Page 325 - Contributed Paper Session (CPS) - Volume 4

CPS2245 Azrie Tamjis
funds and placing greater resources into managing potentially delinquent
loans. At the same time, BNM reduced its policy interest rate (OPR) from 3.5%
to 2.0% in November 2008 to February 2009. The policy interest rates required
banks to drastically adjust their input prices and outputs according to the
indicative market interest rate (i.e., the OPR). Similar to Berger and Humphrey
(1992), a slower response in adjusting to changes resulted in Malaysian banks
experiencing lower cost efficiencies during the third phase of the FSMP. In
addition, Basel II was also implemented between 2008 and 2010 (Standard
Approach and Internal Ratings Based Approach) and Malaysian banks invested
heavily in technology, physical assets, external consultants and specialised
labour to comply with the new capital regulation.

4. Discussion and Conclusion
Before the Asian crisis, banks were found to lack effective risk management
and corporate governance, resulting in a high level of fragility. Furthermore,
the market conditions were very rigid, where prescriptive rules-based
regulation and supervision was implemented in the financial sector. The
pricing mechanism of banking products and services was also rigid, which did
not encourage competition among financial players. Islamic finance was
limited and not given full attention as to its possibilities and potentials. These
conditions made Malaysian banks more vulnerable to macroeconomic distress
and the inability to withstand these pressures during the Asian financial crisis.
A major response by the Malaysian government to these pressures has been
a substantial consolidation measure, resulting in a reduction in the total
number of banks, in which a fragmented banking system of 33 domestic
banking groups was reduced to 10 anchor domestic banking groups. At the
same time, the FSMP was introduced to strengthen and further liberalise the
Malaysian banking industry following the Asian financial crisis in 1997–98.
The implementation of the FSMP changed the financial landscape of the
banking industry. Within the FSMP period, Malaysia witnessed a series of
financial liberalisation measures, including; liberalisation of interest rate to
market players, introduction of new foreign banks (both Islamic and
conventional banks), branch liberalisation by allowing foreign banks to
increase their branches, de-pegging of Malaysian Ringgit to US Dollars,
simplified product approval process, lifting of wage moratorium, and allowing
of outsourcing of banks’ non-core activities. With these initiatives, excessive
government intervention in banks’ operations (particularly in relation to
interest rates (e.g. BLR)) was reduced. One of the key objectives of the FSMP
was to improve competition, which at the same time promotes the banking
industry’s resilience and soundness.
This study found that the cost inefficiencies in Malaysian banks are
substantial, inefficient banks being approximately 20.0% less cost-efficient

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