A System That Stimulates The Transfer

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02 Nov 2017

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Chapter 1

1.0 Overview

Financial system is a system that stimulates the transfer of funds from lenders which is the surplus unit to borrower, the deficit unit (Boot & Thakor, 1997). It allows lenders and borrowers transfer of funds either directly or indirectly. It can be divided into financial market, financial institutions, and financial instruments (Allen & Gale, 2004). Financial system also comprises few differences of levels which are global, regional and firm specific level. Difference of area is using the difference of components.

Financial market is a marketplace which channels the funds from lenders to borrowers. Financial market such as NYSE and NASDAQ is a marketplace which gathers borrowers to trade their securities in the market. Borrowers can borrow either directly via lenders or indirectly via financial institutions. Normally, lenders will expect some compensation from borrowers such as charging interest rate as cost of borrowings. In addition, it can be divided into few dimensions which are debt and equity market via buying bonds or stocks by receiving dividends or coupon payment, primary market and secondary market which purchase the new issue securities after that sold to secondary market included NYSE and NASDAQ either in exchange markets or Over The Counter. Money market and capital market is the classification of markets that depends on the maturity of the security.

Meanwhile, financial institutions act as an intermediary to channel the funds to match lenders and borrowers. They act as an important role in improving the efficiency of economy. They provide risk sharing, diversification, transaction cost, economies of scale and sometimes adverse selection and moral hazard will incur when transaction occurs. There is also different type of financial institutions which act in different role. Depository Institutions which act as a depository bank while Contractual Savings Institutions such as pension funds or insurance companies is a long term agreement to obtain their funds. In addition, Investment Intermediaries who act as M&A assistance which will act on behalf on firm to acquire another firms’ asset, rights, stocks and others (Angeli & Maarse, 2012).

On the other hand, Financial Instruments comprises money market instruments and capital market instruments. Different instruments are use in different situations with different securities issued. For example, government will issue treasury bills to public in term to raise the funds for other purposes.

The structure of financial system is shown in table 1. We will describe the three dimension of financial system which is financial market, financial institutions, and financial instruments in detail in the following chapter. Also, we will introduce our domestic country, Malaysia‘s financial system as well as the Islamic Finance.

Table 1: The Structure of Financial System

Primary market and secondary market

Money market and capital market

Equity market and debt market

Organized exchanges and over the counter(OTC)

Financial Market

Money Market Instruments

Capital Market Instruments

Financial Instruments

Depository Institutions

Non-Depository Institutions

Government-Sponsored Enterprises (GSEs).

Financial Institutions

Financial System

Chapter 2

2.0 Financial Market

Financial Markets can be defined as a market that financial instruments such as equities, bonds, currencies and derivative are traded. Stock exchanges, bond markets and foreign exchange (FOREX) markets are some of the example of financial markets. Mostly all transactions in financial markets are direct financing where no middleman takes place. Financial intermediaries, also known as financial institutions are those that act as middleman between two parties (borrowers and lenders) in financial transaction. The process that financial intermediaries occur is known as indirect financing.

Direct financing mean funds are gathering directly from market where the borrowers sell the financial instruments directly to lenders. In the other hands, indirect financing the funds is gathered and distributed by institutions. Lenders are those with excess funds for investing or saving while borrowers are those who need the funds from lenders. According to the chapter 1 of text book "Financial Institutions, Markets and Money (10th Ed)" , written by Kidwell, D. S., Peterson, R. L., Whidbee, D. A., & Blackwell, D. W., it stated that the users of financial market in the transferring of funds can be categorized in four units which are households, business firms, governments, and foreign investors. These units can be as the lenders and the borrowers in the financial markets. Table 2 shows how the funds flow in the financial system.

Table 2: Funds Flowing through the Financial System

2.1 Structure of Financial Market

Financial market is categorized into several categories. Each market has certain functions and activities. Generally, financial market is categorized into:

Primary market and secondary market

Money market and capital market

Equity market and debt market

Organized exchanges and over the counter (OTC)

In the following part, we will explain detailed for each market.

2.1.1 Primary Market and Secondary Market

Primary market is the financial market where corporation and government agency that has fund deficit issues new security, such as bond or stock, to sell to initial buyer with the purpose of fund raising from investors that have fund surplus. The security issued in primary market is known as initial public offering (IPO). Secondary market is the financial market to trade previously issued securities among investors and issuer of securities. The trading of the securities will not involve any cash inflow. Secondary market is important in providing the liquidity of the securities issued and determines the price of the security.

There are two markets under secondary market which are money market and capital market. Money market is the financial market that allows the trading of short term financial instruments which also known as money market instruments that consists of debt securities that its maturity is less than one year. While capital market allows the trade of long-term financial instruments which is known as capital market instruments that consist of debt and equity securities that its maturity is more than one year. Table 3 has summarized some of the common examples of domestic and international dimension of these two classes of financial instruments.

Table 3: Financial Instruments in Domestic and International Dimension

Domestic Dimension

International Dimension

Money Market Instruments

Treasury bills

Federal funds

Repurchase agreement

Certificates of deposit

Banker’s Acceptances

Commercial paper

Eurodollars

Eurocurrencies

Capital Market Instruments

Bonds

Stocks

Eurobonds

Foreign bonds

Cross-listing shares

International stock offerings

2.1.2 Equity Market and Debt Market

Equity market and debt market are the financial markets where the corporations and individuals can raise fund from here. In equity market, equities, such as common stock, are issued to raise fund. Investors get return on the net income and the assets of the issuer’s business which is periodic payment most of the time and also through capital gain in trading the equities. Equities have no maturity date and the holders of the equity have the voting right in board of director of the issuing firm. Another way to raise fund is to issue debt instrument, such as bond or mortgage, in debt market. Debt instrument is a contractual agreement between issuer and holder of the instrument in which the issuer has to pay holder fixed amount of money at regular intervals until the maturity date of the instrument.

2.1.3 Organized Exchanges and Over the Counter (OTC)

All the money market instruments and capital market instruments can be traded in organized exchanges and over the counter (OTC). Organized exchange is a centralized market to trade securities. It is a physical place where all buyers and sellers of securities or agents or brokers gather to trade whereas OTC is the decentralized market that does not has a physical place to trade. Investors in OTC trade over electronic network, telephone or facsimile. In organized exchange market, product terms are standardized and expose to market risk while product terms in OTC market are customized and is exposed to market risk and counterparty risk. Table 3 has summarized the differences between organized exchanges and OTC.

Table 3: Differences Between Organized Exchanges and OTC Market

Organized Exchanges

OTC Market

Higher cost of transaction

Lower cost of transaction

Highly regulated therefore comparatively less risky

Less regulated therefore comparatively more risky

Has a physical location or venue

Has no physical location or venue

Has detailed rules and regulations in order to be enlisted

Rules and regulations to trade are quiet lax

Centralized due to fewer intermediaries or stock brokers

Decentralized due to the presence of multiple intermediaries or stock brokers

Mostly for large corporations that have stable credit raring

Mostly for small corporations that are less recognized

Less high-tech and communication between concerned parties can also take place face to face (e.g. NYSE)

More high-tech and communication between concerned parties takes place via electronic devices (e.g. NASDAQ)

Product terms are standardized

Product terms are customized

2.2 Malaysia Financial Market

However, there are some difference between international financial market and Malaysia’s financial market. Malaysia’s financial market consists of four major markets which are money and foreign exchange market, capital market, derivatives market and offshore market. Table 4 shows the financial system structure in Malaysia:

Table 4: Financial System Structure in Malaysia

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In Malaysia, money and foreign exchange market are necessary to the functioning of the banking system. This is because money and foreign exchange market provides funding to the banking system and also serve as channel for the transmission of monetary policy. Capital market in Malaysia includes conventional and Islamic markets for financial assets that are medium to long term and conventional markets is divided into equity market and bond markets. There are two types of bonds in Malaysia bond market, Malaysian Government Securities (MGS) which are issued by Malaysia government and private debt securities (PDS) which are issued by private corporations. Offshore market in Labuan, Malaysia was set up following the establishment of the Labuan International Offshore Financial Centre (IOFC) with the objective to promote Malaysia as a regional financial centre in year 1990. The Labuan IOFC is the financial offshore centre which wants to provide a broad range of offshore financial products and services worldwide (Ang, 2009).

2.3 Functions of Financial Market

Based on the text book "Money, banking and financial markets (3rd ed.)" chapter 3 and an article title "financial market" publish in finance.mapofworld.com, in total there are six key functions in financial markets. Three functions were introduced in the text book and six in the articles, due to some of the functions have similarity and so concluded there are total of six functions.

Firstly is that financial markets offers liquidity where the owners of financial instrument can buy or sell in lower price and the transaction costs in being kept low. Liquidity also allows the asset holder to buy and sell financial assets easily. For example, stocks can be traded within a day either buying low or selling high through exchanges. Next is the assimilation and coordination of information. The information is gathered and organized regarding the value of financial assets and movement of funds in the economy. The information is enough and well organized to the public, also the information all are being shared and communicated about the issuers of financial instruments thus individuals such as owners and investors have same amount of information in the markets.

Thirdly, is the risk sharing of an individual. Financial market is a place for buying and selling financial instruments on risk. Each individuals share the same risk when information are symmetry. Risk sharing can defined as the risk linked with any transaction is being distributed thus reduces the risk through portfolio diversification or shared among investors. Example of risk sharing is hedge fund investors gather a pool of funds and share the risk on the investment invested.

Fourth is the borrowing and lending, where borrowing and lending is the transfer of fund from the lender to the borrower in financial market, either in the form of consumption goods or investment. For example, a listed company gather fund through issuing new stocks and investors purchase the stocks for the dividend and capital gain. Following with determination of prices, determination of prices mean of the value of new financial instruments and existing financial instrument are set in financial market. For example, the initial public offering price is set upon selling and the trade of existing stock prices are determine by the supply and demand of the stocks. Lastly is the efficiency where cost of transaction and cost of gathering information is reduced. For example, credit rating agencies will rate the financial assets and share to public thus reduce the cost of research toward the assets.

The characteristic of a well-run financial market must have the following criteria: the transaction costs is kept low, information that pooled, shared and communicated must have a rate of accuracy and widely available, and the borrower of funds must guarantee paying lender much be trustworthy. With these criteria, the government will then play an important role in financial markets as they are the one that enforce the rules of the game. For example, countries that have greater investor protections will be having bigger and deeper financial markets

Chapter 3

3.0 Financial Instruments

Financial markets and financial intermediaries are crucial for financial sector in the allocation of funds between lenders and borrowers in order creating optimum uses in the economy and lowering transaction costs. These markets encourage economic efficiency as providing a system for a fast processing and cheap in the purchase and sell of the financial instrument and thus it offers liquidity to the economy. Healthy financial institutions will be able smoothen the flow of resources or the funds thus increase the system’s efficiency.

Financial instruments also known as financial assets is defined as the written legal obligation of one party to transfer something of value, usually money, to another party at some future date, under certain condition (Cecchetti, Schoenholtz, 2011). Financial instrument have three function whereby financial instruments work as a mean of payment, as stores of value, and allow for transfer of risk. The first two are similar to the use of money but not the third. For examples, the employees can have stock options as a payment for working or futures contract allows a person to transfer risk of increasing or decreasing value of goods to another person.

3.1 Types of Financial Instruments

There are two fundamental classes of financial instruments: underlying instruments and derivative instruments. Underlying instruments mainly are those funds transferred directly to borrowers by lenders. These instruments includes stocks and bonds, it’s able to improve the efficient distribution of funds. Meanwhile, derivative instruments are those value and payoffs are "derived" from the behavior of the underlying instruments. Futures and options are some of the example for derivative instruments and mainly use to transfer risk among investors. The value of a financial instrument can be affected by the following: size of the payment, timing of payment, likelihood payment is made and conditions under with payment is made. For examples, the larger the payment, the faster the payment made is more valuable financial instruments. Table 5 shows financial instrument that being organized based on how they are used.

Table 5: Financial Instrument that Being Organized Based on How They Are Used

Financial Instruments

Description

Used as stores of value

Bank Loans

Borrowers get resources from lender and repaid in the future with certain interest.

Bonds

Government issued to gather resources. Low risk.

-treasury bill, treasury bond

Home Mortgages

A specific asset the borrower assurance to protect the lender’s interests.

Stocks

A way for firms to raise capital. Stockholders own a small piece of the firm

Asset-backed Securities

Returns or payments arising from specific assets.

Used to transfer risk

Insurance Contracts

To assure that payments will be made, rarely occur.

Futures Contract

An agreement between two parties where one exchange commodity or asset at a fixed price on a set future date

Options

One of the derivative instruments. It gives holders the right but not obligation, to buy or sell a fix amount of an asset at a pre-determined price.

Chapter 4

4.0 Financial Institutions

Financial intermediaries, also known as financial institutions are those organizations that involved in providing a variety of financial services to their customers. Rules and regulations set down by government authorities are followed by financial institution for controlling and supervising. They mainly act as middleman between two parties (borrowers and lenders) in financial transaction. Financial intermediaries take place in channeling funds between borrower and lenders. The process that financial intermediaries occur is known as indirect financing.

4.1 Types of Financial Intermediaries

Financial intermediaries in broad can be classified into two categories (Jalan, 2006): fee-based or advisory financial intermediaries and asset-based financial intermediaries. The first is those financial intermediaries that offer advisory services relate to financial issues with a charge of fee according to the services requested by clients. The advisory services include issue management, underwriting, portfolio management, corporate counseling, stock broking, syndicated credit, arranging foreign collaboration services, mergers and acquisition, debenture trusteeship, and capital restructuring. Meanwhile the asset-based financial intermediaries are those that finance based on the specific requirement from their clients. They provide infrastructure either in the form of required asset or finance, renting it out and earn incomes through interest spread, the difference between interest paid and earned.

Through the text book "Money, banking and financial markets (2nd ed.)", it said that financial intermediaries can be categorized based on their asset and liabilities which also represent on the uses of funds gathered and how the fund gathered. There are a total of three categories which included depository institution, non-depository institutions and government-sponsored enterprises (GSEs).

4.1.1 Depository Institutions

Firstly, we look into the depository institutions. These institutions are mainly referred to as banks and accept both deposits or savings and making loans. Depository institutions play an important role in the monetary policy. The categories lies on depository institutions are commercial banks, thrift institutions and credit unions. Commercial banks major in deposit products such as savings accounts checking accounts and loan products such as commercial loans, mortgages. Major assets for commercial banks are loans products and government bond while major liabilities for commercial banks are deposits products and certificates of deposit (CDs). Commercial banks are the largest class in the financial intermediaries.

Thrift institutions are institutions that similar to commercial bank. Some examples of thrift institutions are Savings and Loan Associations (S&Ls) and savings banks. S&Ls were first established in the 1930s and do not allowed offering services such as savings account and CDs or giving out loans but after 1980s these boundaries were relaxed. In order for greater asset and liability choices, S&Ls is made similar to commercial bank while the mutual savings banks are similar with S&Ls with the different in ownership in which mutual savings banks owned by depositors.

Lastly is the credit union, they are the smallest group in the depository institution with major products of deposits and consumer loans. Credit unions have two features than the others in depository institution, they are non-profit institutions and have membership system that organized around a particular group such as company employees, or church parish which mean owned by members and tax-exempt.

4.1.2 Non-Depository Institutions

Next, let move on to the non-depository institutions that major in investment activities or insurance activities. The institutions that included in this category are insurance companies, finance companies, securities firms and pension fund. Insurance companies can be divided into few: life insurance, fire and casualty insurance, reinsurance companies and takaful. The first is on the protection from the risk of death as the mortality rates are predictable, thus can calculate the risk and the payout of premium from an individual. Besides, life insurance also diversified their funds collected from insurance, sell and invest in investment products. Fire and casualty insurance gives protection on the risk of property damage and loss. The different between these is the type of protection. Reinsurance companies are those funds collected from insurance companies share the spreading of risks, Malaysian National Reinsurance Berhad is one of the reinsurance companies in Malaysia. Takaful provides insurance following the Islamic Principle.

Meanwhile, finance companies raising their funds through issuing commercial paper or given out consumer and commercial loan. For example, automobile companies such as General Motor and Ford have financial companies in managing their consumers finance the auto purchases. Securities firms mainly are those brokerage firms, investment banks and mutual funds. Brokerage firms and investment banks mainly issue stocks and bonds to customers, making trading and advising customer while mutual funds will pool an amount of resources from investors then invest them in portfolio and give a percentage returns back to the investors. Pension funds companies in Malaysia is known as Employee Provident Fund (EPF), it gathers the funds from employees and invest them in stock, bonds, and real estate then give out interest payment of 6% as of year 2011. The funds are gathered from a percentage of employee monthly salaries.

4.1.3 Government-Sponsored Enterprises (GSEs)

Lastly is the Government-Sponsored Enterprises (GSEs) that consists of federal credit agencies which provide loans direct to farmers or home buyers or even students loans. These agencies may and may not be government agencies but are created through government charters and have special access to government services. For examples in U.S., Fannie Mae take place in home mortgages and Sallie Mae take place in student’s loans. In Malaysia, GSEs also called as Development Finance Institutions (DFIs) that support the investments in the manufacturing and agriculture sectors. It main target borrowers are those new ventures that hardly find financing in commercial banks and provides low interest loans. The Development Finance Institution Act 2002 (DFIA) is enacted to guarantee safe and sound financial management of the DFIs. There are now five prescribed institutions builds under the preview of Bank Negara Malaysia: Bank Pembangunan Malaysia Berhad, SME Bank (Bank Perusahaan Kecil & Sederhana Malaysia Berhad), Export-Import Bank of Malaysia Berhad, Bank Kerjasama Rakyat Malaysia Berhad and Bank Simpanan Nasional .

4.2 Functions of Financial Intermediaries

According to the text book "Money, banking and financial markets (3rd ed.)" chapter 11, it listed that there are total of five functions performed by financial intermediaries. First is the pooling of resources over limited fund lenders in the markets. Pooling savings is the most straightforward ways in gathering resources from many lenders. For example, banks accept small deposits from many lenders and strengthen the fund then loan large amount out. To make this success, intermediaries must attract an amount of lenders and depositors are convinced that this institution is soundness and low risk.

Next function will be on providing safekeeping and accounting services, with access to payment system. Banks is the most common place for safekeeping of money and it’s also offer deposits and withdrawal through the uses of debit/Automated Teller Machine (ATM) card and checks as payment tools. As banks will be having lots of payments transaction daily which then allowing them to have a lower charges on services. This uses the principle of comparative advantage where banks provide services and users pay with money. The economy will function more efficiently with the reliable and inexpensive payment system given by financial intermediaries. They also take return on economies of scale as the larger the amount of same services provide, the lower the cost per unit transaction.

Thirdly is that financial intermediary provides liquidity such as credit card system where offer individuals and businesses limited uses of credit per month give a repayment later. This gives customers access to liquidity. The fourth function is diversifying risk as financial intermediaries allow investors to diversify investment and reduce the risk of investments. Some risks are hardly able to diversify by investors themselves as it may cost a lot but financial intermediaries provide solutions for it. For examples, mutual funds gather funds from many investor then purchase and manage a stock portfolio. It will be higher cost if investors manage the portfolio himself.

Lastly is the collecting and processing of information. There will be a situation of information asymmetry when lender unknown the trustworthiness of the borrower but it will need some costs to get information of the borrower. Financial intermediaries take part in colleting and processing the information among lenders and borrowers which allow reduce the problem of information asymmetries.

Chapter 5

5.0 Islamic Finance in Malaysia

The plan to develop Islamic finance in Malaysia was first mentioned and taken into action in year 2001 by the Bank Negara Malaysia (BNM) (Bank Negara Malaysia, 2001). The objective of the plan is to create an alternative to commercial financing where Islamic financing focuses on profit-sharing basis. By looking back at year 1997, before the Asian Financial Crisis burst, Islamic finance is a less popular tool for financing around the world. After the crisis happened, the BNM foresees a potential future of Islamic finance as a substitute of commercial finance for those affected businesses and investors during the crisis. Since then, a 10-year Financial Sector Masterplan (FSMP, hereafter as the Masterplan) was introduced (Bank Negara Malaysia, 2001), included one of the objectives, to create a competent, progressive and extensive Islamic financial system that contributes greatly to the effectiveness and efficiency of the Malaysian financial system while meeting the economic needs of the nation. A decade after the Masterplan was introduced, Malaysian Islamic financial system has significantly developed and positioned as a leading international Islamic financial hub. This key development contributes a huge support for the stability of Malaysian financial system after the Asian Financial Crisis 1997. This development can be seen by the increased Islamic financial institutions from 2 institutions (year 1986) to 19 institutions (year 2011). Statistically, the Islamic banking sector in Malaysia has expanded from 6% to 22% of the overall banking industry while the Sukuk market (Islamic bond) is now 55% of the debt securities market in Malaysia.

The Masterplan was a successful plan where most of the recommendations are implemented. Continuing the succeeded Masterplan, the BNM introduced the second Masterplan (Bank Negara Malaysia, 2011), named the Financial Sector Blueprint (hereafter as the Blueprint). As a successor of the Masterplan, the Blueprint seeks for enhancements on strength and stability of Malaysian financial system to maintain the performance even in a challenging condition such as global financial crisis. Nevertheless, Malaysian Islamic financial system was part of the plan, as a stepping stone to achieve the main objective of the Blueprint. The BNM is further aiming for strengthen Malaysia’s position as an international Islamic financial centre. With the current strong brand and image of Malaysian Islamic financial market, aggressive will internationalize Islamic finance and establish a more important role of the financial system in the connection of international financial flows. In order to succeed this goal, more innovative financial products and services will be introduced to satisfy the diverse global demand of Shariah-compliant financial solution. Statistically, further development of Malaysian Islamic finance is foreseen to grow from 29% of total domestic financing (year 2010) to 40% of total domestic financing in year 2020. The rate of the growth of Islamic financial industry will be maintained in this decade, establish by more innovation products and services on Islamic finance.

Several directions and strategies were given by the BNM (Bank Negara Malaysia, 2011) to foster Malaysia’s position as an international one-stop Islamic financial centre.

Financial Sector Blueprint 2011 – 2020 (Recommendations)

Increase the diversity of players in the domestic Islamic financial industry to support a wider range of financial products and services that serves the best interest of Malaysia.

Support the growth of the Islamic fund and wealth management industry in collaboration with relevant authorities.

Enhance the dynamics of the Islamic money, foreign exchange and capital markets.

Increase market efficiency by facilitating the use of standard documents and agreements among financial market players.

Promote active participation in issuance and trading of sukuk.

Enhance the depth and vibrancy of the Islamic financial markets by providing a conducive regulatory and tax environment.

Position Malaysia including Labuan International Business and Financial Centre (IBFC) as an international retakaful centre.

Continue to enhance financial linkages between different jurisdictions.

Optimise the potential of existing Islamic financial market platforms.

Develop Malaysia as a reference centre for Islamic financial transactions.

Enhance Islamic finance knowledge propositions supported by a comprehensive talent development programme.

Promote greater global engagement and alliances in the development of the Islamic finance industry.

As the central bank of Malaysia, BNM will stimulate international participation, in addition to partner with several relevant ministries and Government agencies, financial regulatory authorities, market players in the Malaysian Islamic financial sector to achieve the vision for the Islamic finance sector. Besides, BNM will also partner with other multilateral agencies and national regulatory authorities to ensure the Islamic finance sector’s increasing internationalization.

Chapter 6

6.0 Recommendations

From a general and broad point of view, the financial system consist of the entire aspects dealing with finances, thus, it encompasses the role of any firms’ finance departments, banks, central banks, World Bank, major banks, International Monetary Fund or any other financial institutions. Thus, improving any aspects related to these bodies would render improvements in the financial system. We have five recommendations on financial system.

6.0.1 Improving Financial Institutions

Regulatory framework for financial institutions should constantly be up to date so that it complements the modern world. A good framework will lead to higher competitiveness, lower operation costs and better efficiency. Thus said, to improve these aspects, financial institutions should adapt new technologies to enhance operations efficiency, which will subsequently lead to creations and combinations of new financial instruments or better services. Through continuous innovations and competitions, efficiency can be maximized, benefiting the consumers, which will in turn keep the cycle of spending and saving going round.

When a good regulatory framework is in place, it most certainly must be maintained. Therefore, there should not be any hesitation in removing any restrictions that could inhibit competition and efficiency of any financial operations. In time, banks should exploit economies of scale of their operations so that the benefits will flow to the economy.

6.0.2 Improve and Ensure Enforcement

The markets will no doubt work more efficiently when there are transparent, clear and reasonable rules and regulations. However, rules and principles are nothing more than just "all talk and no actions" if they are not appropriately enforced. Ergo, the responsible authorities and bodies must strengthen the enforcement of any rules expressed. For instance, insider trading, frauds or any other offences must be addressed and punished accordingly.

In another scenario, to ensure an efficient market, information must be made available to everyone, be it the investors, firms, authorities or prosecutors so that every party has the incentives to play by the rules.

Nevertheless, improving and ensuring enforcement requires extensive effort and great co-operations among the police, securities commissions, the prosecutors and the industry. Hence, though requiring massive participation of everyone, enforcement should move quickly and forcefully, with momentum, as it is surely a pay-off in the long run.

6.0.3 Establish a Single Agency

Set up a single agency named Corporations and Financial Services Commission (CFSC) to provide Commonwealth regulation of corporations, consumer protection, and financial market integrity. Like Australia, this agency should possess and imitate the roles of integrating existing market, protecting corporations and consumer of the Australia Securities (ACS), the Insurance and Superannuation Commission (ISC), and the Australia Payments system Council.

In order to achieve the objective of financial market integrity, CFSC should be responsible for ensuring the adequate disclosure for all securities and retail investment products. Also, stimulate the development of the debt and equity instruments market. On the other hand, monitor the innovations and technological developments on financial products and services are one of the important roles for CFSC in financial market integrity.

In the respect of protecting corporations, CFSC should regulate the corporations consist of takeovers, insolvency, incorporation, liquidation, and much more. CFSC should carry out all the consumer protection laws for financial services. It can include the consumer protection provisions in the Trade Practices Act 1974 in CFSC’s legislation. Additionally, it should regulate and supervise the conduct of consumers dealing, industry codes of conduct, and new payments technologies code of conduct. Setting a benchmarks and supervise the performance of self-regulatory bodies to prevent the fraud.

6.0.4 Consistency and Prudential Requirements on Financial Report

Generally, financial institutions should consistent on financial report and accounting standard as other corporations are under the Corporations Law. An appropriate accounting standard for financial report enable financial institutions to draw up a systematic financial statement in order to meet the Corporations Law and prudential requirement. It also can help the policy maker to make decision easily based on the financial report.

6.0.5 Imposed Prudential Regulation

A common way to promote financial safety is impose the prudential regulation between financial institutions and investors. Prudential regulation can be defined as a promise governing the prudential behavior of financial institution in implementing some specific rules or standard. For instance, minimum liquidity standards for institutions, minimum capital requirements, and risk management standard. Since the regulatory have to absorb the risks from institutions and investors, it may encounter the problem of adverse selection and moral hazard. Therefore, imposed prudential regulation is an essential action. At the same time, imposed prudential regulation can directly minimize the risk of failure.

6.1 Future Plans on Regulatory and Supervisory Regime on Malaysia’s Financial System

Regulations and supervision on the financial system is an essential element to maintain the financial system stability. Besides, the transparency of financial institutions has significant influence for the sustainable growth and development of the financial industry. Over the past decade, main concern was drawn to enhance the effectiveness of the regulatory system for financial industry and to provide extended governance practices and risk management. Some implemented rules in year 2008 and 2009, such as Basel II capital adequacy rules and Risk-Based Capital Framework, have enhanced risk management for the financial system where financial institutions are required to specify risk profiles. The extended governance, risk management and disclosure standards helped to create awareness on risk taking and reduction on risks to ensure the transparency and stability of the financial system. In addition, the Bank Negara Malaysia (BNM) was also given the authority to respond quickly to potential threats on financial system stability by the reinforcement of the Central Bank of Malaysia Act 2009.

As mentioned in the Financial Sector Blueprint (hereafter as the Blueprint) by Bank Negara Malaysia (2011), they will continue to reinforce the regulations and supervisions on financial system focusing on the support of overall financial system stability, the adaptability of each financial intermediaries, the ability of the BNM to regulate and supervise effectively and the responsibility and fairness of deals towards financial consumers. On top of that, several aspects will need to be taken into account: complexity and size of financial institutions, evolution of financial conglomerations, the operating environment, the significance of Islamic finance and the diversity of market players. In this case, the BNM has made suggestions in three approaches, to address any potential risks and come out with appropriate policy from time to time, to revise and raise the standards of governance and risk management, and lastly, to have greater integration and regulation regionally and internationally.

For the first approach, several steps was highlighted by the BNM (Bank Negara Malaysia, 2011) to achieve this objective. One of the important steps was to formulate a common and generalized legislation for conventional and Islamic financial systems. This proposed framework will strengthen the financial system with a more consolidated regulation and supervision across banking, insurance, takaful and other services sectors. Secondly, BNM suggests tightening the supervisory on financial holding companies. Financial holding companies are required to disclose their group structures so that it is transparent enough to trace non-financial-related activities. Besides, financial groups are required to strictly comply with judicial standards because their actions may have huge impact on the financial system as a whole. As a supervisory function of the BNM, its power of supervision should be increase for requesting information and implementing policies on financial holding companies. One of the hottest issues discussed in the financial industry was money laundering and terrorism financing. The BNM also included to build up frameworks for preventing such financial crimes to be happened in Malaysia that may collapse the whole Malaysian financial system.

For the second approach, the BNM recommend to build a stronger governance of financial institutions where requiring financial institutions to provide periodic audits of corporate governance and Shariah governance. As similar to what have done by past decade, the BNM will raise the risk management measures to create awareness for new potential risks. Besides, it is said to develop a code of ethics and practices, and a series of training programmes on promoting sound risk culture in the financial industry.

For the third approach, in the international dimension, BNM will joint effort working with other central banks and authorized supervisory to monitor the stability of the financial sector regionally and internationally. This can result in better consistency in standards and regulations across different countries. Moreover, Malaysia as a leading Islamic finance hub, it is recommended to develop a solid infrastructure to improve liquidity in Islamic finance. This is a path to develop an international Islamic financial industry.

Implementation of the Blueprint is not only the responsibility of the BNM, it is the responsibility of all regulators, supervisory authorities, financial intermediaries, nonetheless, all the players in the financial system. With the collaboration of all units, the plan can be run smoothly as what have done in the past decade, the Financial Sector Masterplan 2001.

6.2 Conclusion

The world has come a long way to the present financial system it functions in. It is acknowledged that, the financial system is no longer a passive passage of just allocating scarce resources for efficient uses, but rather, a sound and active financial system is integral for development. Continuous improvement of the financial system will enable higher growth and may reduce chances and severity of financial crises on any scale.

To ensure a sound and functioning financial system at firm, regional or national level, everyone should take the effort to understand the business cycle and the fundamental mechanism of the financial markets. Liberalization of economic or political system that could enhance financial reformation should always be encouraged.

In a nutshell, every party must realize the role they play in the financial system, so that there is stable and proper allocation of domestic capital, which would in turn help countries to manage international capital flows, in which, these efficiency will later be reflected in the global financial system as a whole.



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