer.
B. Commercial Banks
Like merchant banks, commercial banks raise funds for their overall operations as an integrated institution and allocate the funds as necessary to support their capital market activities (underwriting and dealing in government debt, underwriting corporate debt, and margin lending).
Commercial bank funding is more varied than merchant bank funding (Table 9b). In 1991, approximately 62 percent of all liabilities were from deposits, a sizable proportion of which was retail based (i.e. individuals and small businesses), including NCDs at 9 percent of total funds and RPs at 6 percent. Note too that the proportion of commercial bank deposits drawn from the private54
sector has grown significantly compared to those from the government or state entities.
Although total capital and reserves accounted for just 5 percent of total funding sources, this figure already reflected a sizable increase in 1990 and 1991 (13 and 10 percent, respectively), as
Several features of discount houses make them attractive places for banks to park their surplus funds. Discount55
houses (a) offer deposits which qualify as a liquid asset for LAR purposes; (b) are the only institutions authorized by Bank Negara to pay interest on deposits with less than one month maturities; and (c) offer a call feature on their deposits.
accounted for 16 percent and "amounts due from other institutions" for 13 percent. Unlike merchant banks, which seem to rely almost wholly on domestic sources, commercial banks raised over 8 percent of their total funds offshore, almost all from the international interbank market.
The total funding needs of commercial banks have grown on average by about 18 percent in each of the past four years -- from M$93 billion at the end of 1988 to almost M$152 by 1991. And as with
merchant banks, the percentage funded by deposits has fallen, though not so significantly from 66 percent in 1988 to 62 percent in 1991, while the amounts due from other institutions both domestic and foreign have increased.
Here too the maturity structure of commercial bank funding has become shorter over the years. In 1991 over half of all fixed deposits had maturities of 9 months or less, compared to 33 percent in 1988. Again, some of this may reflect greater uncertainty about interest rates in Malaysia compared to the mid to late 1980s rather than a structural change in the funding sources available.
In 1989, the Government allowed commercial banks more flexibility in their liquidity
management by reducing the required level of "primary liquid assets" from 8 percent to 5 percent of their eligible liabilities.
C. Discount Houses
Discount houses need funding to finance their primary and secondary market activity in the government debt market. Discount houses have a simple funding structure (Table 9c). About 96 percent of their funds are deposits from banks and corporations -- mainly from commercial banks -- looking to invest their excess funds in other than the interbank market. Most of the remainder is from55
