Banking Restructuring and Resolution: Malaysia’s Experience WorldBank / IMF / US Federal Board 3rd Annual International Seminar on Critical Issues in Financial Stability: Preventing and Confronting Bank Insolvency Banking Restructuring and Resolution: Malaysia’s Experience by Mohd Razif Abdul Kadir Assistant Governor Central Bank of Malaysia 4-6 June 2003

Presentation outline Malaysia’s economy and banking sector prior to Asian financial crisis Impact of financial crisis Framework for crisis containment Moving forward

Malaysian economy: pre-Asian crisis Enjoyed strong GDP growth & price stability for 4 decades Broad-based growth, averaging 8% for 8 consecutive years until 2Q 1997 Strong fiscal surpluses since 1993 Low unemployment (1997: 2.6%) High domestic savings (1997: 39.4% of GNP) Low foreign indebtedness Short term debt: 29% of total debt Debt servicing ratio: 5.5% (end-1997)

Banking system: pre-Asian crisis At onset of crisis, banking sector in position of strength Policies were focused on development and reform: Strengthening supervisory framework and intervention powers by BNM BAFIA 1989 provided integrated banking supervision framework Broadening and deepening financial market Developing the bond market Implemented pre-emptive measures to reduce vulnerability Measures to slow down credit growth started in 1995 Contained formation of asset bubble in property and stock market with imposition of lending limits in March 1997 as at Jun-97 RWCR 12% Net NPL ratio 2.2% Loan loss coverage 91.8% Profit before tax (half-year) RM 5,310 m* Loan growth ~ 29% * RM3.8 = USD1

Nevertheless, there were areas of concern Strong loan growth in 1994-97 of 23% p.a., with increased lending to vulnerable sectors High loan exposure of the banking system Under-developed bond market Concentration of risk in banking system Fragmented finance company industry (39 cos.) and narrow business focus Finance cos. industry vulnerability While property market plateaued, stock market continued to rally Risk of correction and outflows

Impact of financial crisis Sharp drop in currency value RM depreciated by about 40% against USD Deteriorating economic conditions Real GDP contracted by 6.7% in ‘98 Major corrections in equity market KLSE fell by about 79% Weak regional export demand Downgrading of sovereign rating Strains on banking sector Rising NPL (2.2%7.3%) Capital erosion Higher funding cost Tight liquidity Distressed corporate sector Inflation peaked at 6.2% in June ‘98

The vicious cycle of the crisis Fall in currency value Fall in stock market value Extreme volatility in financial markets  Health of companies  Wealth of consumers  NPLs  Health of banks  Economic activities Inefficiencies in intermediation process

Framework for crisis containment INSTITUTIONAL FRAMEWORK Pre-emptive & comprehensive package to ensure intermediation process functioning Danaharta Remove NPLs Maximise recovery Danamodal Recapitalise viable institutions Corporate Debt Restructuring Committee Voluntary debt workout SME special funds Provide financing at reasonable rate Domestic banking sector consolidation Consolidate fragmented industry

Linkages between Danaharta, Danamodal & CDRC Steering Committee - BNM Rehabilitation Funds Danamodal New loans/ restructure distressed loans Bonds New Capital Cash Borrowers Bank New Loans Restructure existing loans Sell NPLs Bonds/ Cash CDRC Danaharta Rehabilitation

Operating principles Danaharta Danamodal CDRC Market-based Hair-cut Backed by legislation Sharing of excess recoveries (80:20) Mgmt of NPL First loss principle Viable institutions Danamodal appointees Management revamped where necessary Voluntary Complements Danaharta Facilitates debt restructuring of larger firms Ceased operations in August 2002 Danaharta Danamodal CDRC

Danaharta Acquired RM39.8 billion* or 38.5% of NPLs of the banking system at average discount rate of 54.4% Successfully dealt with all of the NPLs under its purview amounting to RM52.5 billion* Implemented various recovery strategies through restructuring, settlement, foreclosure and schemes of arrangements to maximise recovery Average recovery rate of 57% (50% for acquired loans, 63% for managed loans) Expect to cease operations in 2005 as planned * RM3.8 = USD1

Danaharta – Key success factors Special powers accorded under the Act to enable them to operate quickly and efficiently Include powers of compulsory acquisition, to change shareholdings and substitute existing boards, as well as powers to repudiate contracts, transfer assets and liquidate companies Act also protects Danaharta against unknown claims in relation to acquired NPLs. However, claimant continues to have recourse to the selling BI or original lending BI NPLs acquisition are on willing buyer, willing seller basis – BIs are free to sell or keep their NPLs However, those seeking capital injection from Danamodal must sell their NPLs (in excess of 10%) Sharing of surplus recovery is on 80:20 basis (selling institution : Danaharta)

Danaharta – Governance structure Danaharta structured to facilitate transparency with strong corporate governance (diverse Board members – 9 members including foreigner reps, 7 from industry & 2 from Government) Establishment of an oversight committee to oversee, approve and terminate appointments of special administrators Not allow any one person to make decisions on loan restructuring or sales of assets Helps fend off legal action and challenges Foreclosed property sold through an open tender process

Danamodal – initial budget of RM16 billion However, only RM7.1 billion* was injected into 10 viable banking institutions Adhered to first-loss principle Repayment began after 1year of injection RM5 billion* repaid to date RM2.1 billion* remain in 3 banking institutions Targeted for closure in 2003 * RM3.8 = USD1

Corporate Debt Restructuring Committee Voluntary platform for creditors and borrowers to work out feasible solutions to debt problems amicably without resorting to legal action or liquidation Preserve value of viable companies Steering Committee provide oversight Eligibility criteria: Company must be viable Aggregate debts of RM100 million* or more (adjusted fr RM50m) More than 5 creditors (adjusted fr 3 creditors) Company not in any insolvency administration eg liquidation * RM3.8 = USD1

CDRC – Principles and progress Principles of debt restructuring: Fair treatment to ALL stakeholders Haircuts borne by shareholders (greater proportion) and creditors Accompanied by corporate restructuring Sale of non-core assets, refocus business activities Full information disclosure and sharing of information Status of CDRC cases as at 31 March 2003 Total debt outstanding (RM m) Number of accounts Total transferred to CDRC 67,644 87 Cases withdrawn / rejected 12,615 28 Transferred to Danaharta 2,470 11 Cases accepted 52,559 48 Resolved Implemented 44,557 33 Pending implementation 8,002 15

Consolidation was also promoted to further strengthen the banking sector To attain minimum capital size Increased larger capital size of domestic banking groups to RM2 billion* To reap the benefits of economies of scale To increase capacity to deal with increasing pressure from globalisation and liberalisation Massive capital investments in infrastructure and technology To address fragmentation of the domestic banking sector The number of banking institutions has reduced from 71(end-97) to 30 banking institutions under 10 banking groups Tax incentives to facilitate consolidation * RM3.8 = USD1

Institutional arrangements have yielded positive result at low cost of <5% of GDP At end-April 2003, capitalisation remained strong RWCR : 13.2% (98 : 10.1%) Core Cap Ratio : 11.0% (98 :7.9%) Asset quality improved further Net NPL ratio (6-mth basis) - 7.0% (98 :9.0%) (3-mth basis) - 9.8% (98 : 14.9%) Closure of Corp Debt Restructuring Committee in August 2002 Winding down operations of Danamodal and Danaharta

Key success factors Strong commitment and support by Government Pre-emptive and comprehensive approach Focused role and clear objective of institutional arrangement Enabling legal infrastructure Pengurusan Danaharta Nasional Berhad Act 1998 (PDNBA) Political will – speed in passing of PDNBA Market principles and strong governance “Carrot and stick” approach

Moving forward – medium and long term strategies Enhancing financial system stability (surveillance system, deposit protection) Enhancing regulatory and supervisory framework Managing financial liberalisation (GATS etc) Achieving socio-economic objectives Developing a competitive banking sector FINANCIAL SECTOR MASTERPLAN

Financial Sector Masterplan Launched in March 2001 Five main characteristics: efficient, effective, stable, prudential regulation and infrastructure Broad strategies with 119 recommendations 6 building blocks Alternative Modes of Financing Islamic Banking & Takaful Development Financial Institutions Banking Insurance Labuan IOFC

FSMP - Objectives Create a more efficient, effective and stable financial system efficient: services at lowest cost effective: broad range of services stable: minimal systemic risks Meet socio-economic objectives in an effective and efficient manner Meet international commitments and prepare domestic financial institutions for global competition Support the overall economic transition Develop and strengthen the real sector Meet the demands of the consumers Develop a core of strong domestic banks to be the backbone of the financial system

Recommendations will be implemented in Three Phases ( after 7 years) Phase 1 (3-4 years) (3 years) Assimilate into global arena Introduce new foreign competition Intensify competitive pressure in the domestic financial sector Enhance capacity of domestic institutions to compete Enhance financial infrastructure Checkpoints Checkpoints

Thank You