Malaysia: Reserve Requirements, AFC

By early 1998, illiquidity in domestic financial markets disrupted corporate borrowers’ access to credit. Lending rates rose above the official target interbank rate, creating debt servicing problems in the corporate sector. In response, BNM lowered the SRR for commercial banks, merchant banks, and finance companies (BNM 1998a; BNM 1999). The central bank said in press releases that it would sterilize the SRR cuts on February 16 and July 1, 1998, to maintain its tight monetary policy (BNM 1998a; BNM 1998e). The central bank said in press releases that it would sterilize the SRR cuts on February 16 and July 1, 1998, to maintain its tight monetary policy (BNM 1998a; BNM 1998e).

As inflationary pressure subsided, BNM began monetary easing in August 1998 (BNM 1998h). Thus, BNM did not sterilize the SRR cuts on September 1 and 16, 1998 (BNM 1998h; BNM 1998j). These SRR reductions along with the reduced interbank rate would ease liquidity in the banking system so that borrowers could more readily obtain loans at a lower rate (BNM 1998h; BNM 1998j; BNM 1999).

BNM sought to stem inflation from the ringgit’s depreciation during the first half of 1998 (BNM 1998a; BNM 1999). To sterilize the additional liquidity that would have been released by the SRR reductions, BNM reduced direct lending on the interbank market in conjunction with its SRR reductions on February 16, 1998, and July 1, 1998 (BNM 1998a; BNM 1998b; BNM 1998e; BNM 1998f). BNM estimated that the February 16 and July 1 reductions would have released MYR 14 billion and MYR 8 billion of additional funds, respectively, if the central bank had not reduced direct lending (BNM 1998a; BNM 1998e).

To maintain tight monetary policy, BNM raised the three-month interbank rate from 10% to 11% with the first SRR reduction on February 16, 1998 (BNM 1998a).

BNM began “cautious” monetary easing in August 1998 and lowered the three-month interbank rate to 9.5% with the SRR reduction on September 1, 1998 (BNM 1998g).

Earlier in March 1998, BNM said that it would review the role of the the SRR and liquid asset requirement (LAR) to “fully [restore] investor confidence and [create] an environment that would support the return of the economy to a stronger growth path” (BNM 1998c). The LAR required that commercial banks hold at least 17% of their eligible liabilities in liquid assets; the requirement was 10% for finance companies and merchant banks (or 12.5% if they granted negotiable instruments of deposit) (BNM 1998g).

On July 31, 1998, BNM announced a new liquidity framework that phased out the LAR. Instead, the BNM required banking institutions to forecast their assets, liabilities, and off-balance-sheet commitments to meet near-term obligations in addition to “unexpected heavy withdrawal for at least one month” (BNM 1998g). In practice, commercial banks had to be able to withstand the withdrawal of 5% of their deposit base over a week or 7% over a month; merchant banks and finance companies had to be able to withstand the withdrawal of 5% of their deposit base over a week or 15% over a month (BNM n.d.a). BNM phased in the new framework over six months. It required companies to continue to comply with the LAR standard during the transition (BNM 1998g).

The Central Bank of Malaysia Act 1958 (Revised—1994) established BNM as Malaysia’s central bank (CBM Act 1994, secs. 3–4). Under this framework, and with the finance minister’s approval, BNM could require banking institutions^FUnder Section 2 of the Central Bank of Malaysia Act 1958 (Revised—1994), “banking institution” was an inclusive term that meant “a licensed bank, a licensed merchant bank or a licensed finance company as defined in the Banking and Financial Institutions Act 1989 or an Islamic Bank” (CBM Act 1994, sec. 2). Banking institutions obtained licenses by submitting applications to BNM and the finance minister with detailed memoranda on constituent documents, governance, audited balance sheets, and more (Banking and Financial Institutions Act 1989, sec. 5). to hold reserves in Malaysian or foreign currency, possibly differentiated by the size or location of banking institutions (CBM Act 1994, secs. 37, 39).

With the finance minister’s approval, BNM required banking institutions to meet the SRR (CBM Act 1994, secs. 37, 39).

A board of directors was responsible for BNM’s policy and general administration (CBM Act 1994, sec. 8). The board included the governor, three or fewer deputy governors, and five to eight directors (CBM Act 1994, sec. 8). The board informed the finance minister of its monetary and banking policy. The finance minister could issue binding directives if he or she disagreed with their plans and operations. In the event that the board objected to the finance minister’s override, the House of Representatives would hear the objections and reasoning of both sides (CBM Act 1994, sec. 34).

Beyond legal frameworks, research did not uncover specific instances of oversight pertaining to SRR reductions during the AFC.

BNM announced changes to the SRR through press releases^FBNM’s Communication Centre accepted queries about its policy measures by telephone from 8:30am to 12:00am Malaysian Standard Time. International parties could send queries beyond these business hours by fax (BNM 1998i). (BNM 1998a; BNM 1998e; BNM 1998h; BNM 1998j).

In first half of 1998, BNM sought tight monetary conditions (BNM 1998a). However, a contemporaneous Morgan Stanley report suggested that BNM’s SRR reduction on February 16, 1998, had an easing effect. The Business Times quoted this report and characterization on March 9, 1998. BNM Deputy Governor Fong Weng Phak issued a follow-up press release in response on the same day. He pointed to reduced direct lending to the interbank market by BNM and higher interbank lending rates as evidence that monetary conditions remained tight (BNM 1998b). BNM issued a similar clarification press release on June 26, 1998, to reiterate its larger commitment to tightened monetary policy (BNM 1998f).

When the government began to pursue monetary easing in August 1998, BNM said that the “combined impact of the reduction in SRR and [three-month interbank rate would] ease liquidity in the system, making available more loanable funds to borrowers, and at a lower rate” (BNM 1998h; BNM 1998j).

Banking institutions had to hold reserves at the central bank, whether in Malaysian ringgit or other foreign currencies (CBM Act 1994, sec. 37).

Research did not identify contemporaneous BNM public statements describing the liabilities covered by reserve requirements.

According to more recent BNM documentation, reservable liabilities included demand deposits, savings deposits, fixed deposits, specific investment deposits, general investment deposits, commodity murabahah,^FAlso known as cost-plus financing; an Islamic financing structure where the buyer and seller agree on an asset’s cost and markup. The markup takes the place of interest, since interest is illegal under Islamic law. Thus, murabahah is a form of credit sale under Islamic law rather than an interest-bearing loan (Young 2020). call deposits, short-term deposits, investments linked to derivatives, other deposits, notional interest deductions (NIDs), repurchase agreements, special deposits (withholding tax), housing development account deposits, amounts due to designated financial institutions, miscellaneous borrowings, interest payable to nonresidents, bills payable to nonresidents, and other miscellaneous liabilities due to nonresidents (BNM 2020).

Reservable liabilities excluded subordinated debt capital, exempt subordinated debt capital, subordinated debt capital with special approval from BNM, and recourse obligations on loans to Cagamas, the National Mortgage Corporation of Malaysia (BNM 2020).

BNM computed the SRR for all banking institutions on the basis of the average amount of reserves each institution held during a two-week reserve maintenance period. BNM allowed an institution’s reserves to vary over that period. In May 1998, BNM widened the band for permissible daily variation in reserve assets from ±0.5% to ±2.0%,^FIn a press release announcing the computation change, BNM stated that the 2.0% band was based on a 20% variation on the prescribed SRR rate (BNM 1998d). It is unclear what the mechanics are behind the 20% variation. to increase transparency and liquidity flows in the interbank market (BNM 1998d; BNM 1999).

In its press releases, BNM stated that the SRR reductions applied to “commercial banks, merchant banks and finance companies” (BNM 1998a). BNM interchangeably used the inclusive term, banking institutions,^FIn its 1998 Annual Report, BNM defined the “banking system” similarly to its definition of “banking institution”: The banking system consisted of commercial banks, merchant banks, and finance companies (BNM 1999). According to the IMF, Malaysia had 37 commercial banks in 1994, of which 21 were domestic-owned, and 16 were foreign-owned. Commercial banks made up approximately 85% of the banking system’s total assets in 1994 (IMF 1994). By year-end 1996, commercial banks accounted for 67% of total banking system assets (IMF 1997). According to data from the World Bank, total assets of the five largest banks as a share of total commercial banking assets were 61.6% in 1998 (World Bank n.d.). to refer to eligible commercial banks, merchant banks, and finance companies in communications to the public (BNM 1998a).

Malaysia began to acutely feel the effects of the AFC in the early months of 1998—after the crisis had peaked in Thailand and Korea (BNM 1999; Kaplan and Rodrik 2001). BNM lowered the SRR twice during the second phase of the government’s crisis response: from 13.5% to 10% on February 16, 1998, and from 10% to 8% on July 1, 1998. The central bank reduced its direct lending to the interbank market to offset additional liquidity and set the three-month interbank rate at 11% to maintain tight monetary policy (BNM 1998a; BNM 1998e). By August 1998, BNM began easing monetary policy, as ringgit rates stabilized and inflation calmed (BNM 1998h). To this end, BNM also began to lower the three-month interbank rate (BNM 1998i). BNM reduced the SRR during the third phase of the crisis response on September 1, 1998, from 8% to 6% (BNM 1998h). The central bank lowered the SRR during the fourth phase of crisis response on September 16, 1998, from 6% to 4% (BNM 1998j).

Effective February 16, 1998, BNM announced a reduction in the SRR of commercial banks, merchant banks, and finance companies from 13.5% to 10% of eligible liabilities. The announcement stated that BNM would sterilize additional liquidity to the banking system by lowering its direct interbank lending, so as not to accelerate base money growth (BNM 1998a).

BNM began to publish information on April 30, 1998, about its daily operations—cash flow projections, liquidity operations, and money market tender results—to improve transparency (BNM 1998d).

On May 1, 1998, BNM widened the band for permissable daily variation in the average balances required to meet the SRR from ±0.5% to ±2.0%, to give banking insitutions more flexibility in their daily liquidity operations (BNM 1998d; BNM 1999).

On July 1, 1998, BNM further reduced the SRR from 10% to 8% of eligible liabilities. This 2% reduction, they posited, would lower the BLR of commercial banks and finance companies by 0.21% and 0.27%, respectively (BNM 1998e). BNM anticipated an additional MYR 8 billion to the banking system, sterilized by reducing its interbank lending, and closely monitored interbank market liquidity (BNM 1998e; BNM 1998f).

Effective September 1, 1998, BNM dropped the SRR of eligible liabilities of commercial banks, merchant banks, and finance companies from 8% to 6% (BNM 1998h).

On September 16, 1988, BNM lowered the SRR from 6% to 4% of eligible liabilities at banking institutions, finance companies, and merchant banks to “improve the distribution of liquidity among individual banking institutions, thereby enhancing lending capacity of banking institutions” (BNM 1998j).

The two September cuts would inject about MYR 15 billion^F4% of eligible liabilities (8% minus 4%) as of August 31, 1998. into the banking system (BNM n.d.b).

See Figure 2 for a timeline of SRR reductions.

Malaysia’s SRR was unremunerated, according to an October 1997 IMF report. Malaysian officials told the IMF that “the high level of unremunerated reserves impose[d] a significant implicit tax burden on financial intermediation” (IMF 1997, 15).

Beyond banking institutions—defined as licensed banks, licensed merchant banks, and licensed finance companies—research did not find additional restrictions for institutions eligible for reductions in the SRR (CBM Act 1994, sec. 2).

BNM estimated that the February 16 and June 26 reductions to the SRR released MYR 14 billion and MYR 8 billion into the banking system, respectively, although it simultaneously offset these increases by cutting its direct lending on the interbank market (BNM 1998b; BNM 1998e).

By the end of July 1998, BNM determined that its overall policy package had successfully combated inflation; it said that “cautious” easing was in order (BNM 1998g).

BNM reported that the unsterilized SRR reductions on September 1 and 16 injected about MYR 15 billion into the banking system (BNM n.d.b).

BNM announced the last change to the SRR from 6% to 4%, effective September 16, 1998. None of the press releases contained a predetermined end date to the SRR reduction^FBNM maintained the SRR at 4% until November 24, 2008, when the central bank lowered the SRR from 4% to 3.5% during the Global Financial Crisis (BNM 2008; BNM n.d.c). (BNM 1998j).