Malaysia Deposit Insurance ready for the worst

Monday April 6, 2009

MALAYSIA Deposit Insurance Corp (PIDM) has set up teams and a comprehensive risk assessment system in preparation for any crisis.

“Last year, we developed a risk assessment system which allows us to slice and dice the information, do trending between peer groups and monitor non-performing loans,’’ said PIDM CEO Jean Pierre Sabourin.

As an independent statutory body, PIDM assesses the financial institutions based on the least cost approach. Backed by a team of six risk managers, it meets Bank Negara, which is the supervisor, once a month to share information and discuss issues of concern.

“We also spend a lot of time on the intervention and resolution framework,’’ Sabourin told StarBiz. PIDM has powers to intervene into a problem institution to mitigate the loss, provide financial assistance, purchase assets, provide guarantees or make deposits. If the institution is deemed unviable, intervention powers include taking control, nationalisation, liquidation, finding the least cost solution, purchase assumptions, recapitalisation, doing bridge banks or agency agreements.

The US Federal Deposit Insurance Corp (FDIC) and the Canadian Deposit Insurance Corp (CDIC) have all those powers too. Sabourin had worked at the CDIC for 30 years, of which he was CEO for 15 years.

The deposit insurance system complements Bank Negara’s role in protecting depositors and contributing to financial stability.

The principle is to intervene properly and find quick solutions in the best interests of the financial system.

“If the institution is liquidated through the court process, we would be obligated to reimburse depositors,’’ said Sabourin who has experience with 43 bank failures in Canada.

Since the end of last year, PIDM has been developing a comprehensive payout system which will be rolled out in phases over the next two years. This involved complex calculations, looking at ways to obtain access to all the deposits, reconciling all deposit liabilities and aggregating accounts.

Besides that, the payout system looks at calculation of interest, uncleared cheques, reconciliation for depositors and transfer of the deposit base to a new institution. Another avenue is to sell the bank branches.

“When we do resolution, we don’t just look at costs but at other issues such as contagion and public concerns,’’ said Sabourin.

“We are the responsible organisation to deal with troubled banks. When the situation cannot be rectified by the regulator, it becomes a viability issue and our responsibility to intervene,’’ he added.

However, banks in Malaysia are in good shape based on financial stability reports and the data and observations made at PIDM.

“We have teams working day and night now on approaches and policies on contingency planning,’’ he said.

To reward banks with better risk profiles, a new method of collecting premiums called the differentiated premium system was implemented.

Taking into account qualitative and quantitative factors, it does back testing and checks on factors to assess banks individually and as a group.

PIDM has come up with the best bank model looking at ratios such capital, efficiency and profit volatility.

In comparison with the previous flat rate of 0.06% of insured deposits, banks in No. 1 category pay less premiums which had totalled RM100mil per year for three years since the formation of PIDM.

Based on the higher deposit base at banks, the premiums collected by PIDM is projected to increase. But this amount can be mitigated if a bank falls in No. 1 category (0.03%); No. 2 (0.06%); No. 3 (0.12%) and No. 4 (0.24%).

For 2008 which was the first year of implementation, the banks enjoyed a transitional mechanism where quantitative scores were adjusted upwards by 20%. Risk ratings also take into account Bank Negara ratings (35%).

For 2009, there is no transitional mechanism; by May 31, the results will be available of the first year of implementation of the new system.

“Based on the Canadian experience of the best bank model, we saw a substantial increase in banks going to highest category.

“This information is provided to the board which will probably ask the CEO why their bank is paying more premium to PIDM,’’ said Sabourin.

PIDM has a current fund size of about RM280mil. “The premiums charged cannot be large enough for the banks to start charging customers for it,’’ said Sabourin.
In most cases, deposit insurers build a target fund which is large enough to deal with losses expected. A system of early intervention based on viability, not insolvency, should help to contain losses.

In Malaysia, the deposit insurer is a government agency. It also has the authority to borrow from the Government or issue debt.

PIDM funds are invested only in government securities, based on the objective of capital preservation.

“This year, we are building a target fund with some proxies to evaluate the kind of fund and level we would be comfortable with. Then, we can reduce premiums further. We have done that in Canada and the process can take 10 to 15 years,’’ he said.

The target fund is based on probability of bank failures and loss given default (how much it costs if a bank fails). There is no history in Malaysia, hence the need to find some proxies.

Target funds can become very huge. The FDIC had more than US$50bil two years ago and paid rebates.

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