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FOUNDATIONS OF
BANK LENDING
CHAPTER 1
Module Authors
Jasman Tuyon, PhD
Rapheedah Musneh, PhD
Siti Julea Supar
Nurziya Muzzawer
Next Slide
Faculty of Business and Management
Universiti Teknologi MARA, Sabah Branch, Kota Kinabalu Campus
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FOUNDATIONS OF BANK LENDING

CHAPTER'S OUTLINE

1.1 Fundamental Principles of 1.2 Rules and 1.3 Ethics and

Bank Credit Regulations Governing Corporate Governance
1.1.1 Introduction to Bank Credit Bank Credit in in Bank Credit
1.1.2 The Credit Process Cycle Malaysia
1.1.3 Lending Decision
Framework in Business Banking

More Info More Info More Info

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Learning Objectives:
Upon completion of this chapter,
students should be able to:

1. Define bank credit.

2. Clarify the important of bank credit
to the bank business.
3. Understand the flow of credit
process cycle.
4. Understand major provisions of
Financial Services Act 2013 and BNM
guidelines affecting credit function.
5. Explain ethics and governance in
financial institution.
Read More. . .
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Fundamental Principles
of Bank Credit

Sub-topic 1.1
Next Slide
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1.1.1 Introduction to Bank

Credit
1.1.1.1 Bank definition and
scope
of business
1.1.1.2 Bank lending
business
1.1.1.3 Bank operation is
highly
Read More. . .

regulated
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Introduction to Bank Credit (Cont.)

1.1.1.1 Bank definition and scope of
business
• Definition:
• Central Bank of Malaysia Act 2009 [Act 701]
• “financial institution” means a person carrying on a financial business regulated
under the laws enforced by the Bank and in addition includes any—
• (a)person who operates any payment system or issues any payment instrument;

• Financial Services Act 2013 [139]

• “the word “bank” unless such person is licensed under this Act to carry on banking
business or investment banking business”

• Business:
• Financial Services Act 2013 [139]
• “banking business” means—
• (a) the business of—
(i) accepting deposits on current account, deposit account, savings account or
other similar account;
(ii) paying or collecting cheques drawn by or paid in by customers; and
(iii) provision of finance; and
• (b) such other business as prescribed under section 3;
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Introduction to Bank Credit (Cont.)

1.1.1.2 Bank lending business
• Financial Services Act 2013
 “provision of finance” includes:
(a) lending of money;
(b) leasing business;
(c) factoring business;
(d) purchase of bills of exchange, promissory notes,
certificates
of deposit, debentures or other negotiable
instruments; and
(e) the acceptance or guarantee of any liability,
obligation or duty of any person;.
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Introduction to Bank Credit (Cont.)

1.1.1.2 Bank lending business (cont.)
• Typically a universal banking
operations are divided into five
areas:
• 1. Wholesale and corporate
banking, responsible for providing
financial services to large Or Investment banking
enterprises (public firms) SME/Business
• 2. Business/SME banking, Banking

responsible for providing financial

services to medium to large SMEs
(private firms) Focus of
this course
• 3. Retail and consumer banking,
responsible for providing financial
services to individuals and small
businesses
• 4. Treasury, responsible for managing
the bank’s funding and liquidity needs Sample of Bank Structure
Source: Adapted from Golin and Delhaise (2013).
• 5. Asset management, responsible for
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Introduction to Bank Credit (Cont.)

1.1.1.2 Bank lending Balance Sheet Profit & Loss Account

business
• Credit to SMEs is an important
(cont.) Loans Equity Interest income……….……[+]
business of the bank and contributes Deposit
Fee-based income…..…...[+]
large part to the bank credit Interest paid………………….[-]
Loan losses (Loss).………..[-]
portfolio. Total Assets Total Liabilities Expenses……………………….[-]
and Equities
• Granting more loans to SMEs will Net Profit……………….[+/-]
exposed the bank to high credit risk
Bank Lending to SMEs Credit risk impacts to bank’s
that is directly impacting the bank’s Credit to SMEs profitability
profitability.

• Hence, SME credit analysis need to

be properly undertaken to mitigate
Bank Project Borrower
credit risk following internal credit
analysis process, credit policy,
compliance to laws and regulations.
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1.1.1.3 Bank operation is highly

regulated Financial System Stability
International Level [Key regulatory – BASEL Framework]

Domestic Level

External regulations
External regulations
Shareholder Theory/Stakeholder Theory Internal regulations
 Regulations,  Bank credit policy
Guidelines, Internal regulations
and guidelines
Notices and
Directions Issued
by Bank Negara
Malaysia
 Financial Services
Act 2013 Agency Theory > Agency problem
 National Land
Code Act 828
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Introduction to Bank Credit (Cont.)

1.1.1.3 Bank operation is highly
regulated (cont.)
 The Basel Framework
The Basel Framework is the full set of standards of the Basel Committee on Banking
Supervision, which is the primary global standard setter for the prudential regulation
of banks.

 External Laws & Regulations

The external laws and regulations affecting bank credit functions including:
 Regulations, Guidelines, Notices and Directions Issued by Bank Negara Malaysia
 Financial Services Act 2013
 National Land Code Act 828 (for land charges and lien as collateral)

 Internal Policies and Guidelines

The credit policy is a document that determines all the guidelines which allow
these lending companies to make these critical lending decisions. These guidelines
are important for risk management and provide necessary guidelines to the staff to
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1.1.2 The Credit Process

Cycle
1.1.2.1 Origination
1.1.2.2 Approval
1.1.2.3 Administration
1.1.2.4 Monitoring
1.1.2.5
Settlement/Recovery
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The Credit Process Cycle

1 Origination

Principles of
lending
2 Approval applies
(in
Chapter ?)

3 Administration

What is credit process cycle?

• It is the operational flow of credit
lending, from loan origination to full loan Monitoring
repayment. 4

Why credit process cycle is important?

• It provides vital information to the lender
Settlement/
in the
Read More.process
.. of loan origination, data 5 Recovery
and information for verification of
borrowers, and credit evaluation based
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The Credit Process Cycle (Cont.)

1.1.2.1 Origination
• The “marketing phase” of credit process cycle.

• Lender will :
• Initiate the contact with customer
• Discuss business requirements
• Evaluate credit risk relative to the acceptance criteria

• This phase is conducted based on Bank’s internal lending policies and in compliance
with external regulations such as Bank Negara Malaysia guideline and Financial
Services Act 2013.

• At this stage, the credit officer will identify the target market and key customer group
for retail and business lending in accordance with lending Bank’s Risk Assets
Acceptance Criteria (RAAC).

• The RAAC can be set for business lending and individual or consumer lending.
• For business lending, - the RAAC can be set based on minimum sales, profitability,
net worth, and account profitability to the lender.
• For individual or consumer lending - the RAAC can be based on age, minimum loan
amount, employment tenure, income, payment history etc.
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The Credit Process Cycle (Cont.)

1.1.2.2 Approval
• This stage involves credit evaluation/credit risk analysis.

• At this stage, the credit officer will review and analyse the credit application based on the available
financial information (audited financial statement, income tax, financial forecast) and non-financial
information (borrowing track record, litigation status, business background etc) in order to determine
borrower’s repayment ability.

• The credit evaluation can be carried out based on principles of lending, and using tools such as 5Cs
basic credit factors, qualitative, and quantitative financial analysis.

• The Bank’s credit officer will submit the credit proposition to Credit Approval for consideration and the
loan will be approved/modified/declined with status (outright reject due to poor bankable credit,
approved with or without conditions, refer to borrowers for more information, approved with reduce
limit, recommend to higher approval authority) based on the Discretionary Approving Authority of the
Credit Approval (Credit Approval Committee, Bank’s BOD).

• The Bank’s credit officer has the responsibility to recommend a quality credit proposition with
acceptable credit risk that allow lender to maximize their risk weighted return.

• Upon approval, the Letter of Offer (LO) will be issued in the Bank’s standard format incorporating all
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The Credit Process Cycle (Cont.)

1.1.2.3 Administration
• This stage involves loan documentation and disbursement.

• Once the borrowers accept the LO incorporating the approved terms and conditions,
the Bank’s legal documentation department will handle the execution and perfection
of loan agreement and security agreement between the borrower and the lender.

• Alternatively, they may instruct the Bank’s panel of solicitor to handle the legal
documentation depending on the complexity of security arrangement.

• To ensure effective check and balance and to minimize risk of conflict of interest and
fraud, another independent unit of the Bank known as loan disbursement department
will handle the release of loan/ banking facilities. They are to ensure that all approved
terms and conditions are duly complied with, and legal documentation duly perfected
before the loan is disbursed for borrower’s utilization. This is also to ensure Bank’s
right is protected with good enforceability over collateral taken as security for the
loan.
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The Credit Process Cycle (Cont.)

1.1.2.4 Loan monitoring covers the following:

Monitoring
• This stage involve activities, roles and
responsibilities of credit officers after the loan is
• Monitor facility utilization in order to generate
profitability to the bank.
disbursed. • Monitor loan repayment to ensure satisfactory
• The lender must monitor the loan account to ensure
conduct and prompt payment, and to detect any
borrower meets all repayment obligation in a timely
potential warning signal/ red flag.
manner, and actively utilize the facility in order to
generate profitability for the Bank. • Tracking of antecedent (post draw dawn)
• The loan monitoring also includes tracking of all conditions to ensure full compliance e.g.
post-drawn down terms and conditions for placement of sinking funds, quarterly submission
compliance by borrower. of financial accounts, certified progress billing
• In addition, credit officer is required to carry out
before loan draw dawn.
review of borrowing account of at least once a year
• Site visitation to verify business visibility and
to revisit borrower’s credit risk profile and financing
needs, and to assess the need to management competency.
restructure/modify/renew or wind down the banking • Interim or annual review to revisit borrower’s risk
facility. profile, financing requirement or the need to
• Proactive loan account management and loan restructure facility terms according to borrower’s
monitoring is important for lender to identify operating cycle.
potential warning signals or red flags that would
weaken the borrower’s loan repayment and increase
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The Credit Process Cycle (Cont.)

1.1.2.5
Settlement/Recovery
• The final phase of the credit process cycle involves repayment and settlement of loan
owing to lender by borrower upon the maturity of loan period.

• In the event where borrower encounters problem in meeting the loan repayment or
unable to make full loan settlement, lender is required to undertake loan
rehabilitation which involves loan rescheduling and restructuring to prevent loan from
turning into non-performing.

• Loan recovery will be the last resort for the lender.

• It is applicable in situation where borrower’s business cash flow and repayment
ability is permanently affected and is unlikely to recover to meet its loan obligation.
• The bank will commence legal proceeding and sell the asset held as collateral to
settle the loan outstanding owed by the borrower.
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1.1.3 Lending Decision

Framework in Business
Banking
1.1.3.1 Overview of the bank
lending decision process
1.1.3.2 Lending approaches
1.1.3.3 Credit decision
operation in
Read More. . .
business banking
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By Department By Process
Marketing/Sales Marketing/Sales leads
Department
2 Head Office Origination
Credit Risk Management Submission of application
1.1.3.1 Overview of Department form and other required
documents
the bank lending Credit Committee Credit Analysis Principles of Assessment and approval of The 5Cs of
Approval
decision process Approval Department Lending facilities requested Credit Analysis

• Business Issuance of letter of offer/

rejection to borrower
Compliance to
banking/Business rules and
center – credit regulations
Borrower declines
decision by (internal and Borrower accepts offer
offer or appeal against
external)
department and facilities
Borrower comply to legal
process requirement and pre- Administration
Appointed disbursement conditions
• Head office – Solicitor
Credit Administration
Credit Risk (perfection of legal
Department Disbursement of credit
documentations)
Management facilities
3 Panel Solicitor
department Credit facilities Monitoring
• Panel Solicitor– monitoring

Perfection of Credit Rehabilitation & Recovery Credit facilities recovery

Recovery
legal
Source: Adapted from Bank Negara Malaysia (2003)
Department
documentations.
https://www.bankinginfo.com.my/pdf/sme_loans.pdf 1 Business Banking / Business Center
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Introduction to Bank Credit (Cont.)

1.1.3.2 Lending approaches Bank Credit Analysis
i. Credit Scoring (Standard
process)
• Credit scoring only apply to
small business financing. 1 2
Standard Process Individual Process
• Reasons:
 small amount of credit (Credit Scoring) (Credit Judgement)
(System approach) (Judgement approach)
request and low probability
of default.
ii. Credit Judgement (Manual
process)
• Credit judgement apply to SMEs The 5Cs of Credit
Score Board
and corporate financing. Analysis
• Reasons:
 Information asymmetry is
higher that need to be assessed
manually by the credit officer. Apply to Apply to
 Higher amount of credit request Small Business Medium & Large SMEs
and high probability of default.
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Introduction to Bank Credit (Cont.)

1.1.3.2 Lending approaches
Standard Process (Credit
(Cont.)
Scoring)
• Documents required: Annual financial
statements or the business plan.
• A typical rating process consists of two
components:
• 1. financial rating (or quantitative
rating)
 Financial rating comprises an
analysis of the financial data
available for the credit applicant
(focus on debt service capacity)
• 2. qualitative rating
 Borrower characters – knowledge,
experience, and past credit conducts
 Business characteristics -
Source: Adopted from Oesterreichische Nationalbank (2004).
profitability, competitiveness, and
survival.
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Introduction to Bank Credit (Cont.)

1.1.3.2 Lending approaches
(Cont.)
ii. Credit Judgement
• Judgmental credit analysis is a
method of approving or
denying credit based on the
lender's judgment rather than
on a particular credit scoring
model.
• Judgmental credit analysis
entails evaluating the
borrower’s application and
using prior experience dealing
with similar applicants to
determine credit approval.
• Credit judgement analysis will
be guided by the 5Cs of credit Conceptual presentation of the credit judgement process
Source: Oesterreichische Nationalbank (2004).
analysis and principles of
lending.
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Introduction to Bank Credit (Cont.)

1.1.3.3 Credit decision operation in business
banking
Business banking/Business center Head Office

Economic Recommend/
Economic analysis Credit Officers Revision
 Information Credit Risk Committee
Industry
asymmetry
Industry analysis  Adverse
selection Credit Files feedback
SME Compliance to laws
 Moral hazard
and regulations
Business & (internal and
Credit Managers Revise/
Financial external)
Approve/
analysis
Reject
Analysis and recommendation Approval

Internal Credit Audit (Bank Auditors)

SME credit application
External Credit Audit (BNM Auditors)
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Introduction to Bank Credit (Cont.)

1.1.3.3 Credit decision operation in business

banking

(Cont.) Shareholder Theory/Stakeholder Theory
The asymmetric information problem in a bank–customer
relationship. Bank assessments of SME applications for loan
finance are examples of decision making under uncertainty,
incorporating asymmetric information for the provider and the
client.
 Due to information asymmetry, banks face the twin problems of
moral hazard (monitoring problem) and adverse selection (risk
assessment problem) when dealing with small firm lending.
Agency Theory > Agency problem

Reference: Deakins and Hussain (1994); Behr, P., & Güttler, A. (2007); Tupangiu (2017).
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Introduction to Bank Credit (Cont.)

1.1.3.3 Credit decision operation in business

banking (Cont.)
 Information asymmetry Shareholder Theory/Stakeholder Theory
Asymmetric information means that the lender does not have information that is symmetric with that of the
borrower, i.e. there is (or could be) a discrepancy between the information provided by the borrowing
company (or person) and the actual state of affairs (financial and otherwise) of the company (or person).

 Adverse selection
The lenders are at a major disadvantage in terms of information about the borrower and, coupled with the
fact that bad credit risks are more inclined to borrow than are good credit risks, the lenders are more likely
to select borrowers with dubious projects (i.e. projects that have an adverse outcome) than borrowers with
projects that will succeed.

 Moral hazard Agency Theory > Agency problem

Moral hazard means that after a loan is granted, there is a high probability that the borrower may engage in
activities that do reflect the information gathered by the lender in connection with the borrower and his/her
planned projects. There are countless examples where borrowers borrow with good intentions, but when
the access to funds becomes a reality, they take on higher risk projects.
Reference: https://ebrary.net/765/economics/credit_risk
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Introduction to Bank Credit (Cont.)

1.1.3.3 Typical set-up of credit decision in business
banking
i. Credit application
• Credit application will be received from SMEs. In the process of analyzing the
proposal, credit officer is exposed to information asymmetry and moral hazard risk.

ii. Credit analysis

• Credit analysis and recommendation will be performed by the credit officer using in-
house credit review format. The analysis will be based on credit judgement applying
5Cs of credit analysis and respecting principles of lending.

iii. Credit approval

• As part of credit risk control, every credit proposal is to be reviewed by the credit risk
committee which will have the final decision (i.e. revise, approve, or reject)

iv. Credit audit

• The credit files will be audited by internal credit auditor (i.e. Bank auditors) and
external credit auditors (i.e. BNM auditors).
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Laws and Regulations

Governing Bank Credit
in Malaysia
Sub-topic 1.2
Next Slide
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1.2 Laws and Regulations Governing

Bank Credit in Malaysia
1.2.1 Roles and Responsibilities of BNM
1.2.2 Financial Services Act (FSA) 2013
1.2.3 Regulations, Guidelines, Notes, and
Directions Issued by BNM

Read More. . .
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Laws and Regulations Governing Bank Credit in Malaysia

BANK NEGARA MALAYSIA
(BNM)

Regulations, Guidelines,
Notices and Directions Financial Services Act
Issued by Bank Negara 2013
Malaysia

Exposure to Single
Counterparty
Credit Transactions and Anti-Money Laundering
Exposure with Connected and Counter Financing
Parties for Terrorism
Taking shares of Licensed
Person as Security

Classifications of
Impairment Provision for
Loans or Financing Banking Secrecy
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Laws and Regulations Governing

Bank Credit in Malaysia
• The Banking system plays the role of financial intermediary and facilitate
settlement of payment obligation.
• It is important for the banking industry to maintain a high level of public
trust in its operations, and to ensure that it carries its roles in an efficient
and reliable manner.
• The absence of trust can lead to mass withdrawal of deposit funds, which
has the potential to collapse the entire banking system.
• There is a crucial need for regulatory control over the banking system to
safeguard public interest, and maintain public trust within the banking
sector.
• The regulation ensure that banking players perform their fiduciary duties to
exercise competency and prudence in all lending activities using public
funds.
• Banking regulations also protect the banking system from a whole range of
risks ranging from human error, system malfunction and fraud.
Read More. . .
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1.2.1 Roles and Responsibilities

of BNM
• BNM, the Central Bank of Malaysia is the principle regulatory agency
responsible for enforcing FSA 2013.
• BNM will issue guidelines from time to time to all banks and financial
institutions, which are covered by the FSA 2013.
• BNM through FSA shall:
• Foster the safety and soundness of financial institutions.
• Ensure orderly functioning of money market and foreign exchange
market.
• Maintain reliability and efficiency of the payment system.
• Ensure responsible and professional conduct of financial institutions.
• Protect the interests of financial services and product’s consumers.
• BNM has through FSA 2013 restricts the amount of exposure a licensed
institution can have to a single counterparty and persons connected to the
counterparty to ensure that banking institution uphold the principle of well
spread lending portfolio. It also covers exposure to a particular financial
instrument or a particular market segment. Read More. . .
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1.2.1 Roles and Responsibilities

of BNM (cont.)
• BNM enforces Banking Secrecy through section 133 of FSA 2013.
• BNM has also specified standards relating to Credit Transaction and
Exposure with Connected Party to prevent conflict of interest and misuse of
power by connected party.
• BNM enforces a stringent guideline pertaining to Classification and
Impairment Provision for Loans/Financing.
• BNM requires banking institution to adopt the Best Practice for Risk
Management which necessitate:
• An integrated risk management process
• Adequate credit policies and procedures
• Adequate independent of credit risk management committee and
internal audit for comprehensive internal control.
• BNM has through FSA 2013, provided Anti-Money Laundering and Counter
Terrorism Financing (AMLCTF) guideline.

Read More. . .
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1.2.2 Financial Services Act (FSA) 2013

Bank Negara Malaysia
(BNM)

FSA 2013

The principle objective of FSA 2013 is to promote financial

stability.

Taking shares of
Exposure to Single
Licensed Person as Banking Secrecy
Counterparty
Security

Read More. . .
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1.2.2 Financial Services Act (FSA) 2013 (cont.)

1. Exposure to Single Counter
Party
a) Single Counterparty Exposure Limit (SCEL)

For purpose of section 50(1) FSA:

i. A banking institution’s SCEL shall be 25% of the banking institution’s Total Capital;
and
ii. Large exposure to a single counterparty is >=10% of the Banking institution’s Total
Capital

Rationale of The Policy

• SCEL is to mitigate concentration risk

• Risk concentration refers to an excessive exposure to a single counterparty and
persons connected to it, a particular instrument or market segment with the
potential to produce losses that are substantial enough to threaten the financial
condition of a banking institution.
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1.2.2 Financial Services Act (FSA) 2013 (cont.)

2. Taking Shares of Licensed Persons as
Section 87 (1) Security

Prohibits a person from entering into an agreement to acquire any interest in shares of
a licensed person which will result in such person holding (together with any interest in
shares already held by such person) an aggregate interest of five per cent or more in
the shares of the licensed person unless the approval of BNM is obtained.

Section 87 (2)

Prohibits a person from entering into an agreement to acquire any interest in shares of
a licensed person which will result in such person holding more than fifty per cent of
interest in shares of a licensed person unless the approval of the Minister of Finance, on
the recommendation of BNM is obtained.

Section 88

Prohibits a person from exercising control over a licensed person, unless the approval
of the Minister of Finance, on the recommendation of BNM is obtained.
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1.2.2 Financial Services Act (FSA) 2013 (cont.)

2. Taking Shares of Licensed Persons as Security
(Cont.)
Section 89

Requires a person who has an aggregate interest in shares of a licensed person of:

More than fifty per cent; or

Fifty per cent or less but has control over the licensed person, to obtain the prior
written approval of the Minister of Finance, on recommendation of BNM, if he disposes
his interest in shares in licensed person, or ceases to have control over a licensed
person.

Section 92

States that an individual shareholder shall not hold more than ten per cent of interest
in shares of a licensed person.

Rationale of the Policy

• To minimize the impact of lender’s enforceability in the event of loan default.

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1.2.2 Financial Services Act (FSA) 2013 (cont.)

3. Banking Secrecy
Section 133 (1)

Prohibits:

i. A person who has access to any document or information relating to the affairs or
account of any customer of the relevant institutions (including banks and investment
banks); and
ii. The institution itself and any of its director, officer or agent of the institution,
whether during his tenure of office or during his employment or after that to disclose
to another person any information or document relating to the affairs or account of
any customer of an institution.

Section 133 (4)

Any person who commits an offence, shall upon conviction, be liable to imprisonment of
not exceeding 5 years, or/and fine of not exceeding RM10 million.

Rationale of the Policy

• To instill public confidence within banking sector and uphold the professionalism and
integrity of banking players.
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1.2.3 Regulations, Guidelines, Notes, and

Directions Issued by BNM
Bank Negara Malaysia
(BNM)

Regulations, Guidelines,
Notices and Directions
Issued by Bank Negara
Malaysia

Credit Transactions and Classifications of Anti-Money Laundering

Exposure with Impairment Provision and Counter Financing
Connected Parties for Loans or Financing for Terrorism

Read More. . .
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1.2.3 Regulations, Guidelines, Notes, and

Directions Issued by BNM (cont.)

1. Credit Transactions and Exposures with Connected

Parties
This guideline is issued pursuant to section 47 of Financial Service Act 2013.

Connected parties are:

i. Director of a licensed institution (LI) and his close relatives

ii. Controlling shareholder or influential shareholder of LI and close relatives
iii. Executive Officer, Credit Officer and his close relatives
iv. Firms, partnership, companies or legal; entities controlled by i, ii, iii
v. Legal entities in which i, ii, and iii is a director, partner, officer, guarantor
vi. i, ii, and iii above and close relatives are a guarantor

Total credit exposure to connected parties (including credit exposure through

subsidiaries or other entities that are under Licensed Institutional control) shall not
exceed 100% of Total Capital or 25%of Total Outstanding Credit Exposure, whichever is
lower.
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1.2.3 Regulations, Guidelines, Notes, and

Directions Issued by BNM (cont.)

1. Credit Transactions and Exposures with Connected Parties

(Cont.)
Credit transaction with connected parties must be on arm’s length basis, and complied
with the following principles:

• Credit worthiness of the connected parties not less than what is normally required of
other persons.
• The terms and conditions of connected parties’ transaction should not be more
favourable than those enters with other counterparties.
• The credit transaction must ne in the interest of licensed institutions.
• The credit transaction is approved by the Board of Directors with not less than 3
quarters of all the board members present.
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1.2.3 Regulations, Guidelines, Notes, and

Directions Issued by BNM (cont.)

2. Classification and Impairment Provision for Loans/

Financing
Financial institutions must classify a loan as impaired if:

• The principal and interest is more than three months or 90 days in arrears.
• For revolving facilities (e.g. overdraft) are in excess of the approved limit for a similar
period.
• Where the amount is past due or in excess of the approved limit for 90 days or 3
months or less, the loan exhibits weaknesses according to the institution’s credit risk
grading framework.
• Payments scheduled to be made at interval of 3 months or more, than as soon as
default occurred.
• Once classified as impaired, a loan can only be reclassified as non-impaired when it
has been continuously performing based on its restructured terms for the period set
by the institution in its policy.
• Loans rescheduled or restructured by “Agensi Kaunseling dan Pengurusan Kredit
(AKPK)” can be immediately reclassified as non-impaired once customers and banking
institutions agreed to the new terms and conditions.
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1.2.3 Regulations, Guidelines, Notes, and

Directions Issued by BNM (cont.)
3. Anti-Money Laundering and Counter Financing of Terrorism
(AML/CFT)
The primary aim is to increase vigilance against deposit and transfer of illegally sourced
money within the financial system of the country. Sources of illegal money include
money from illegal drug operations, tax evasion, human trafficking and money intended
for terrorism activities.

BNM is the Competent Authority appointed by the Ministry of Finance for AMLATF 2001
through its Financial Intelligence and Enforcement Department (FIED).

Under the guideline, Financial Institutions are required to conduct the followings:

• Identify new customers using proper processes and procedures

• Report suspicious transactions by all bank employees
• Keep customer records for future inquiries
• Provide training to bank employees on AMLATFA

BNM guidelines require a Customer Due Diligence (CDD) process or an Enhanced

Customer Due Diligence (ECDD) process by which the Bank can identify, verify, and
understand the customer and its background. This is part of the Know Your Customer
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Ethics and Corporate

Governance in Bank
Credit
Sub-topic 1.3
Next Slide
 FIN367

Ethics and Corporate Governance

in Bank Credit
1.3.1 The roles of ethics and governance
in bank
credit decisions
1.3.1.1 Compliance to laws
1.3.1.2 Mitigating misbehaviors in
credit
decisions
1.3.1.3 Strengthening Conduct and Read More. . .
Culture
in the Financial Industry
1.3.2 Corporate Governance for Financial
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Ethics and Corporate Governance in Bank

Credit (Cont.)
PRUDENTIAL REQUIREMENTS
1.3.1 The roles of ethics and
governance in bank Division 1
credit decisions Standards on prudential matters
Power of Bank to specify
standards on prudential matters
Institution, director and officer to
1.3.1.1 Compliance to laws
comply with standards

Division 2
Corporate governance
Functions and duties of board of
directors
Duties of directors
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Ethics and Corporate Governance in Bank

Credit (Cont.)
1.3.1.2 Mitigating misbehaviors in credit decisions (Del Gaudio
et al., 2022).
The European Systemic Risk Board (ESRB) (2015) defines misconduct as risk related
to how customers and investors are treated, mis-selling of financial products,
violations of rules and manipulation of markets.

Misconduct risk has gained prominence in financial stability debates in recent years.
Misconduct risk is a critical issue because it can be a source of losses caused by
negligence and insufficiently cautious management and, therefore, has the potential
to harm investors and overall banking stability

Therefore, the mitigation of misconduct risk represents an important issue for both
banks and financial regulators. To preserve the integrity of the financial system,

Banks and other financial providers to engage in misconduct. However, engaging in

illegal behaviour with their clients may expose organizations to detrimental effects.
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Ethics and Corporate Governance in Bank

Credit (Cont.)
1.3.1.2 Mitigating misbehaviors in credit decisions
(cont.)
According to many commentators, the credit crisis was caused by moral
deficiencies on the part of market parties in the financial sector (Graafland &
van de Ven, 2011):
 unrealistic and risky mortgage loans to poor residents;
 packaging and selling of these loans in a way that disguised the real
risks;
 unreliable ratings by specialists;
 risky investment policies (of banks);
 driven by an exorbitant bonus culture of top management.
In response, a renewed sense of the importance of ethics is necessary to
prevent a future crisis
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Ethics and Corporate Governance in Bank

Credit (Cont.)
1.3.1.3 Strengthening
Conduct and Culture in
the Financial Industry
(Li and Tsan, 2018).
 Recent instances of conduct failures
present a major threat to this continuing
trust, as they can be seen as a reflection
of underlying weaknesses of governance
in financial institutions.
 Recognising that addressing misconduct
calls for a multifaceted approach, a
number of regulators have begun to focus
on reinforcing ethical and professional Corporate Ethics
behaviour in the financial sector.
Governance
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1.3.1.3 Strengthening Conduct and

Culture in the Financial Industry (cont.)
BASIS FOR ETHICS GOVERNANCE
COMPARISON (CODE OF ETHICS) (CODE OF CONDUCT)
Meaning An aspirational document, issued by the A directional document containing specific
board of directors containing core practices and behavior, that are followed or
ethical values, principles and ideals of restricted under the organization is Code of
the organization is Code of Ethics. Conduct.

Nature General Specific

Scope Wide Narrow
Governs Decision making Actions
Length Short Comparatively longer
Disclosure Publicly disclosed. Employees only.
Focused on Values or principles Compliance and rules
Source:
https://keydifferences.com/difference-between-code-of-ethics-and-code-of-conduct.html#
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1.3.2 Corporate
Governance for Financial
Institutions
Guidelines on Corporate Governance for Licensed
Institutions
 The Guidelines set out broad principles and minimum standards as well
as specific requirements for sound corporate governance, which are
expected of Licensed Institutions and Bank Holding
Companies/Financial Holding Companies.
 The adoption of sound corporate governance standards and practices
ensures that Licensed Institutions are managed safely and soundly
where risk -taking activities and business prudence are appropriately
balanced so as to maximise shareholders’ returns and protect the
interests of all stakeholders.
 Effective corporate governance by financial institutions is critical to
strengthen public trust and confidence in the financial system (Li and
Tsan, 2018).
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1.3.2 Corporate Governance for

Financial Institutions (cont.)
Principle 1: Every Licensed Institution should be headed by an effective board, which assumes specific
responsibilities. The vision, strategy and corporate values of the Licensed Institution should be clearly specified and
understood
Principle 2: There should be an effective board composition, with a strong independent element where no individual
or small group of individuals should be allowed to dominate the board’s decision making
Principle 3: There should be a clear division of responsibilities at the helm of a Licensed Institution, which will ensure
a balanced and clear lines of role, responsibility, authority and accountability throughout the Licensed Institution
Principle 4: There should be a formal and transparent process for the appointment of directors to the board and the
appointment of CEO
Principle 5: Directors must be persons of caliber, credibility and integrity with the necessary skills and experience and
be able to devote time and commitment
Principle 6: Board should meet regularly and be duly furnished with complete and timely information
Principle 7: There should be a formal and an ongoing assessment of the effectiveness of the board as a whole, the
directors and the CEO
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1.3.2 Corporate Governance for

Financial Institutions (cont.)
Principle 8: There should be a formal and transparent procedure for fixing theremuneration packages of board
members, CEO and senior management and the remuneration policies and practices should be in line with the
Licensed Institution’s ethical values, objectives and culture
Principle 9: Persons empowered with decision-making authority (including directors) should exercise care to avoid
situations that may give rise to a conflict of interest situation
Principle 10: There should be clear separation between shareholders and management so as not to impede sound
corporate governance
Principle 11: There should be robust auditing requirements and the auditor, board and management need to maintain
professional and objective relationships
Principle 12: Licensed Institution should engage in regular, effective and fair communication with
shareholders/stakeholders
Principle 13: Conducting corporate governance in a transparent manner can reinforce sound corporate governance
Principle 14: Board is collectively responsible and accountable for the veracity of disclosures and management of risk
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1.3.2 Corporate Governance for

Financial Institutions (cont.)
Best practice for the governance system related to bank credit revolves around four key principles,
which are critical to the quality of the credit originated (Golin and Delhaise, 2013).

1. Guidelines: Clear guidelines governing the approval of transactions generating credit risk.
 Guidelines are a set of documents that explain the rules that must be complied with before a transaction is concluded. These
guidelines are sometimes called “credit policies,” “risk management standards,”
 Bad human judgment is a common characteristic of poor transactions, but the executive management of a firm is ultimately
accountable if the guidelines, either by direct authorization or omissions, permit certain transactions to occur.
 Process must be in place to maintain guidelines, keeping them up to date and in-step with the evolution of the business.

2. Skills: Delegation of authority to committees and people with appropriate skills.

 The chief risk officer's office will own the guidelines, and it is this department's responsibility to draft, seek approval for,
promulgate, and maintain the guidelines.
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1.3.2 Corporate Governance for

Financial Institutions (cont.)
Best practice for the governance system related to bank credit revolves around four key principles,
which are critical to the quality of the credit originated:

3. Limits: Setting up of limits.

 Limits refer to credit exposure limit. Credit limits can be attached to counterparties, industries, countries, or
products.

4. Oversight: Qualified staff with adequate independence and resources.

 The authority granted by the Board of Directors to the credit risk committees.
 Transactions need to be accessed and approved by credit risk committees
 The role of risk managers is to see beyond the expected profitability of a
transaction and to think of the consequences of a nonfavorable development.
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1.3.3 Code of Ethics for Financial

Institutions
1. CODE OF ETHICS FOR THE FINANCIAL
SERVICES INDUSTRY

The Financial Services Professional Board (FSPB)

launched the Code of Ethics for the financial
service industry on 6 January 2016.

Organisations and individuals across the financial

services industry shall continuously uphold and
abide by the following ethical principles that are
vital to the achievement of a high standard of
professionalism and ethics across the industry.
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1.3.3 Code of Ethics for Financial

Institutions (cont.)
Principle 1: Competence
Individuals across the financial services industry shall develop and maintain the relevant knowledge, skills and
behaviour to ensure that their activities are conducted professionally and proficiently. This includes acting with
diligence, as well as obtaining, and regularly updating, the appropriate qualifications, training, expertise and
practical experience.

Principle 2: Integrity
Organisations and individuals across the financial services industry shall be honest and open in all their dealings. This
includes behaving in an accountable and trustworthy manner, and avoiding any acts that might damage the
reputation of, or bring discredit to the industry at any time.

Principle 3: Fairness
Organisations and individuals across the financial services industry shall act responsibly and embrace a culture of
fairness and transparency. This includes treating those with whom they have professional relationships with respect
and ensuring that they consider the impact of their decisions and actions towards all stakeholders.
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1.3.3 Code of Ethics for Financial

Institutions (cont.)
Principle 4: Confidentiality
Organisations and individuals across the financial services industry shall protect the confidentiality and sensitivity of
information provided to them. This includes using it for its intended purposes only and not divulging information to
any unauthorised persons, including third parties, without the necessary consent from those involved unless
disclosure is required by law or regulation.

Principle 5: Objectivity
Organisations and individuals across the financial services industry shall not allow any conflict of interest, bias or
undue influence of others to override their business and professional judgment. They shall declare, to those
concerned, all matters that could impair their objectivity.
.
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References

 Behr, P., & Güttler, A. (2007). Credit Risk Assessment and Relationship Lending: An Empirical Analysis of German Small and Medium-Sized
Enterprises. Journal of Small Business Management, 45(2), 194–213.
 Brown, K., & Moles, P. (2014). Credit risk management. Edinburgh Business School Heriot-Watt University Edinburgh, United Kingdom.
 Central Bank of Malaysia (2016). Corporate Governance. BNM/RH/PD 029-9.
 Deakins, D., & Hussain, G. (1994). Risk Assessment with Asymmetric Information. International Journal of Bank Marketing, 12(1), 24–31.
 Del Gaudio, B. L., Salerno, D., Sampagnaro, G., & Verdoliva, V. (2022). Misconduct risk in banking services: Does a propensity to be
sanctioned exist?. International Review of Financial Analysis, 81, 102081.
 Financial Service Professional Board (2015). Code of Ethics for the Financial Service Industry.
 Financial Services Act 2013, Laws of Malaysia.
 Graafland, J. J., & van de Ven, B. W. (2011). The credit crisis and the moral responsibility of professionals in finance. Journal of business
ethics, 103, 605-619.
 Golin, J., & Delhaise, P. (2013). The bank credit analysis handbook: a guide for analysts, bankers and investors. John Wiley & Sons,
Singapore.
 Li, S.T.Y & Tsan, K. L. S. (2018). Strengthening Conduct and Culture in the Financial Industry. Prudential financial policy department, Central
Bank of Malaysia.
 Tupangiu, L. (2017). Information asymmetry and credit risk. Finance: Challenges of the Future, 1(19), 153-157.
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CREDIT LENDING ASSESSMENT AND MANAGEMENT

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