Malaysia: Macroeconomic Outlook - 3Q 2017

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1. Macroeconomic Outlook HIGHLIGHTS • Global growth on track to expand at a faster pace in 2017, supported by improvements in both advanced and emerging market economies. • The Malaysian economy will record a stronger growth in 2017. • Headline inflation is expected to average at the upper end of the forecast range of 3 - 4% for 2017 as a whole. The strong performance of the global economy in the third quarter reiterates the positive global growth outlook in 2017. The IMF has revised upward its global growth projections twice (in April and October), to reflect the stronger-than-expected growth momentum, as growth becomes more synchronised and entrenched across countries. Growth improvements projected across regions Chart 34: GDP Growth Annual change (%) 5 4.3 4 3.6 3.2 3 2.2 1.7 2 1 0 Advanced Economies Global In the advanced economies, consumption continues to anchor growth, with additional impetus from investments. Of significance, the rise in investment growth has been mainly supported by stronger demand amid lower spare capacity. Labour market conditions are projected to improve further, providing impetus to private consumption. Growth in the emerging market economies will continue to benefit from strong external demand, particularly from the advanced economies, and continued expansion in domestic activity. 4.6 2015 Emerging Market Economies Global growth on track to expand at a faster pace, supported by improvements across regions 2016 2017f Source: IMF World Economic Outlook (October 2017) Nevertheless, the growth outlook remains vulnerable to several risks. These arise mainly from uncertainty regarding the timing, pace and magnitude of the monetary policy normalisation in major economies, protectionism, and political uncertainty in parts of Europe. Geopolitical tensions and volatility in oil price also pose risks to global growth prospects. THIRD QUARTER 2017 55
2. BNM QUARTERLY BULLETIN 1 Feature Article Better Boards - The Path Towards Stronger Corporate Governance in Financial Institutions Authors : Mohammad Khairul Ismail and Atikah Abd Aziz HIGHLIGHTS • Boards of financial institutions are responsible for ensuring all decisions and actions made are in the best interest of the financial institutions, depositors and insurance policyholders. • The boards set the right ‘tone from the top’ to reinforce ethical, prudent and professional behaviour. • The changing financial landscape coupled with growing focus on social responsibility and stakeholders’ activism will continue to change the role of boards. • Boards must keep pace and continue to steer the financial institutions with impeccable integrity and conduct. Sound corporate governance - the key to institutional soundness leading to financial stability and sustainable economic growth Unlike other companies, a banking institution performs the role of facilitating the functions of the economy by intermediating funds to support the real economy. Likewise, insurers and takaful operators provide safety nets to individuals to reduce their hardship following loss events such as accidents and natural disasters. Underpinned by these factors, a sound corporate governance standard in financial institutions is important to ensure that intermediation activities are conducted effectively and responsibly, while all obligations are met on a timely basis. Sound corporate governance standards must be institutionalised and become a way of life in the organisational context of a financial institution. Ultimately, the realisation of these expectations lies with the boards of financial institutions. Past global financial crises show that among the key contributing factors to financial losses suffered by financial institutions and consumers were ineffective boards that exercised inadequate oversight on executive and senior management who are responsible and accountable for the soundness of the financial institutions’ day-to-day management activities. These significant losses caused erosion in public confidence, disruption in financial markets and in some cases, destabilisation within the wider economy. Learning from these costly and painful episodes, regulators in advanced economies and many others across the globe have cast their focus and attention on the strengthening of financial institutions’ corporate governance standards. In Malaysia, the Bank’s efforts to improve financial institutions’ corporate governance standards were first directed towards enhancing the governance arrangements at the board level, strengthening board evaluation policies and practices and complemented by continuous training programmes to ensure the boards are effective in providing stewardship, oversight and direction. The Bank also saw the need to hard code the boards’ fiduciary duties into law so as to elevate and give prominence to the role of directors in tandem with their growing accountability and responsibility. The duties and responsibilities of the boards and directors have therefore been codified into the Financial Services Act 2013 and Islamic Financial Services Act 2013. 58 THIRD QUARTER 2017
3. BNM QUARTERLY BULLETIN Leading indicators suggest continued expansion in the domestic economy The Malaysian economy will register higher growth in 2017 Chart 35 : Composite Leading Index Given the continued strong performance in the third quarter, the Malaysian economy is on track to register stronger growth in 2017. Looking ahead, the economy is poised to register a strong growth that is close to the upper end of the official forecast range of 5.2 – 5.7% in 2017. Growth momentum has been lifted by stronger spillovers from the external sector to the domestic economy. The operating environment has also improved significantly as households and businesses have steadily acclimatised to the adjustments in the global and domestic economic conditions in the past few years. Annual change (%) 3 2 1 0 -1 Source: Department of Statistics, Malaysia Business sentiments remained above the optimism threshold in 3Q 2017 Chart 36: MIER Business Conditions Index Points 140 120 100 60 40 20 4Q 16 1Q 17 2Q 17 Source: Malaysian Institute of Economic Research (MIER) 56 Leading indicators such as the Department of Statistics Malaysia’s composite leading index and MIER Business Conditions Index corroborate expectations for continued expansion of the domestic economy. For 2018, domestic demand is expected to remain the key source of growth. Private consumption will remain the largest driver of growth, supported by continued improvements in income and overall labour market conditions. Investment will be sustained by infrastructure projects and higher capital investment in the manufacturing and services sectors. The external sector will provide additional impetus to the economy, benefitting from the improvement in global growth. Overall, the assessment is for growth to remain strong in 2018. Optimism threshold = 100 points 80 0 Aug 17 Jul 17 Jun 17 May 17 Apr 17 Mar 17 Feb 17 Jan 17 Dec 16 Nov 16 Oct 16 Sep 16 Jul 16 -3 Aug 16 -2 THIRD QUARTER 2017 3Q 17 On the supply side, the improvement in both external and domestic demand will benefit the manufacturing and services sectors. The agriculture sector’s growth will be driven by a recovery in CPO yields post-El Niño. Growth in the mining sector is projected to be supported by output from the ramping up of production in new oil and gas facilities. In the construction sector, growth will be supported by new and existing civil engineering projects.
4. BNM QUARTERLY BULLETIN Going forward , inflation could remain elevated over the coming months amid rising global oil prices but is projected to moderate thereafter Since the end of October 2017, there have been significant shifts in the development of cost factors. Global oil prices have risen rapidly following reports of stronger oil demand and geopolitical tensions in the Middle East. This has led to increases in domestic fuel prices, which translate into higher upside risks to inflation outlook in the near term. Should the high level of global oil prices be sustained, domestic fuel prices and in turn, headline inflation, would remain elevated over the coming months. For 2017 as a whole, inflation is expected to be at the upper end of the forecast range of 3 – 4%. Going forward, while underlying inflation will be sustained by robust domestic demand, continued expansion in productive capacity is expected to contain further increases. Along with expectations of smaller effects from global cost factors, headline inflation is projected to moderate in 2018. However, the trend will depend on future global oil prices, which are highly uncertain. THIRD QUARTER 2017 57
5. BNM QUARTERLY BULLETIN Regulatory framework provides conducive environment for boards to perform their roles e ffectively (i) Stronger independence and improved board competency profile Since the Asian Financial Crisis 1997/1998, boards’ independence and composition in terms of size, diversity and skills have improved significantly. To ensure robust checks and balances, the number of independent directors required on the boards of financial institutions was initially increased to one-third and more recently to form a majority of the board. These requirements have since been complied with underlining the industry’s recognition of the importance of board independence from elements of excessive influence that may be exerted by significant shareholders and dominant management. As financial institutions become larger and more complex, the boards must have the requisite skills and capacity to assess material risks and emerging developments affecting the business and operating environment. This entails the need for boards to have a diverse set of skills, experience and competencies to identify and deliberate on current and emerging risks as well as challenges faced by financial institutions. Today, boards of financial institutions have evolved into having members with diverse skill sets including in areas such as risk management, accounting, law, human capital, information technology, Islamic finance and Shariah. Financial institutions with regional presence have also appointed board members with regional exposure to better manage inherent risks related to cross border business. The increasing diversity in skills and background have also enhanced the boards’ strategic and technical capabilities to meet the challenges associated with an environment of increasing uncertainty and complexity. (ii) Clear separation of management and board As part of the reforms made post crisis, the Bank has introduced a number of prudential measures to reduce the involvement and influence of management on the boards of financial institutions. A significant milestone was achieved when the Bank directed financial institutions to separate the roles of executive function from the chairman in 2005. Subsequently, the number of executive directors was restricted to a maximum of two in 2013 and further reduced to one in 2016. In addition, the definition of executive directors has been expanded to include any individual who has management responsibilities in the financial institution’s affiliates1. A former executive of a financial institution must also serve a two-year cooling off period before being eligible as an independent director of the same institution. These developments represent a forward leap towards making boards’ judgement and decision-making more independent of management influence and also lead towards more objective scrutiny of management’s performance. who are also serving the board of FI’s affiliate to form minority m at Thre rity li ia Independent directorship shall not exceed 9 years Majority independent board member Strong Corporate Governance 2-year gap for former executive to become independent member Do m Non-executive Chairman Only one Executive Director t en nk thi up ro Board members eholders and M a har na tS ge an m in G Chart 1: Regulatory requirements have created conducive environment for boards to effectively discharge their fiduciary duties Regulatory requirements to support conducive environment Fa Potential threats to boards’ effectiveness and independence Source: Bank Negara Malaysia 1 The definition for affiliates includes a corporation that controls, is controlled by, or is under common control with the financial institution. THIRD QUARTER 2017 59
6. BNM QUARTERLY BULLETIN (iii) Greater oversight over risk, internal controls, remuneration, succession planning, directors and senior management appointments and performance assessment A sound board oversight structure is key to good governance. In line with the Bank’s expectation, financial institutions have established dedicated board oversight functions through audit, risk management, nomination and remuneration committees. Some large financial institutions have also established other board committees to provide enhanced oversight on compliance and information technology, in tandem with the nature and complexity of their institutions. Dedicated committees ensure key matters are given sufficient focus and in-depth deliberation to ensure informed decision-making. The empowerment to the dedicated committees enables the boards to sharpen their focus on strategic matters concerning the financial institutions. This structure also promotes efficient management of boards’ resources. (iv) Enhanced directors’ competencies through on-going training regime In order to be able to constructively challenge and guide the management team, boards must be in a position to understand and evaluate the risks emerging from the activities and operations of the financial institutions. Recognising this need, the Bank, together with the financial institutions have taken concerted measures to ensure that boards collectively possess the requisite experience and expertise to steer the financial institutions in the right direction. Financial institutions have established bespoke on-boarding programmes to further expose board members to the regulatory framework governing the financial institutions, as well as to expedite their institutional understanding. In addition, it has also been made compulsory for board members to complete the Financial Institution Directors’ Education (FIDE) Programme2. Through such structured training programmes, directors have been given further exposure to deepen their understanding on boardroom governance, examine the interlinkages between risk dimensions and capital management, and explore key issues facing financial institutions in areas such as business strategy, risk management, succession planning and stakeholders’ management. Chart 2: Evolution of corporate governance standards has elevated the effectiveness of board stewardships in financial institutions Guidelines on responsibilities of Directors and Appointment of Chief Executives Nov 1985 Nov 1994 Revision of 1985 guidelines. New measures include: ࠮ ([SLHZ[ independent directors on board ࠮ 5\TILYVM executive directors restricted to 3 Requirement to establish board sub-committees for nomination, remuneration and risk management matters May 2003 Mar 2005 ࠮ :LWHYH[PVUVMYVSLZ between Chairman and CEO ࠮ *OHPYTHUVM[OL board must be non-executive FIDE programme made compulsory for all directors Apr 2011 ࠮ *VKPMPJH[PVUVM functions and duties of board in Financial Services ࠮ :[YLUN[OLULK (J[HUK expectations for 0ZSHTPJ-PUHUJPHS group wide :LY]PJLZ(J[ governance ࠮ :[YLUN[OLULKMP[ and proper criteria ࠮ ;LU\YLVM independent for directors directors should not exceed 9 years June 2013 ࠮ 5\TILYVM executive directors YLZ[YPJ[LK[V ࠮ 0UKLWLUKLU[ ࠮ directors must form at least 1/3 of board members Aug 2016 5\TILYVM executive directors restricted to 1 ࠮ 0UKLWLUKLU[ directors must form board majority Source: Bank Negara Malaysia 2 60 FIDE programme is jointly organised by Bank Negara Malaysia, Perbadanan Insurans Deposit Malaysia and The Iclif Leadership and Governance Centre. THIRD QUARTER 2017
7. BNM QUARTERLY BULLETIN Expectations on boards will continue to evolve along with changes in operating landscape and regulatory demands It is imperative that board members of financial institutions uphold the highest level of integrity as boards set the tone and culture of an organisation . With the right tone and culture from the top, business dealings and decision-making will be guided by sound judgment and ethical values. Financial institutions with sound risk cultures are more likely to grow their business in a sustainable manner while observing greater standards of risk management and compliance to regulatory expectations. The corporate governance standards of Malaysian financial institutions have been significantly enhanced over the years. Nevertheless, the evolution of sound corporate governance is far from over. In the era of innovation and digitalisation, the rising leverage of global financial services on information technology such as Big Data and cryptocurrency widens the range of risks facing financial institutions. In navigating this uncharted territory, higher expectations will be put upon the boards for their oversight of technology risk such as data management and cyber security. In this regard, financial institutions are expected to be proactive in prepping the boards with the required expertise. The Bank is now accelerating efforts to elevate the level of professionalism, ethical standards and integrity of the financial industry. For instance, enforcement actions taken against financial institutions and intermediaries for non-compliance to rules and regulations will be published starting from January 2018. With greater repercussion and higher reputational risk at stake, matters such as compliance and risk management are expected to be given greater prominence by the boards. Regardless of the forces of change, the relentless pursuit of a strong corporate governance foundation by financial institutions remains; to protect the critical role of financial institutions in supporting the real economy and preserving financial stability. References Bank Negara Malaysia’s policy document on “Corporate Governance”, issued on 3 August 2016. Bank Negara Malaysia’s “Guidelines on Corporate Governance for Licensed Institutions”, issued on 19 June 2013. Bank Negara Malaysia’s “Guidelines on Directorship in the Banking Institutions”, issued on 28 November 1994. Bank Negara Malaysia’s policy document on “Fit and Proper Criteria”, issued on 28 June 2013. Bank Negara Malaysia’s “Guidelines on the Establishment of Board Committees, Minimum Qualifications and Training Requirements for Directors and Definition and Responsibilities of Independent Directors”, issued on 29 May 2003. THIRD QUARTER 2017 61
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