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Banking Restructuring and Resolution:

Malaysia’s Experienceby

Mohd Razif Abdul KadirAssistant Governor

Central Bank of Malaysia4-6 June 2003

WorldBank / IMF / US Federal Board 3rd Annual International Seminar on Critical Issues in Financial Stability:

Preventing and Confronting Bank Insolvency

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Presentation outline

Malaysia’s economy and banking sector prior to Asian financial crisis

Impact of financial crisis

Framework for crisis containment

Moving forward

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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)

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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

Banking system: pre-Asian crisis

as at Jun-97RWCR 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

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Nevertheless, there were areas of concernStrong loan growth

in 1994-97 of 23% p.a., with increased lending to vulnerable sectors

Under-developed bond market

Fragmented finance company industry (39 cos.) and narrow business focus

High loan exposure of the banking system

Concentration of risk in banking systemFinance cos. industry vulnerability

While property market plateaued, stock market continued to rally

Risk of correction and outflows

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Impact of financial crisis

Sharp drop in currency

valueRM depreciated by about 40% against USD

Major corrections in equity market

KLSE fell by about 79%

Inflation peakedat 6.2% in June ‘98

Strains on banking sector

Rising NPL (2.2%7.3%)

Capital erosionHigher funding cost

Tight liquidity

Distressed

corporate sector

Downgrading of

sovereign rating

Deteriorating economic conditions

Real GDP contracted by

6.7% in ‘98

Weak regional export

demand

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The vicious cycle of the crisisFall in currency value

Fall in stock market valueExtreme volatility in financial markets

• Health of companies• Wealth of consumers

Economic activities

Inefficiencies inintermediation

process

NPLs Health of banks

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Framework for crisis containment

Pre-emptive & comprehensive package to ensure intermediation process functioning

Corporate Debt Restructuring Committee

Voluntary debt workout

Danaharta•Remove NPLs•Maximise recovery

DanamodalRecapitalise viable institutions

Domestic banking sector consolidation

Consolidate fragmented industry

INSTITUTIONAL FRAMEWORK

SME special funds

Provide financing at reasonable

rate

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Restructure existing loans

Danamodal

Bank

Danaharta

Borrowers

CDRC

Rehabilitation

New Capital

Sell NPLs

Bonds/ Cash

New Loans

BondsCash

Steering Committee - BNM

Rehabilitation

FundsNew loans/ restructure distressed loans

Linkages between Danaharta, Danamodal & CDRC

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Operating principles

• Market-based

• Hair-cut

• Backed by legislation

• Sharing of excess recoveries (80:20)

• Mgmt of NPL

Danaharta • First loss principle

• Viable institutions

• Danamodal appointees

• Management revamped where necessary

Danamodal• Voluntary

• Complements Danaharta

• Facilitates debt restructuring of larger firms

• Ceased operations in August 2002

CDRC

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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

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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 – Key success factors

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Danaharta – Governance structureDanaharta 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

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•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

Danamodal – initial budget of RM16 billion

* RM3.8 = USD1

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Corporate Debt Restructuring Committee

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

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

* RM3.8 = USD1

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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 87Cases withdrawn / rejected 12,615 28Transferred to Danaharta 2,470 11Cases accepted 52,559 48Resolved 52,559 48

Implemented 44,557 33Pending implementation 8,002 15

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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

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Institutional arrangements have yielded positive result at low cost of <5% of GDP

Closure of Corp Debt Restructuring Committee in August 2002 Winding down operations of Danamodal and Danaharta

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J an May Sep Jan May Sep Jan May Sep Jan

%

Net NPL ratio

Core capital

RWCR

2000 2001 2002 2003

11.8%12.3%

13.3% 13.2%

11%

6.3%

8.3%

7.0%

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%)

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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

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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

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Launched in March 2001 Five main characteristics: efficient, effective, stable,

prudential regulation and infrastructure Broad strategies with 119 recommendations 6 building blocks

Banking Insurance

Islamic Banking & Takaful

Development Financial Institutions

Labuan IOFC

Alternative Modes of Financing

Financial Sector Masterplan

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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

FSMP - Objectives

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Phase 1

Phase 3

• Intensify competitive pressure in the domestic financial sector

•Assimilate into global arena• Introduce new foreign competition

Enhance capacity of domestic institutions to compete

Enhance financial infrastructure

Recommendations will be implemented in Three Phases

Phase 2

Checkpoints

Checkpoints

(3 years)(3-4 years)

( after 7 years)

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Thank You