Chapter 2:

Bank Negara Malaysia (BNM) and

the financial system

Topic outline
1. Principal objectives and functions of BNM.
2. Reserves safeguarding currency (balance
sheet)
3. Monetary instruments tools and its impact

PRINCIPAL OBJECTIVES AND

FUNCTIONS OF BNM

The

Central Bank of Malaya Ordinance 1958 (CBO)

(Central Bank of Malaya until the formation of
Malaysia in 1963) was enacted on 23 October 1958,
while the Central Bank of Malaysia was established
on 24 January 1959.
At the same time, the Banking Ordinance, 1958,
provided for the licensing and regulation of the
business of banking in the Federation of Malaya
also came into force.
The CBO was revised in 1994 and is now the
Central Bank of Malaysia Act 1958 (CBA).

 Objectives of BNM as outlined in the CBA are:

To promote monetary stability and a sound
financial structure;
To act as a banker and financial adviser to the
Government;
To issue currency and keep reserves safeguarding
the value of the currency;
To influence the credit situation to the advantage
of the country;

Over the years, the roles and responsibilities of BNM

have evolved and expanded.
Today, BNM focuses on three pillars of central
banking, namely:

monetary stability

financial stability; and

the payments system

Its main objectives as defined in the Central Bank of Malaysia Act 2009 are to:

Issue currency and keep the

reserves safeguarding the
value of the currency.

Act as a banker and

financial adviser and
financial agent to the
Government.

Promote the reliable, efficient and smooth operation of

national payment and settlement systems and to ensure that
the national payment and settlement systems policy is directed
to the advantage of Malaysia.

Promote monetary
stability and a sound
financial structure.

Influence the credit

situation to the advantage
of Malaysia.

Issue of Currency
Bank Negara commenced with the issue of the
Malaysian currency on 12 June 1967.
The unit of the currency then was the Malaysian
dollar made up of 100 cents.
The Malaysian currency board replaced the old
Malayan currency issued by the Currency board.
The Malaysian dollar and cent were renamed
ringgit and sen under the Malaysian Currency
(Ringgit) Act 1975.

Holding Reserves and to safeguard the

value of the currency
The Central Bank is the main keeper of the
Countrys official external reserves.
A small amount is however still held by the
Government.
The external reserves are normally held in the
form of gold, reserves position in the
International Monetary Fund (IMF), Special
Drawing Rights, and a diversified portfolio of
foreign exchange assets denominated in major
international currencies in the form of bank
balances, treasury bills, and long term securities.

Holding Reserves and to safeguard the

value of the currency
Since 27 September 1975, the external value
of the ringgit has been determined in terms of
a basket of currencies of those countries
which are significant trading partners of
Malaysia.

International Reserves of BNM as at 30

June 2010
The international reserves of Bank Negara Malaysia
amounted to RM309.8 billion (equivalent to
USD94.8 billion) as at 30 June 2010.
The reserves level as at 30 June 2010 has taken into
account the quarterly adjustment for foreign
exchange revaluation loss, following the
strengthening of the ringgit against most major
currencies during the quarter.
The reserves position is sufficient to finance 8.1
months of retained imports and is 4.4 times the
short-term external debt.

Banker and Financial Adviser to the

Government
BNM does not provide financing to the Government.
However, as the financial adviser to the Government,
BNM gives regular advice to the Government on the
management of its domestic and external debts and
the terms and timing of Government loan programmes.

Banker and Financial Adviser to the

Government
BNM also acts as the agent for the Government in
negotiations and concluding of loan agreements.
BNM is also responsible for trading, registering,
settlement and redemption of Government securities
through its computerised systems (RENTAS, FAST and
BIDS).

Monetary Policy
As the monetary authority of the country, BNM is
responsible for ensuring the monetary stability of the
country, encouraging a good financial structure and
influencing the credit situation so as to facilitate the
achievement of overall economic goals.
BNM conducts its monetary policy by influencing the
level of interest rates that borrowers have to pay on
their loans and that depositors earn on deposits.

Why is Monetary Stability Important?

When there is monetary instability, prices are
either rising (inflation) or falling (deflation)
and this can result in distortions and
undermine the long-term economic growth
prospects of the country.

Why is Monetary Stability Important?

If inflation is too high, people will be concerned about the
purchasing power of their money balances.
This would result in a greater demand for real assets like
houses and properties, which are thought to more
inflation-proof.
There would be less interest to invest in productive capacity
of the economy.
Similarly, savers would be less inclined to hold savings in
the financial system if they expect that the value of their
savings would be diminished.
Fixed income earners will find that they are able to buy less
goods and services and will experience a reduction in their
standard of living.

Whys is Monetary Stability Important?

High inflation would also make exports more
expensive to foreigners and this would reduce the
competitiveness of the exports.
Persistently high inflation would therefore reduce
the growth potential of the economy.
When the rate of inflation is negative, prices are
falling and businesses find their profits shrinking.
They may reduce their costs by cutting
expenditure and laying off staffs.

Why is Monetary Stability Important?

Workers in turn would have less money to
spend and thus reduce spending, resulting in a
further reduction in the demand for goods
and services.
This creates a vicious circle of falling prices
and contracting demand resulting in a
contraction in the level of overall economic
activity.

Banker to Banks
BNM is always ready to provide lender of last
resort facilities to institutions. BNM functions
to other banks:
Licensing of banks and other financial institutions.
Banking relationship
Lender of last resort
Inspection of banks
Distribution of currency

OVERVIEW ON THE BALANCE SHEET

OF BNM

BNM Balance Sheet (12 July 2009 12

July 2010)
Assets
Gold and Foreign Exchange and Other Reserves including SDR
Malaysian Government Papers
Deposits with Financial Institutions
Loans and Advances
Other Assets

Liabilities
Paid-Up Capital
General Reserve Fund
Other Reserves
Currency in Circulation
Deposits by:
Financial Institutions
Federal Government
Others
Bank Negara Papers
Allocation of Special Drawing Rights
Other Liabilities

RM
309,789,763,310
2,808,725,612
13,342,490,000
11,725,362,066
6,609,357,185
344,275,698,173
RM
100,000,000
13,478,068,329
6,803,005,809
51,355,022,699
151,185,581,501
17,175,371,105
1,335,843,536
72,076,452,338
6,469,138,649
24,297,214,207
344,275,698,173

BNM Balance Sheet (12 July 2009 12 July 2010)

Effective from 1999, all foreign assets and liabilities are revalued at the end of each
quarter. The US Dollar equivalent of International Reserves was USD 94,772.5
million as at 30 June 2010.
KUALA LUMPUR
7 July 2010
International Reserves (with Main Components)
30 June 2010
Total Gross International Reserves
Foreign Currency Reserves

DR. ZETI AKHTAR AZIZ

GOVERNOR
USD billion
94.8
84.9

IMF Reserve Position

0.4

SDRs

2.0

Gold

1.5

Other Reserve Assets

6.0

BNM Balance Sheet (12 July 2009 12 July 2010)

BNM Assets Components Chart

BNM Assets Components Chart

MONETARY INSTRUMENTS

How BNMs Monetary Policy affects

the Economy and Inflation
BNM

Economic Growth/
Inflation
Consumer &
Business Spending

Monetary
Operations

Money Supply

Interest Rates

Exchange Rate

Bank Reserves
(Liquidity)

Examples of Monetary Policy

BNM conducts its monetary policy by influencing the
level of interest rates that borrowers have to pay on their
loans and that depositors earn on their deposits.
When the economy is overheating and the threat of
inflation is high, monetary policy will be tightened by
withdrawing funds from the banking system and raising
interest rates.
The higher interest rates will encourage people to save
more and spend less.
It would also make it more expensive for people to
borrow money.

Examples of Monetary Policy

This will cause consumption and investment to slow
down to a level that is more sustainable and reduce the
prospect for high inflation.
Conversely, when economic conditions are weak, funds
will be injected into the banking system to reduce
interest rates.
With lower interest rates, spending and borrowing will
increase.
The resulting increase in consumption and investment
would stimulate further economic activity leading to
higher income, employment and economic growth.

When BNM wants to STIMULATE the

Economy
Economic
Growth Below
Potential

Inflation Very
Low

Short-term
Interest Rates
Economic
Activity

Bank
Reserves
Loans

When BNM wants to CONSTRAIN the

Economy

Inflation Too
High

Bank
Reserves

Short-term
Interest Rates
Loans

Economic Growth
Exceeding
Potential

Economic
Activity

Monetary Instruments
BNM formulate and implement the policy to
attain price stability.
The framework can be categorized by the
followings:
Shift in monetary strategy from monetary
targeting towards interest rates targeting
Transition towards a more market-based
monetary policy implementation procedure.

Monetary Instruments
Why shift?
The liberalization of interest rate led to a more market
oriented interest rate determination process.
Financial regulation and linearization has enhanced the
role of interest rate in monetary transmission mechanism.
A shift of pattern of the economy towards a more interestinelastic market.
BNM holds view that interest rate stability is an important
policy variable to promote a stable financial system.

Monetary Instruments
Quantitative

Qualitative

Statutory Reserve Requirement

Interest rate ceiling

Statutory Liquidity Requirement

Selected credit control

Discount Rate

Moral Suasion

Open Market Operations

Statutory Reserve Requirement

It is defined based on the ratio of the banks
eligible liabilities based on the following
components:
Deposits (including NCD and RA)
Net Interbank borrowings

All banks are required to place a certain

amount of eligible liabilities as cash reserve
with BNM.

Statutory Reserve Requirement

Monetary instrument for the purpose of
liquidity management.
Also serve as an instrument that deals with
any fundamental changes in the economic
environment.

Statutory Liquidity Requirements

This ratio was imposed to:
Ensure there are liquid assets at all times to meet
depositors withdrawals.
As a selective credit policy to influence liquidity
situation in the system.
SLR is also expressed as a percentage of the ELR
base.

Statutory Liquidity Requirements

Mobilized to the banking system before they can
earn return.
Increase in the ratio will provide less scope for
liquidating its assets to support an expansion of
loans.
This can control money creation.
Banks are allowed to average the liquidity ratio
over a fortnight period and a daily deviation of
2.0 percentage point of the prescribed ratio is
allowed.

Discount Operations
A deliberate measure to influence the interest
rate and liquidity situations.
Banks and FIs can have access to BNM credit
facilities at the maximum of two weeks.
It is conducted through:

Rediscounting of eligible short-term assets

Secured advances
As a bankers bank to act as a lender of the last resort.
Duty to regulate the volume of credit.

Open Market Operations

Intervention of BNM to the open market
through sales and purchase of Government
paper in the money market.
Operations effects banks reserves and flow of
credit and money.
The papers are thinly traded and mainly being
bought to fulfill the reserve requirement.

Open Market Operations

Paper eligible to be traded are:
Cagamas Bonds
BNM Bills
Selected PDS

Direct Lending and Borrowing

To influence the level of interest rate.
Done through principal dealers.
Allows BNM to focus on liquidity
management.

Interest Rate Regulation

Involves setting of the minimum lending rate
to the banks and ceilings interest rate that can
be offered to depositors.
Regulation of deposits help to influence the
level of savings and maturity structure of
these savings.

Moral Suasion
Informally inducing a positive voluntary
response from the financial system to its
policy initiatives.
Philosophy:
The implementation of policies could be more
effective if financial institutions on their own
accord take the necessary action to fulfill the role
that they are to perform.

Challenges on Monetary Management

Rapid growth (9.3%) before 1997 brought high
prices on financial assets.
Sharp contraction (-7.5%) in 1998, assets price
inflations
Volatile short-term speculative capital flows in
1992 1994
Regional financial crisis in 1997 1998.

Study Questions
1. Discuss the functions of Bank Negara
Malaysia.
2. Briefly discuss different forms of financial
regulations in Malaysia as to maintain
monetary stability and sound financial
structure
3. What is Statutory Reserve Requirement
(SRR)?

List of References
1. Madura, J. Financial Markets and Institutions, 5th
Edition, South-Western.
2. Ghani, R. A. and Rahman, I. A. Financial Market and
Institution, InED, Universiti Teknologi MARA.
3. Bank Negara Malaysia, Banking Info General
Information: Bank Negara Malaysia.

End of Chapter 2

ANY QUESTIONS?