Cautious Malaysia takes a longer road to Basel II
A 2010 start date for banks adopting a more sophisticated capital model gives time for them, and supervisors, to get it right
Malaysian bank regulators are not taking any chances with the implementation of the new Basel capital accord. By picking 2010 as the date when banks may start adopting an advanced credit risk measurement option under the new accord, regulators in Kuala Lumpur are giving themselves and their banking industry a comfortable cushion of time to get ready.
"We think 2010 will give us a more flexible time frame, and allow both the industry and supervisors to undertake capacity building and acquire the necessary specialised skills," says one local supervisor.
The Basel Committee, architect of the new capital regime aimed at bolstering the solvency of the world's banking system, proposes that banks in the developed countries adopt the accord during 2007 and 2008. Those banks pursuing the simpler and intermediate options for measuring credit and operational risks start the process in 2007, with banks adopting the advanced approaches beginning the following year. However, banks in the emerging market countries are advised to implement the new accord - Basel II - only when they are sure they are ready.
Turbulent years
After the turbulent events of recent years, which witnessed east Asia's devastating 1997-98 financial crisis, and Malaysia's wholesale banking industry consolidation, cutting bank numbers from 54 to 10, it is hardly surprising that the country's central bank - Bank Negara Malaysia (BNM) - is moving towards Basel II implementation with a considerable degree of caution.
Under the BNM's plans, the Malaysian banks choosing Basel II's simplest credit risk measurement option (standardised approach), will implement it in 2008. Three or four of the country's biggest banks are expected to seek permission to adopt the intermediate credit risk option - the foundation internal ratings based approach (F-IRB). If these banks' capital models are approved, they will be able to move directly to the F-IRB approach in 2010 (no banks are likely to be allowed to adopt the most sophisticated option - the advanced internal ratings based approach or A-IRB - for many years to come).
Those banks implementing the standardised credit measurement option in 2008 are also most likely to adopt the basic indicator approach to calculating their operational risks, although they may be allowed to undertake the intermediate op risk calculation method if they can justify the case to the authorities. All three op risk measurement options will be theoretically available to the handful of banks moving to F-IRB in 2010, but once again they will have to demonstrate to supervisors that the choice is appropriate in relation to their data and skills.
According to ratings agency Fitch Ratings, an assessment of the impact of Basel II on the Malaysian banking system, conducted in October 2002 by BNM, found that the capital ratios of banks on the standardised credit risk measurement approach would probably drop marginally, but still remain above the 8% regulatory minimum requirement set by the accord. A study of the banks' readiness to adopt the F-IRB concluded that they faced big problems in collecting historical loss data.
Internal risk rating systems are quite new, where they exist at all. On top of that, the bank mergers of recent years have added another layer of complexity. Mergers often disrupt data collection, and the data sets of merged banks are frequently incompatible.
On the other hand, the Malaysian banking system is arguably more robust and better managed and supervised as a consequence of events since the later 1990s. "Malaysia handled the crisis pretty well, and probably better that most other countries in the region," says John Tham, a senior bank analyst at Moody's rating agency, in Singapore. South Korean banks also made a fairly rapid recovery, but subsequently stumbled into a new crisis as a result of excessive credit card lending. "Malaysian banks are intrinsically stronger than before the 1997 Asian financial crisis," Moody's concluded in a recent report.
Unconventional policies
Malaysia emerged from the crisis after a mixture of orthodox and unconventional policies. Cash was injected into banks and their bad loans were bought by a government-created asset management company. But the government also imposed capital controls in the teeth of condemnation from Western investors and the International Monetary Fund, the Washington-based multinational agency. Although these controls were widely predicted to exacerbate the crisis and have a ruinous affect on the economy, the move paid off by keeping interest rates much lower than in the rest of east Asia, and thus containing the damage to the banks. Most controls have now been removed.
"So far, the affects [of the crisis] have been positive for Malaysian banks, in the sense that it created an awareness of the importance of credit risk. It showed banking is not just about profits and loan growth," says Adrian Chee, banking analyst at Standard and Poor's rating agency, in Singapore.
Driving consolidation
The crisis also created the conditions for the government to drive through fairly comprehensive consolidation of the industry. In the aftermath of the crisis there were a raft of small banks that had been greatly weakened, and in need of government support.
The response of Kuala Lumpur was to "call on the better quality banks that had survived the episode in relatively better shape to acquire the weaker banks," explains Peter Tebbutt at Fitch Ratings in Hong Kong. In some cases, the acquiring bank had to pay a premium. But with a mixture of arm-twisting, cajolery and inducements, the government got its way, largely dictating which bank would takeover which other. "It was inevitable," says Tebbutt. "Something had to be done."
Thus, during 2000 and 2001, the Malaysian government was able to achieve mergers between often very independent and jealously-defended institutions - something other authorities in over-banked Asian countries have not been able to achieve. A further reduction in the number of banking groups is contemplated by the government, from ten to around six or seven. However, this process will now, apparently, be left to market forces rather that state guidance.
Financial Master plan
As part of phase one of the Government's Financial Sector Master Plan (FSMP), the ten bank groups also took over independent finance companies or merged their existing commercial bank and finance company subsidiaries. A combination of commercial banking, merchant (investment) banking, and hire purchase, has effectively created a universal banking model among the leading institutions. And, by allowing the merger of merchant banks, discount houses and stockbrokers, the government is also promoting the emergence of full-blown investment banks. This FSMP phase, covering the years 2001-2004. is described as the Domestic Capacity Building period.
This is being followed by a phase of Increasing Competition (2004-2008), involving a gradual relaxation of regulatory restrictions currently imposed on foreign banks. At the time of the country's independence nearly 50 years ago, foreign banks controlled 90% of the local market. Restrictions on foreign banks have reduced the share to 20% today.
However, there is an acceptance by the government that these restrictions must be scaled back if Malaysia is to develop as a financial and trading centre in the region. Integration with the International Market is the third phase (2008-2011) of the master plan. During this phase, some larger local banks are likely to begin trading offshore. Additional foreign bank entry into the country may be allowed.
Today, as the banking system approaches the mid-point of the master plan, the verdict of the rating agencies is pretty positive: well-capitalised banks, with above average earnings, are operating in a stable and well-regulated environment. Non-performing loans (NPLs) remain high, but are still steadily improving. On a three-month overdue basis, NPLs were reckoned to be 13.8% of total loans, on average, at the end of 2003 (the latest figures available), down from 17.8% in 2001. However, bad loan ratios vary widely between banks. At the height of the crisis, NPLs are estimated to have been approaching 30%, before allowing for the sale of bad loans to a special asset-management company created by the government.
Meanwhile, Fitch calculates that the capital ratio for the banking system as a whole is a "solid" 13.6%, compared with 10.1% at the end of 1998.
In general, the quality of bank regulation also gets good marks. "Bank Negara is staffed by some very competent people. They are quite impressive," says Fitch's Peter Tebbutt, "particularly compared with those at other Asian central banks." The problem is that BNM is very close to the banks and very secretive about its dealings with them, he says. "There is a culture of secrecy both among banks and supervisors." Bank Negara undoubtedly keeps the banks on a tight rein, and knows everything that is going on, but very little information is disclosed publicly, Tebbutt adds.
This does throw up a potential problem in relation to Basel II, which requires transparency in the supervisory oversight process, as well as public disclosure by banks of their risk management procedures and controls.
A change in attitudes in Malaysia is quite possible, Tebbutt says, noting that Singapore was very similar before the regional financial crisis. Afterwards, however, the authorities decided to introduce international standards of disclosure in Singapore.
As elsewhere in Asia, however, it is risk management that remains the prime weakness. A new credit bureau, known as CCRIS (Central Credit Risk Information System), run by BNM, now allows banks to undertake credit checks on large and small companies and individuals. This should enable banks to better price their loans according to the credit-worthiness of borrowers. But internal risk rating models "are not much more than basic," says S&P's Adrian Chee.
This weakness was acknowledged in a speech on risk management given last spring by BNM governor Zeti Akhtar Aziz. Malaysia's implementation of Basel II would be based on four principles she said, including combining capacity building efforts with "strong emphasis on gradual enhancement to risk management framework for all banking institutions."
Left in no doubt
The other principles included: "a more flexible timeframe [for Basel II's introduction] that allows capacity building measures to be implemented;" a strong business justification for banks adopting F-IRB, rather than a specifically regulatory one; and an "enhanced supervisory methodology to assess [banks'] internal models and advanced risk management systems."
The BNM governor left bankers in the audience in no doubt that they had to start giving risk management a high priority. As the government owns 30% of banking assets, including majority stakes in the country's two biggest banks, it has powerful levers to pull in order to ensure that it gets what it wants.
The message is unlikely, however, to have caused any concern to those from the top three or four Malaysian banks - Malayan Banking (Maybank), the country's largest; Commerce Asset-Holding Berhad (parent of Bumiputra-Commerce Bank); RHB Bank; and Public Bank. They are all thought to want to adopt the foundation internal ratings based approach credit risk measurement under the new Basel capital accord.
For the smaller banks, obliged to invest in costly systems, the insistence on strong risk management may have been a little less welcome. Given the government's past success in driving the banking industry down the officially chosen path, it will be unsurprising if Malaysian banks are all deploying risk management systems before very long.
