According to the International Monetary Fund's 2005 Public Information Notice, at the time, the capital adequacy of banks in Malaysia was strong, the ratio of non-performing loans had continued to decline, and efforts to mitigate companies' high exposure to interest rate risks, and banks' potential exposure to credit risks in the household sector had been enhanced. The implementation of the ten-year Financial Sector Master Plan, formulated by the Central Bank of Malaysia (BNM) in 2001, was also on track with key measures aimed at improving the prudential and regulatory framework. The BNM was established under the 1958 Central Bank of Malaysia Act, as the regulatory and supervisory authority for the banking system in Malaysia, which is composed predominantly of commercial banks. According to a 2006 study published by the Bank for International Settlements, Malaysian authorities are focused on aligning the country's financial institutions' prudential regulations to international standards. Malaysia has also implemented a more principle-based regulatory regime for the financial sector, which remains at a relatively early stage, according to the BNM's 2007 Financial Stability and Payment Systems Report (published in 2008). In addition, the BNM has enhanced its risk-based supervisory framework applicable to all types of financial institutions, thus enabling consolidated supervision of financial conglomerates, as stated in a 2008 study by the South East Asian Central Banks. Despite the information provided above, there is insufficient information publicly available regarding Malaysia's actual compliance with the Basel Core Principles for Effective Banking Supervision.

General Overview

In March 2005, the International Monetary Fund (IMF) published a Public Information Notice regarding the conclusion of an Article IV consultation with Malaysia in February 2005. The report highlighted that indicators of financial and corporate sector soundness continued to improve in Malaysia, with strong capital adequacy ratios for banks, a decline in the ratio of non-performing loans, and efforts to mitigate companies' high exposure to interest rate risks, and banks' potential exposure to credit risks in the household sector. However, there is little information publicly available that actually addresses Malaysia's compliance with the Basel Core Principles for Effective Banking Supervision.

Banking and Financial Institutions Act No. 372 of 1989 provides the legal framework for banking supervision in Malaysia. The Islamic Banking Act No. 276 of 1983 further stipulates the licensing, regulation and supervision of Islamic banks with branches operating in various parts of the country. The Central Bank of Malaysia (BNM) was established under the Central Bank of Malaysia Act No. 519 of 1958, which was last revised in 1994. According to a 2008 Bank Watch Guide by the South East Asian Central Banks (SEACEN), the BNM functions as the regulatory and supervisory authority for the banking industry. Furthermore, the BNM oversees and regulates the insurance sector, money changers and development finance institutions, and has been appointed the competent authority under the Anti-Money Laundering (AML) and Anti-Terrorism Financing (CFT) Act No. 613 of 2001. In 2005, per the U.S. Department of Commerce's (DoC) 2008 Country Commercial Guide, the government of Malaysia established the Malaysian Deposit Insurance Company (MDIC) to improve consumer protection. Furthermore, in June 2007, the BNM launched the Regulatory Handbook to enable more timely and efficient dissemination of regulatory guidelines to financial institutions under its purview.

As of 2007, per the BNM's 2007 Financial Stability and Payment Systems Report (published in 2008 and hereafter referred to as the BNM's 2008 report), there were 22 commercial banks in Malaysia, including finance companies, 14 investment banks and merchant banks, 1 universal broker, and 11 Islamic banks. Commercial banks play a major role in Malaysia's financial system, as reported in a 2007 study by Dilli Raj Khanal, with total assets amounting to about USD272.7 billion at the end of 2005. During the same period, total loans and total deposits of commercial banks represented approximately 94 percent and 93 percent of the Malaysian banking system's total loans and deposits, respectively. Operating in parallel with conventional finance, Islamic finance has also experienced rapid growth in recent years, as stated in the BNM's 2008 report, and thereby enhancing its significance in the Malaysian financial system. Islamic banking assets expanded at an average annual rate of 19.3% since 2003 to constitute 15.4% of assets of the total banking system in 2007.

According to a 2006 study by Zamani published by the Bank for International Settlements (BIS), maintenance of financial stability requires an holistic approach, which encompasses "micro and macro surveillance, risk-based supervisory frameworks, prudential standards and risk management principles that are aligned with international practices, and financial safety nets" (p. 272). The study further notes that Malaysian authorities are focused on aligning the country's financial institutions' prudential regulations to international standards. According to the BNM's 2008 report, more than fifty prudential standards have been developed or reviewed under a more principle-based regulatory approach since 2001 in Malaysia. The BNM report notes, however, that the implementation of a more principle-based regulatory regime for the financial sector remains at a relatively early stage. Sixteen prudential standards were issued in 2007, including guidelines on the revised risk-weighted capital adequacy framework (Basel II), capital adequacy framework for Islamic banks, exposures with connected parties, single counterparty exposure limit, appointment of external auditors, and risk governance. The BNM has further enhanced its risk-based supervisory framework applicable to all types of financial institutions, according to the 2008 study by SEACEN, thus enabling consolidated supervision of financial conglomerates. The SEACEN study notes that the risk-based supervisory framework namely focuses on the "assessment of significant activities' inherent risks, the quality of overall risk management and capital adequacy, in line with the implementation of Basel II and risk based capital standards" (p. 48). Furthermore, the enhanced framework provides for on-site and offsite surveillance, and monitoring of board and senior management oversight, internal audit, and risk management. Supervisory reliance has also been placed on the work of external auditors and actuaries. The SEACEN study states that numerous measures have been taken to ensure effective and efficient implementation of the enhanced framework. These measures include the establishment of a Quality Assurance Framework, and increased resources into staff training.

As reported in the U.S. DoC 2008 Country Commercial Guide, Malaysian government's policies are guided by the Banking and Financial Institutions Act of 1989, and the ten-year Financial Sector Master Plan (FSMP). The FSMP was formulated by the BNM in 2001 to outline a three-phase strategy over ten years for developing the Malaysian banking sector. The U.S. DoC report notes that Phase I focuses on developing a core set of domestic banking institutions through mergers of commercial banks with merchant banks, discount houses and stock brokerage firms. Phase II includes the removal of many restrictions on incumbent foreign financial institutions. The government of Malaysia was expected to enter Phase III at the end of 2007 to tackle the issue of foreign competition. The FSMP also set the target for Islamic banking to hold 20 percent of banking assets by 2010. At the time of the IMF's 2005 Public Information Notice, the implementation of the FSMP was on track with recent key measures aimed at improving the prudential and regulatory framework.

In July 2004, the IMF conducted a financial sector regulation and supervision review of Labuan, an offshore financial center located in Malaysia, where businesses receive preferential tax treatment for offshore banking activities, trust and fund management, offshore insurance and offshore insurance-related businesses, and offshore investment holding businesses. According to the report, banking supervision in Labuan was relatively well-developed and on-site and offsite supervision were being intensified. While the broad legal and organizational framework for financial supervision in Labuan was well conceived, the IMF report identified shortcomings in Malaysia's legislation, regulation and actual practice. According to the U.S. Department of State (DoS) 2008 International Narcotics Control Strategy Report, the Labuan Offshore Financial Services Authority is under the authority of the Ministry of Finance, and works closely with the BNM. The report notes that the offshore banking center on the island of Labuan has different regulations for the establishment and operation of offshore businesses.

The Principles

1. (1) Clear responsibilities and objectives for each supervisory agency.

II

According to the 2008 study by SEACEN, the BNM, which was established under the 1958 Central Bank of Malaysia Act, functions as the regulatory and supervisory authority for the banking industry, which comprises commercial banks, including finance companies, investment banks and merchant banks, universal brokers, and Islamic banks. Furthermore, the BNM oversees and regulates the insurance sector, money changers and development finance institutions, and has been appointed the competent authority under the 2001 AML/CFT Law. Nevertheless, there is insufficient information publicly available clearly identifying Malaysia's compliance with this principle.

1.(2) Operational independence and adequate resources.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

1.(3) A suitable legal framework for authorization and ongoing supervision.

II

The Banking and Financial Institutions Act No. 372 of 1989 provides the legal framework for banking supervision in Malaysia. The Islamic Banking Act No. 276 of 1983 further stipulates the licensing, regulation and supervision of Islamic banks with branches operating in various parts of the country. The BNM was established under the Central Bank of Malaysia Act No. 519 of 1958, which was last revised in 1994. However, there is insufficient information publicly available clearly identifying Malaysia's compliance with this principle.

1.(4) A suitable legal framework to address compliance with laws as well as safety and soundness concerns.

II

According to the 2008 study by SEACEN, the BNM has enhanced its risk-based supervisory framework, applicable to all types of financial institutions, and provides a systematic and dynamic supervisory process to assess the safety and soundness of licensed institutions. However, there is insufficient information publicly available clearly identifying Malaysia's compliance with this principle.

1.(5) Legal protection for supervisors.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

1.(6) Arrangement for sharing of information between supervisors and protection of confidentiality of shared information.

II

The BNM, as stated in its 2008 report, has concluded formal agreements with the Securities Commission and the Malaysia Deposit Insurance Corporation, aimed at reducing regulatory overlaps and inconsistencies, and facilitating the sharing of information where appropriate. An agreement between the BNM and the MDIC has also been put in place to outline the accountabilities and responsibilities of both agencies in promoting sound risk management practices in the banking industry. At the regional level, the BNM has deepened supervisory cooperation with the Executives' Meeting of East Asia-Pacific Central Banks (EMEAP), and the SEACEN to, inter alia, facilitate the implementation of Basel II within the region. At the international level, the BNM has signed a Memorandum of Understanding (MoU) with the State Bank of Vietnam to improve cross-border supervisory collaboration. However, there is insufficient information publicly available clearly identifying Malaysia's compliance with this principle.

2. Clearly defined permissible activities for banks and control of the use of the word 'bank'.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

3. Criteria for structure, directors, operating plan, controls, financial condition and capital base.

II

The BNM notes in its 2007 Financial Stability and Payment Systems Report that clear emphasis has been placed on corporate governance, including major revisions to prudential standards focusing on the role of the board and senior management in ensuring a sound risk management and internal control environment within financial institutions. Supervisory processes have also been enhanced to ensure that directors and chief executive officers of financial institutions fulfill fit and proper criteria on an ongoing basis. Per the same report, the effectiveness of board oversight and senior management has, on the whole, continued to improve. However, there is insufficient information publicly available clearly identifying Malaysia's compliance with this principle.

4. Authority to review and reject transfer of ownership.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

5. Authority to review major acquisitions and investments.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

6. Minimum capital adequacy requirements (meet Basle Capital Accord for internationally active banks).

II

According to the IMF's 2005 Public Information Notice, at the time, capital adequacy of banks in Malaysia was strong. In 2007, the BNM issued prudential standards, including guidelines on the revised risk-weighted capital adequacy framework (Basel II), as stated in its 2008 report. Basel II, which is applicable to commercial banks, including finance banks, became effective from January 1, 2008 for a total of 27 banking institutions. As of November 30, 2007, per the same report, the risk weighted capital ratio of the banking system was 13.2%. Prudential standards further addressed the capital adequacy framework for Islamic banks, covering credit, market and operational risks consistent with the capital adequacy standards issued by the Islamic Financial Services Board. The BNM report noted, however, that while capital ratios were adequate, requirements did not conform with the Basel standards. As noted in Khanal (2007), the BNM employs the CAMEL (capital adequacy, asset quality, management quality, earnings performance and liquidity position) framework to evaluate the overall financial and general conditions of a banking institution. Despite the above information, the available sources do not directly address Malaysia's compliance with this principle.

7. A method exists for the evaluation of procedures related to loans, investments and portfolio management.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

8. Policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves.

II

Non-performing loans have declined since the Asian financial crisis, reaching a 10-year low of 3.2% in 2007, as noted in the BNM's 2008 report. Furthermore, continued improvements in asset quality have reduced loan loss provisions. As stated in Khanal (2007), the BNM employs the CAMEL (capital adequacy, asset quality, management quality, earnings performance and liquidity position) framework to evaluate the overall financial and general conditions of a banking institution. However, the available sources do not directly address Malaysia's compliance with this principle.

9. Prudential limits and management information system on concentration of exposure.

II

In 2007, the BNM issued prudential standards, including guidelines on single counterparty exposure limit, as stated in its 2008 report. The guidelines were aimed at strengthening the prudential requirements for controlling concentrated exposures to single names in line with international standards and best practices. However, there is insufficient information publicly available clearly identifying Malaysia's compliance with this principle.

10. Arm's length rule and monitoring for connected lending.

II

According to the BNM's 2008 report, in 2007, the BNM issued prudential standards, including guidelines on credit transactions and exposures with connected parties. The guidelines were aimed at providing greater flexibility for banking institutions to extend credit to connected parties based on arm's length principles and subject to sound risk management practices and concentration limits. However, there is insufficient information publicly available clearly identifying Malaysia's compliance with this principle.

11. Policies and procedures for country risk and transfer risk.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

12. Measuring and monitoring market risk. Limit and/or specific capital charge on market risk exposure.

II

According to the IMF's 2005 Public Information Notice, the government of Malaysia has continued its efforts in mitigating finance companies' relatively high exposure to interest rate risks and banks' potential exposure to credit risks in the household sector. Per the same report, risk management has been strengthened notably through the introduction of pricing innovations for Islamic instruments, and the establishment of a credit reporting system. However, the IMF report does not directly address Malaysia's compliance with this principle.

13. Comprehensive risk management processes.

II

According to SEACEN (2008), the BNM has enhanced its risk-based supervisory framework, applicable to all types of financial institutions. The SEACEN study notes that the risk-based supervisory framework namely focuses on the "assessment of significant activities' inherent risks, the quality of overall risk management and capital adequacy, in line with the implementation of Basel II and risk based capital standards" (2008, p. 48). The SEACEN study states that numerous measures have been taken to ensure effective and efficient implementation of the enhanced framework. As such a Quality Assurance Framework has notably been put in place to provide "quality assurance and consistency in terms of accurate risk assessment, timely and effective intervention and feedback, across the Bank's supervisory departments" (2008, p. 49). Specialized risk units, including credit, market, operational and insurance risk units, have also been formed to support the supervisory function. However, there is insufficient information publicly available clearly identifying Malaysia's compliance with this principle.

14. Adequate internal controls.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

15. Strict "know-your-customer" rules and high ethical and professional standards.

II

According to the 2008 study by SEACEN, the BNM has been appointed by the Minister of Finance as the competent authority for administering the AML/CFT Law of 2001. In 2002, per the 2008 U.S. DoS report, the AML/CFT Law provided for the establishment of a financial intelligence unit in Malaysia. The U.S. DoS report further noted that Malaysia's growing Islamic finance sector was subject to the same AML/CFT supervisory framework as commercial banks. An on-site visit by the Asia/Pacific Group on Money Laundering (APG) for the Mutual Evaluation of Malaysia took place from 29 January - 9 February 2007. According to the 2007 mutual evaluation by the APG, Malaysia is largely compliant with the Financial Action Task Force's (FATF) recommendation on customer due diligence and internal controls by financial institutions. Similarly, the report notes that the country is compliant with the FATF's recommendation on record keeping and partially compliant with the FATF's recommendation on suspicious transactions reporting by financial institutions. Despite the above information, none of the available sources directly address Malaysia's compliance with this principle.

16. Effective supervisory system consisting of on-site and off-site supervision.

II

The 2008 SEACEN study states that the enhanced risk-based supervisory framework of the BNM provides for on-site and offsite surveillance, as well as monitoring of board and senior management oversight, internal audit, and risk management. Supervisory reliance has also been placed on the work of external auditors and actuaries. In 2007, the BNM issued prudential standards, including guidelines on the appointment of external auditors, as stated in its 2008 report. However, the available sources do not directly address Malaysia's compliance with this principle.

17. Regular contact with bank management and understanding of bank's operations.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

18. Analytical reports and statistical returns on solo and consolidated basis.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

19. Independent validation of supervisory information through on-site examination or external auditors.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

20. Ability to supervise on a consolidated basis.

II

The 2006 Zamani study notes that "the increasingly complex group structures involving financial conglomerates have called for the development of consolidated supervision framework" (p. 272). In light of Malaysia's participation in international agreements, including the Uruguay Round and the General Agreement on Trade Services (GATS), as stated in the 2007 report by Khanal, the BNM has introduced several measures to consolidate the banking system, including a two-tier system to encourage banks to recapitalize into larger units so that they could become competitive domestically and abroad. The BNM has also enhanced its risk-based supervisory framework, applicable to all types of financial institutions, thus enabling consolidated supervision of financial conglomerates, according to the 2008 report by SEACEN. However, the available sources do not directly address Malaysia's compliance with this principle.

21. Consistent accounting policies and practices that provide a true and fair view of the financial condition of the bank.

II

According to a regulatory and standard-setting framework assessment published by the Malaysian Institute of Certified Public Accountants, in February 2005, the BNM served as an advisor on the Malaysian Accounting Standards Board (MASB). In addition, the BNM issued guidelines on accounting and financial reporting requirements for compliance by licensed financial institutions. Approval from the BNM is also required for the appointment of external auditors. Per the October 2006 update available from the Deloitte & Touche IAS Plus website, the MASB announced that Malaysia's newly revised Financial Reporting Standards were generally consistent with the International Financial Reporting Standards issued by the International Accounting Standards Board, and would take effect as of January 1, 2007. Nevertheless, there is insufficient information publicly available clearly identifying Malaysia's compliance with this principle.

22. Adequate supervisory measures to ensure timely corrective action.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

23. Banking supervisors must practice global consolidated supervision over their internationally-active banking organizations.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.

24. International exchange of information with other supervisors.

II

The BNM, as stated in its 2008 report, has signed an MoU with the State Bank of Vietnam to improve cross-border supervisory collaboration. At the regional level, the BNM has also deepened supervisory cooperation with the EMEAP and SEACEN to, inter alia, facilitate the implementation of Basel II within the region. However, the available sources do not directly address Malaysia's compliance with this principle.

25. Supervision of local operation of foreign banks and information sharing with home country supervisors.

II

There is insufficient information publicly available regarding Malaysia's compliance with this principle.