1 Introduction and background 1.1 Key demographic and economic data Malaysia covers an area of some 330,000 square kilometres in Southeast Asia. Peninsular Malaysia forms the southern portion of mainland Southeast Asia, with Thailand to the north and the island of Singapore to the south. The East Malaysian states of Sabah and Sarawak constitute the northern part of the island of Borneo. Malaysia is a multi-racial society following large-scale immigration of Chinese and Indians from the nineteenth century. In 1995, the population of 20.1 million included 58 per cent Bumiputera (ethnic Malays and indigenous people), 26 per cent Chinese, 7 per cent Indians and 3 per cent others. The remaining 6 per cent were non-citizens, primarily foreign workers brought in because of labour shortages. The population density is around 61 people per square kilometre, the lowest for any country in this study. The total fertility rate remains relatively high at 3.4 births per woman in 1995. This, combined with substantial immigration of foreign workers from neighbouring countries, contributed to robust population growth of 2.4 per cent per year between 1990 and 1995. Malaysia is by far the wealthiest country included in the study, and is the only one classified as an upper middle income country by the World Bank. GNP per capita was $3,890 in 1995, 40 per cent higher than that of Thailand and nearly four times that of any other country in the study. Economic growth has been rapid in recent years with per capita income increasing by 5.7 per cent per year between 1985 and 1995, although the current financial crisis in Southeast Asia has led to a marked slowdown in growth in the short term. The structure of the economy reflects Malaysia’s status as a newly industrialising country, with industry constituting 43 per cent of GDP in 1995 and agriculture having only a 13 per cent share. Fifty-four (54) per cent of the population lived in urban areas, the highest for any country in the study. Performance in terms of human development is also generally good. Life expectancy at birth was 71 in 1995, slightly below Sri Lanka but higher than for any other country in the study. The infant mortality rate was 12 per thousand live births, the lowest for any country studied. On the other hand, the adult literacy rate was only 83 per cent, below the levels recorded in the Philippines, Thailand, Sri Lanka and Indonesia. While this may partly reflect measurement factors, it would appear to be a cause for some concern. Malaysia was classified as a high human development country under the UNDP human development index for 1994, scoring fractionally lower than Thailand because of the lower literacy rate but well above any other country included in the study. 1.2 Poverty Estimates of poverty The official poverty line in Malaysia has been calculated since 1976. The original poverty line was based on three components. First, household food requirements were derived by the Institute of Medical Research by estimating the daily minimum calorie requirement (set at 9,910 calories per household), and establishing a basket of food items based on the usual consumption patterns that just met this daily minimum. This basket was then costed by the Department of Statistics. Second, household clothing requirements were derived in a similar manner by the Ministry of Welfare. And third, requirements for items other than food and clothing were estimated using the household expenditure survey conducted by the Department of Statistics in 1973. The poverty line level of expenditure on these items was set equal to the average actual household expenditure on items other than food and clothing by those households who just met the poverty line levels of expenditure on food and clothing. Since the initial poverty line was established in 1976, each of these three components has been indexed by movements in the relevant groups of the consumer price index. One poverty line has been established for the whole of peninsular Malaysia, with separate poverty lines for Sabah and Sarawak. The most recent estimates for 1995 put the poverty line at RM425 ($170) per month per household for peninsular Malaysia, with higher poverty lines of RM601 ($240) for Sabah and RM582 ($233) for Sarawak. Based on these poverty lines, the incidence of poverty has fallen significantly in Malaysia over the last two decades. In 1976, an estimated 42.4 per cent of households were below the poverty line. This percentage has fallen consistently to 20.7 per cent in 1984, 17.1 per cent in 1990, and 9.6 per cent or 417,200 households in 1995. The incidence of poverty in 1995 was much higher in rural areas (16.1 per cent) than in urban areas (4.1 per cent). However, it should be noted that the poverty line is the same in both urban and rural areas. Some commentators noted that this is unrealistic. Given the much higher living costs in the Kuala Lumpur region, for instance, it was argued that a higher poverty line is necessary for urban areas. One commentator suggested that an appropriate poverty line for Kuala Lumpur would be monthly household income of RM1,000 ($400) or even higher. This suggests that the official statistics understate poverty in the urban areas. Recently, the Department of Statistics has started collecting separate price data for urban and rural areas, and the Economic Planning Unit is considering establishing separate poverty lines for urban and rural areas. The government has not published estimates of the incidence of poverty by ethnic group or state. It is understood that the great majority of poor households are Bumiputera, although there are also pockets of poverty among the Indian community. It is also understood that the incidence of poverty is higher than the national average in the East Malaysian states of Sabah and Sarawak, the northern states of Perlis and Kedah, and the east coast states of Kelantan and Terengganu. The government also publishes estimates of hard-core poverty, defined as those households with incomes of less than half the poverty line. In 1995, 2.2 per cent of households, or 93,500 households, were in hard-core poverty. Hard-core poverty has fallen even more sharply than overall poverty, falling from 17.0 per cent of households in 1976 to 6.9 per cent in 1984, 4.0 per cent in 1990 and 2.2 per cent in 1995. The Seventh Malaysia Plan projects that the incidence of poverty will fall to 6.0 per cent of households by the year 2000. However, this projection is likely to prove optimistic in light of the current recession. Policies for poverty reduction Poverty eradication has been the major objective of government policy since the commencement of the New Economic Policy in 1971. The main policy for reducing poverty has been rapid economic growth and employment creation. Nevertheless, the government has also recognised the importance of specific policies directed to the poor. This has enabled rapid economic growth to be combined with an improving distribution of income and sharper reductions in the incidence of poverty than would otherwise have been possible. During the period of the New Economic Policy from 1971 to 1990, there was a major focus on reducing poverty and income disparities between ethnic groups, particularly by elevating the position of Bumiputera. This included a range of programs to increase the incomes and productivity of agricultural producers, and to improve access to basic amenities and the quality of life of low-income households. Both of these groups consist predominantly of Bumiputera. Since the Third Malaysia Plan covering the period 1976 to 1980, plans have had explicit targets for poverty reduction. They have also identified specific programs for poverty reduction, directed to specific target groups such as padi farmers, rubber smallholders, coconut smallholders, fishermen, estate workers, agricultural labourers and indigenous groups. As incomes have increased and absolute poverty has declined, the focus of government policy has shifted somewhat from broad-based policies to reduce poverty in general to a greater focus on eradicating poverty among the hard-core poor. Under the National Development Policy which commenced in 1991, the government has established a special development program which incorporates economic and social programs to assist the hard-core poor. This package includes a number of elements:
The government has also recognised the importance of non-governmental organisations (NGOs) in the overall policy framework to eradicate poverty. In particular, it has supported the microfinance activities of Amanah Ikhtiar Malaysia (AIM) as an integral part of its poverty programs. 1.3 Overview of the financial system The financial system in Malaysia includes 37 commercial banks, of which 23 are domestic and 14 are foreign. While most of these commercial banks are owned by private interests, the two largest, Maybank and Bank Bumiputra, have majority shareholding by the government. The commercial banks have a combined total of 1,569 branches, disbursed widely throughout the country. In addition, Bank Islam Malaysia provides Islamic banking services throughout the country. There are also 40 finance companies, 12 merchant banks and seven discount houses. All of these institutions are supervised by the central bank, Bank Negara Malaysia. In addition, there are seven development finance institutions owned by the government which are registered with, but not supervised by, Bank Negara. These include the Development Bank of Malaysia, the Industrial Bank of Malaysia and the Agriculture Bank of Malaysia (Bank Pertanian). There are also a number of savings institutions, including the National Savings Bank, as well as the credit cooperatives and various other non-bank financial intermediaries, all of which are outside the scope of Bank Negara supervision. The financial system has been subject to a process of gradual liberalisation since around 1987, when interest rates on deposits were deregulated. Interest rates on loans were partially deregulated in 1991, when each commercial bank was permitted to establish its own base lending rate according to its cost of funds. In 1995 the average bank lending rate was substantially positive in real terms at 7.6 per cent, well above the inflation rate of 3.4 per cent. Exchange controls have also been liberalised since 1987. In 1994 a two-tier regulatory system was introduced for commercial banks, allowing greater freedom to well-managed banks with strong financial standing. This system has now been extended to finance companies and merchant banks, which have also been given greater freedom to accept deposits. Malaysia has the greatest financial depth of any country in this study with a ratio of money and quasi-money to GDP of 85.0 per cent in 1995, no doubt reflecting its greater economic development. Nevertheless, a number of regulatory requirements remain. Bank Negara has three lending guidelines requiring banks to lend to particular priority sectors of the economy. None of these directly targets poor borrowers. Interest rates also remain regulated by Bank Negara. Each bank must establish a base lending rate, based on the Kuala Lumpur inter-bank offer rate (KLIBOR), its cost of funds and its cost structure. The base lending rate for each bank must be approved by Bank Negara, and the maximum lending rate for any loan is set at the base lending rate plus 4 per cent. Some specific categories of loans face lower ceilings. 1.4 Overview of microfinance The only institutions that engage in microfinance to a significant degree are a handful of NGOs. Of these, by far the largest is Amanah Ikhtiar Malaysia (AIM). AIM was established in 1987 and is modelled on the Grameen Bank. Loans are provided for any type of legal income-generating activity. As in the Grameen Bank, poor borrowers form themselves into groups of five who guarantee each other’s loans. There is also compulsory group training, and a compulsory savings component. In the past loans were provided interest free with a small administrative charge, but from 1997 new loans are subject to an interest rate of 19 per cent. AIM offers a number of loan products.
As at 30 April 1997, AIM had 30,029 current borrowers under schemes 1, 2 and 3, including 18,613 under scheme 1. In addition, there were 9,312 education loans and 3,900 housing loans with outstanding balances. AIM is currently operating in nine states of Malaysia, and it is understood that the vast majority of borrowers are ethnic Malays. Repayment rates were reported to be 99.9 per cent. There are several other NGOs involved in microfinance, but they operate on a much smaller scale than AIM. Yayasan Usahamaju is a Grameen Bank replicator operating in Sabah, with around 5,000 borrowers. Another NGO using the Grameen Bank approach is Partners in Enterprise, which has recently started lending in the Batu Caves area near Kuala Lumpur. Another program which provides individual loans to poor borrowers is the Projek Tekun pilot project of the Centre for Policy Research at the Malaysian University of Science (Universiti Sains Malaysia), which operates in the states of Penang, Kelantan and Terengganu. It is also understood that a number of the state governments operate foundations to alleviate poverty and that some of these incorporate microfinance components, although in most cases these are grants rather than loans. Other institutions do not appear to be actively involved in microfinance. Commercial banks are involved in microfinance through extending lines of credit to AIM, and as a conduit for schemes such as the loan fund for hawkers and petty traders operated by the Credit Guarantee Corporation (CGC), although the schemes do not generally reach poor borrowers. Some commercial banks have very small programs for individual lending to poor borrowers. The financial system also includes a number of urban and rural credit cooperatives which provide savings and credit facilities for their members. The urban credit cooperatives have a combined membership of around 40,000, but these are predominantly relatively well-off wage and salary earners. The rural credit cooperatives have much lower outreach of around 2,000. While they are not targeted at the poor, it is understood that some of their members are low-paid workers in the estate sector. AIM has received large volumes of grants and soft loans from government and from government-related agencies. This relatively easy access to funds has enabled it to expand outreach much more rapidly than would otherwise have been possible, with AIM now the largest Grameen Bank replication outside of Bangladesh. Given the relatively small number of poor households in Malaysia and the widespread opportunities for wage employment which reduce the need for poor households to rely on self-employment, the outreach of AIM and the other small programs is reasonably high in relation to demand. Nevertheless, there is some scope for expansion, and AIM is currently seeking to move into new areas. For instance, it has recently expanded its operations to Sarawak in East Malaysia. AIM and Yayasan Usahamaju could also increase their numbers of clients by relaxing their means tests. For instance, AIM currently uses a means test for monthly household income of only RM270 ($108) per month, above the hard-core poverty line of RM212 per month but well below the overall poverty line of RM425 ($170) per month. Ready access to cheap funds has reduced the pressure on AIM to operate on a self-sufficient basis. In the past, it charged borrowers a modest administrative charge, equivalent to an effective interest rate of around 5 per cent. However, grants for operational expenses have been reduced considerably, and AIM is now focusing much more strongly on sustainability. It has recently increased its interest rates to 19 per cent, and hopes to be able to cover all of its operational expenses from interest earnings by the end of 1997. The other NGOs are still relatively new and are operating on a small scale, and are not able to cover their operational expenses from interest earnings at this stage. Yayasan Usahamaju has received grants from the Sabah state government, while Partners in Enterprise has received donations from the private sector and from foreign donors. 2 Arrangements for direct support 2.1 Support for specialised microfinance institutions Both the government of Malaysia and the state governments have provided considerable support for AIM, while the smaller microfinance institutions (MFIs) have also received funding from government and/or donor agencies. Between 1989 and 1995, the government of Malaysia gave AIM an annual grant from the budget, equivalent to around 60 per cent of its operational costs. These grants have now been terminated. AIM has also received grants from state governments, ranging from around 10 to 40 per cent of operational costs in those states in which it operates, with the amount depending on the particular state government. These grants are continuing. AIM has also received grants and soft loans from the government for loan capital. These funds have been channelled through the Foundation for Islamic Economic Development (YPEIM). The Sixth Malaysia Plan covering the period 1991 to 1995 allocated RM18.2 million ($7.3 million) as a grant to AIM for its revolving fund. YPEIM is providing this amount to AIM over a 30-year period from 1991 to 2020. The Seventh Malaysia Plan covering the period 1996 to 2000 provides for an interest-free loan to AIM of RM200 million ($80 million). The loan will be disbursed over the period 1996 to 2000, and AIM will not have to start repaying it until 2006. AIM has also received soft loans from the Credit Guarantee Corporation (CGC) and from some of the commercial banks. In 1992 CGC allocated an initial sum of RM2 million ($800,000) from its own resources as a revolving fund for on-lending by AIM. In 1995 the revolving fund was increased to RM5 million ($2 million). In 1996 CGC organised another revolving fund for AIM, with 15 financial institutions contributing a total of RM13 million ($5.2 million). Both of these revolving funds are provided to AIM at a highly concessional interest rate of 1 per cent. AIM has received further soft loans at 1 per cent interest from the two commercial banks with majority government shareholding, namely Bank Bumiputra (RM4 million or $1.6 million) and Maybank (RM5 million or $2 million), as well as a grant of RM750,000 ($300,000) and soft loan of RM300,000 ($120,000) from Bank Islam Malaysia. Hence, AIM has received large volumes of grants and soft loans from government and from government-related agencies. These funds have reduced the pressure on AIM to operate on a self-sufficient basis, and have clearly enabled it to expand its outreach much more rapidly than would otherwise have been possible. In this respect Malaysia is very different to any other country included in the study. The incidence of poverty is much lower, while per capita incomes are much higher. It is therefore possible to access far more public resources, relative to the number of poor households, for programs to reduce poverty. The experience of AIM has shown that in Malaysia there are sufficient public resources for an institution like AIM, with relatively low levels of self-sufficiency, to reach a significant proportion of poor households by relying heavily on government funding. Reflecting this relative abundance of public resources and to the extent that microfinance is an effective strategy for reducing poverty, there is a strong case for the government of Malaysia to subsidise it as part of its overall policy strategy for poverty reduction. Anecdotal evidence suggests that AIM has indeed contributed to significant improvements in the lives of many borrowers, although it would be appropriate to conduct a more rigorous study of the impact of the program. In the meantime, it would appear appropriate for governments to continue to subsidise AIM as an effective strategy for poverty reduction. Given the concessional loans currently being disbursed, it is not necessary for AIM to achieve full financial self-sufficiency, at least in the short term. This enables it to continue to concentrate primarily on increasing outreach. While AIM already has significant outreach, there is still considerable scope for it to expand by widening its geographic base and relaxing its means test to cover slightly less poor households. It may also be appropriate for it to consider deepening its activities by offering its clients a wider range of services, such as more flexible savings products. At the same time, the recent increase in the interest rate charged by AIM is to be welcomed. As noted above, the increase is expected to enable AIM to attain operational self-sufficiency. Access to public resources is not unlimited, as demonstrated by the fact that the government of Malaysia has recently replaced grant assistance with soft loans. The current financial crisis is also giving rise to cuts in government spending in a number of areas. Increasing self-sufficiency will ensure that the program can be sustained over the medium term, and will also enable greater AIM to achieve greater outreach for a given call on public resources. 2.2 Support through the banking system Directed credit schemes Bank Negara has three lending guidelines requiring banks to lend to particular priority sectors of the economy. First, commercial banks and finance companies are required to maintain loans to Bumiputera at 30 per cent of total loans outstanding. Base figures for loans outstanding are revised periodically, and the current requirement is for loans to Bumiputera to be at least 30 per cent of loans outstanding as at 31 December 1995. Second, banks and finance companies are required to set aside a certain amount for financing low- and medium-cost housing (that is, housing units costing less than RM100,000 or $40,000). Targets for low- and medium-cost housing are determined in the Malaysia national plans, and quotas are then allocated to individual commercial banks and finance companies based on their assets, capital base and other criteria. The global allocation for all banks is currently around RM10 billion ($4 billion), equivalent to around 4 to 5 per cent of total loans outstanding. Third, banks and finance companies are required to provide loans to small business without good security or established track record under the New Principal Guarantee Scheme of the CGC. At present, commercial banks are required to provide a total of RM1 billion ($400 million) under this scheme, around 0.5 per cent of their loans outstanding. Again, the allocation is divided between banks based on their assets, capital base and other criteria. Individual loans under the scheme must be RM500,000 ($200,000) or less, and are partially guaranteed by CGC. Of the total allocation for each bank, at least 50 per cent must be provided to Bumiputera. None of these guidelines directly targets poor borrowers. Given the relatively large loan sizes and the fact that the banks will tend to lend to households within the target groups which are better off, it is unlikely that these requirements benefit the poor to any significant extent. Microfinance activities of the Credit Guarantee Corporation CGC was established in 1972 with Bank Negara and the commercial banks as its shareholders. It is currently owned as to 20 per cent by Bank Negara, 50 per cent by the 37 commercial banks, and 30 per cent by the 40 finance companies operating in Malaysia. Its main function is to guarantee loans by banks to small and medium enterprises, especially those with inadequate collateral or without collateral or track record, who would otherwise not have access to credit. While most of its activities are beyond the scope of microfinance, it also provides some support to microfinance loans. One scheme is the loan fund for hawkers and petty traders, which provides loan funds and 100 per cent guarantee for loans up to RM10,000 ($4,000) to eligible businesses by commercial banks and finance companies. Eligible businesses are: permanent and market stalls selling groceries, food, handicrafts, etc; mobile stalls with a specific place of business; and stalls and shops providing services such as tailoring, barber, welding, motor repairs, etc. To participate in the scheme, borrowers must be Malaysian, above 18 years of age, have a valid licence to trade, be directly involved in the business, and have a specific place of business. Borrowers with existing business loans in excess of RM10,000 ($4,000) or with an adverse borrowing record are ineligible. Loans must have terms ranging from 42 weeks to 138 weeks, with weekly repayments. A closely related scheme is the Association Special Loan Scheme. Conditions under this scheme are essentially the same as under the loan fund for hawkers and petty traders, except that borrowers apply for a loan through their trade association. The trade association then processes, evaluates and approves the application and applies to CGC for guarantee cover. CGC then issues a letter of agreement to the participating bank or finance company, which releases the loan. These schemes are funded through a one-off soft loan from the government to CGC of RM120 million ($48 million). This money is on-lent to commercial banks and finance companies free of interest, and banks lend to final borrowers at an interest rate of 4 per cent to cover administrative costs. Repayment rates under the scheme are reported to be high, with only around 6 per cent of loans classified as non-performing (in the early 1990s, however, non-performing loans were up to 40 per cent of loans granted under the schemes). In 1996, 6,079 loans were granted under the loan fund for hawkers and petty traders, and a further 291 under the association special loan scheme. Nevertheless, CGC reported that banks generally follow their usual credit practices in approving loans under the schemes. While this no doubt accounts for the high repayment rates, it also means that the schemes do not generally reach poor borrowers. As noted above, CGC has also provided support for AIM in its microfinance activities, through a revolving fund from its own resources of RM5 million ($2 million) and by organising an additional revolving fund of RM13 million ($5.2 million) with contributions from 15 financial institutions. In 1996, 8,407 loans were approved under these revolving funds. In addition, CGC has allocated RM6 million ($2.4 million) to support the Projek Tekun scheme operated by the Centre for Policy Research at the Malaysian University of Science, with 449 loans supported in 1996. 3 Regulation of non-bank microfinance institutions 3.1 The broad regulatory framework Registration There are number of options for registration for NGOs. AIM and Yayasan Usahamaju are registered as trusts, pursuant to the Trustee Act 1949 and Trustees (Incorporation) Act 1952. As trusts, they are required to file an instrument of trust with the Attorney-General’s Office, covering matters such as the objectives of the trust, appointment of trustees, rules and functions of the board of trustees, arrangements for meetings, maintenance of annual accounts, responsibilities of the management committee, and detailed rules and regulations. They are required to submit their annual report, audited financial statements and any amendments to the instrument of trust to the Attorney-General’s Office. Partners in Enterprise, by contrast, is registered under the Companies Act 1965 as a non-profit company limited by guarantee. To be registered as a company, two or more persons must lodge a memorandum and articles of association, outlining the name and objectives of the company, with the Registrar of Companies. Companies are required to maintain regular accounts, and to provide their audited annual financial statements to the registrar. The Act also sets out various requirements concerning the office and name, directors and officers, and meetings and proceedings. It is understood that these requirements are generally quite straightforward. Many NGOs are registered as societies with the Registrar of Societies, pursuant to the Societies Act 1966, although it is not known if any MFIs have registered under these provisions. To apply for registration as a society, it is necessary to complete an application providing details of the name, address, purpose and office-bearers of the society, as well as the rules. It is also necessary to have an annual general meeting, and to provide details of the office-bearers and the financial statements to the registrar on an annual basis. All of these provisions are designed for NGOs in general, rather than for MFIs. Indeed, registration under one of these Acts does not permit an NGO to engage in microfinance. Under Malaysian law, only specified institutions such as banks, cooperative societies and licensed moneylenders are permitted to lend money in consideration of a larger sum being repaid. Trusts, non-profit companies and societies are generally not permitted to make loans. If such bodies are to operate as MFIs and make loans, they need to obtain a specific exemption from the provisions of the Moneylenders Act 1951. Such exemption must be obtained on a one-off basis from the Minister of Housing and Local Government, and is generally granted for a period of three to four years. AIM, Yayasan Usahamaju and Partners in Enterprise have all obtained exemptions under this provision. The ministry requires NGOs who have received this exemption to provide their annual report and audited financial statements on an annual basis, and portfolio data once every six months. However, there are no clear criteria for obtaining an exemption, and some commentators stated that it may be difficult for smaller NGOs without connections to obtain an exemption. It would be appropriate for the government to establish a transparent framework for the registration of MFIs based on a clearly established set of guidelines, rather than requiring them to seek exemption from the Moneylenders Act. There are no requirements on NGOs which receive foreign donations to seek prior approval from any government agency, or even to report that they have received such donations. Any profits from interest or other income earned by MFIs are subject to income tax, but to date no MFIs have made a profit. At present, donations to MFIs are not eligible for income tax deduction. It is understood that it would be difficult to obtain exempt status for such donations, on the grounds that MFIs are engaged in lending money for interest. Given the focus of MFIs on poverty reduction, it would be appropriate to allow donations to them to be income tax deductible. Savings mobilisation The Backing and Financial Institutions Act 1989 provides that no person shall carry on banking business, including receiving deposits on current account, deposit account, savings account or other similar account, without a licence as a bank or financial institution. Hence, it is clear that NGOs are not permitted to accept deposits from the general public. While it is not clear if this provision also covers compulsory and/or other savings by members of MFIs, it is understood that Bank Negara has determined that NGOs can accept compulsory savings at least, so long as these compulsory savings are put into a trust account and not used as loanable funds. AIM and Yayasan Usahamaju keep their borrowers’ savings in separate bank accounts in the names of the borrowers. This would appear to be unnecessarily restrictive. Under the Grameen Bank model used by AIM and Yayasan Usahamaju, almost all members are net borrowers, with the outstanding balance on their loans greater than the balance of compulsory savings. Clearly, such members are not at risk of losing their savings if the institution fails. For these reasons, the Consultative Group to Assist the Poorest (CGAP) has argued that compulsory savings should probably be thought of as part of the cost of the loan, rather than as true financial intermediation requiring public intervention to protect depositors. Most countries in this study allow MFIs to use the compulsory savings of members as loanable funds. It would be appropriate for the government to permit MFIs to use the compulsory savings of their members in their lending programs. This would increase their access to loanable funds and reduce administrative costs. 3.2 Interest rates There are no regulations on MFIs concerning the interest rates that they can charge borrowers. In practice, MFIs have tended to maintain interest rates and charges at low levels, reflecting community expectations and relatively easy access to funds from government and donor agencies. As noted above, AIM in 1997 moved from a flat administrative charge to an interest rate of 19 per cent. While this is below the level charged by successful MFIs in most other countries and below the level necessary for full financial self-sufficiency, it is estimated that it will be sufficient for AIM to cover all of its operational expenses. 3.3 Prudential regulation and supervision There is no prudential regulation and supervision of MFIs, in terms of matters such as minimum capital requirements, capital adequacy ratios, reserve or liquidity requirements, or loan loss provisioning requirements. Reporting requirements are also limited to the provision of annual accounts to the various bodies that regulate NGOs, and do not relate to the specific needs of MFIs. However, AIM provides its annual report, audited annual financial statements and annual portfolio data to Bank Negara on the basis that the banks from which it obtains funds are required to report to Bank Negara. When requested, AIM provides more frequent data to Bank Negara. It is generally considered that it is not appropriate to subject MFIs which do not accept deposits from the public to prudential regulation and supervision. Systems used by regulatory agencies to supervise financial institutions are generally not appropriate to the needs of MFIs. In most countries there is a large number of small MFIs, and it would not be feasible for regulators to monitor their activities properly. And in most cases there is scope for other, more cost-effective approaches to ensuring that MFIs operate at a high standard, such as through the policies of second tier microfinance institutions or through self-regulation. However, it is not clear if these considerations apply in the case of Malaysia. Given the very small number of MFIs, it would not be onerous for Bank Negara or some other regulatory agency to establish some system for monitoring them. Moreover, as discussed below, there would not appear to be much scope for monitoring through a second tier microfinance institution or through a system of self-regulation. It would therefore be appropriate for the government to establish a small cell of one or two people within Bank Negara or some other regulatory agency to monitor and supervise MFIs. The same body could also be responsible for registering MFIs, as discussed above (it should be noted that if Bank Negara were to undertake this role some change in focus would be required, as it has had little involvement with microfinance to date). It would be necessary to develop performance and reporting standards that are appropriate to the needs of MFIs, covering matters such as loan classification and provisioning, savings facilities, accounting and audit standards, progress towards self-sufficiency, etc. Such standards should be developed in consultation with the MFIs themselves. Experience in developing performance and reporting standards for MFIs in other countries, such as through the Palli Karma Sahayak Foundation in Bangladesh and the Coalition to Develop Standards for Microfinance in the Philippines may also be useful (see the Bangladesh and Philippines country studies). 3.4 Performance and reporting standards of second tier institutions In many countries, second tier microfinance institutions have been established to channel funds to specialised MFIs. Often, performance and reporting standards established by such institutions become norms for the microfinance sector. There is no such second tier institution in Malaysia (although to a limited extent the Credit Guarantee Corporation (CGC) has channelled funds to MFIs as an adjunct to its primary responsibilities). Given the very small number of NGOs and the relatively small size of the potential market for microfinance, there is little reason to establish a specialist second tier institution. Hence, this approach to establishing standards for microfinance does not appear to be an option in the case of Malaysia. 3.5 Self-regulation There are no formal arrangements for self-regulation or coordination among the MFIs operating in Malaysia. Given the small number of MFIs and the dominant position of AIM, this is perhaps not surprising. It is understood that one of the smaller NGOs has expressed interest in establishing a national network of microfinance NGOs, but there has been no further progress to date. Nevertheless, both AIM and Yayasan Usahamaju are members of the international Credit and Savings for the Hardcore Poor (CASHPOR) network of Grameen Bank replicators, and there have been some informal contacts between these organisations and Partners in Enterprise. In terms of policy dialogue, AIM commented that it has a very good relationship with government, and is able to engage in constructive policy dialogue on issues relating to microfinance. It would nevertheless be appropriate at least to establish an informal network of MFIs to exchange information and to ensure that the views of all MFIs are taken into account in discussions with government. 4 Regulation of banks 4.1 Licensing and minimum capital requirements As noted above, the Banking and Financial Institutions Act 1989 provides that no person shall accept deposits without a licence as a bank or financial institution. Unlike many other countries included in this study, there is no network of small banks in Malaysia. The minimum capital requirement to establish a commercial bank is RM20 million ($8 million). This is likely to be too high for an MFI wishing to establish a bank, or a body wishing to establish a small bank at the local level. While the minimum capital needed to establish a finance company is less at RM5 million ($2 million), finance companies are not allowed to accept deposits on current account. Moreover, Bank Negara considers that there are already too many financial institutions in Malaysia, and is currently not issuing any new licences for the establishment of either banks or finance companies. In fact, it is seeking to encourage existing banks and finance companies to amalgamate. Experience in other countries suggests that small banks are much more likely to become involved in microfinance than large banks. Hence, if banks are to play an active role in microfinance, it is important that there be some mechanism to enable small banks to be licensed. Such banks would also tend to serve small entrepreneurs who in many cases have only limited access to financial services at present. It would therefore be appropriate for the government to establish a framework for licensing small banks, by setting a realistic minimum capital requirement and removing any other restrictions which prevent the establishment of small banks. In this regard, it may be useful to examine the experiences of countries such as Indonesia and the Philippines (see the Indonesia and Philippines country studies). 4.2 Interest rates As noted above, the maximum lending rate for any bank loan is set at the base lending rate for the particular bank plus 4 per cent. In addition, some specific loans face lower ceilings. For instance, loans for low- and medium-cost housing are subject to a ceiling of the base lending rate plus 1.75 per cent or 9 per cent, whichever is lower. Loans of less than RM500,000 ($200,000) guaranteed by the Credit Guarantee Corporation (CGC) under the new principal guarantee scheme face an interest rate ceiling of base lending rate plus 2 per cent. Banks are also required to lend at below market interest rates under various other schemes where they are able to obtain refinancing or soft loans from Bank Negara. Small loans to poor borrowers inevitably incur high administrative costs. The interest rate ceiling of base lending rate plus 4 per cent would make it very difficult if not impossible for any bank to cover the costs of small loans to poor borrowers. In addition to the minimum capital requirements and other restrictions discussed above, this ceiling further discourages regulated banks from becoming involved in microfinance. It is also perhaps surprising that Malaysia retains interest rate controls when a number of other countries included in this study with less developed financial systems — namely Indonesia, the Philippines, Sri Lanka and Thailand — have removed them. It would be appropriate for the government to remove interest rate ceilings applying to loans by regulated banks, or at least review the spreads applicable to small and very small loans. 4.3 Prudential regulation and supervision Commercial banks are subject to a capital adequacy ratio of 8 per cent of risk-weighted assets in line with the Basle Accord. There is a statutory reserve requirement of 13.5 per cent of net eligible liabilities, to be held as an interest-free deposit with Bank Negara. In addition, commercial banks are required to maintain liquid assets equal to 17 per cent of liabilities. In terms of loan loss provisioning, commercial banks are required to maintain a general provision of 1.5 per cent of loans outstanding, plus specific provisions of 100 per cent for bad debts and 50 per cent for doubtful debts. Banks are also required to provide a series of reports to Bank Negara on a weekly, fortnightly, monthly, quarterly and annual basis. These requirements would not appear to impose any undue restrictions on small banks or banks involved in microfinance. This is largely academic at this stage, as there is no scope for the establishment of small banks in any case. There are no restrictions preventing commercial banks from establishing linkages with MFIs by extending loans for on-lending to poor borrowers. As noted above, a number of commercial banks have provided loans to AIM, albeit not on a commercial basis. 5 Summary and recommendations With GNP per capita of $3,890 in 1995, Malaysia is by far the wealthiest country included in the study and is classified as an upper middle income country by the World Bank. Performance in terms of human development is also generally good. The incidence of poverty was estimated at 9.6 per cent of households in 1995, the lowest for any country in the study. The only institutions in Malaysia that engage in microfinance to a significant degree are a handful of non-governmental organisations (NGOs). Of these, by far the largest is Amanah Ikhtiar Malaysia (AIM), the largest Grameen Bank replicator outside of Bangladesh with around 30,000 borrowers. There are several other much smaller NGOs involved in microfinance. While total outreach is small it is reasonably high in relation to demand, given the relatively small number of poor households in Malaysia and the widespread opportunities for wage employment which reduce the need for poor households to rely on self-employment. Arrangements for direct support Both the government of Malaysia and the state governments have provided considerable support to AIM, for both operational expenses and loanable funds. The smaller microfinance institutions (MFIs) have also received funding from government and/or donor agencies. Continue to subsidise AIM These funds have reduced the pressure to operate on a self-sufficient basis, and have enabled AIM in particular to expand its outreach much more rapidly than would otherwise have been possible. Malaysia is very different to any other country included in the study, in that it is possible to obtain quite large amounts of public resources, relative to the number of poor households, for programs to reduce poverty. Governments should continue to subsidise AIM as an effective strategy for poverty reduction. This will enable AIM to concentrate primarily at increasing its outreach, and possibly offering a wider range of services to its clients. Nevertheless, access to public resources is not unlimited, and AIM’s recent decision to increase interest rates and strive for operational self-sufficiency is to be welcomed. While some support to small borrowers is provided through the banking system, it is unlikely that much of this reaches the poor. None of Bank Negara’s lending guidelines for banks targets poor borrowers. The various schemes of the Credit Guarantee Corporation (CGC) also do not reach poor borrowers. Regulation of non-bank microfinance institutions Establish transparent framework for registering NGOs The registration procedures for NGOs are not designed with microfinance in mind, and NGOs wishing to engage in microfinance must obtain a specific exemption from the provisions of the Moneylenders Act 1951. While a number of institutions have obtained an exemption, there are no clear criteria. The government should establish a transparent framework for the registration of MFIs, based on a clearly established set of guidelines and outside the ambit of the Moneylenders Act. The government should also allow donations to MFIs to be tax deductible. Permit MFIs to use members’ savings in lending programs At present, Bank Negara only permits MFIs to accept compulsory savings if they are put into a trust account and not used as loanable funds. This is unnecessarily restrictive. The government should permit MFIs to use at least the compulsory savings of their members in their lending programs. There are no regulations on MFIs concerning the interest rates that they can charge borrowers. There is also no prudential regulation and supervision of MFIs, in terms of matters such as minimum capital requirements, capital adequacy ratios, reserve or liquidity requirements, or loan loss provisioning requirements. Develop performance and reporting standards While it is generally considered that it is not appropriate to subject non-depository MFIs to prudential regulation and supervision, it is not clear if the usual considerations apply in the case of Malaysia. Given the very small number of MFIs, it would not be onerous to establish some system for monitoring them. And while in some countries second tier microfinance institutions have developed performance and reporting standards for MFIs, there is no such institution in Malaysia. The government should consider establishing a small cell within Bank Negara or some other regulatory agency to monitor and supervise MFIs. This body could develop performance and reporting standards that are appropriate to the needs of MFIs, in consultation with the MFIs themselves and drawing on experience from countries such as Bangladesh and the Philippines. Establish informal MFI network There are no clear arrangements for self-regulation or coordination among the MFIs operating in Malaysia. The major MFIs should establish an informal network to exchange information and for policy dialogue with government. Regulation of banks Establish framework to license small banks The minimum capital requirement to establish a commercial bank is too high for an MFI wishing to establish a bank, or for a body wishing to establish a small bank at the local level. Moreover, Bank Negara is currently not issuing any licences for the establishment of new banks. Experience in other countries suggests that if banks are to play an active role in microfinance, it is important that there be some mechanism for the establishment of small banks. Such banks also tend to serve small entrepreneurs who do not have access to financial services. The government should establish a framework for licensing small banks, by setting a realistic minimum capital requirement and removing any other restrictions which prevent the establishment of such banks. Remove interest rate ceilings The maximum lending rate for any bank loan is set at the base lending rate for the particular bank plus 4 per cent. This ceiling makes it very difficult if not impossible for any bank to cover the costs of small loans to poor borrowers, and further discourages banks from becoming involved in microfinance. It is also perhaps surprising that Malaysia retains interest rate controls when other countries with less developed financial systems have removed them. The government should remove the interest rate ceilings applying to loans by regulated banks, or at least review the spreads applicable to small and very small loans. There are no restrictions preventing commercial banks from establishing linkages with MFIs. A number of commercial banks have provided loans to AIM, albeit not on a commercial basis. References
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