Datuk Zamani Abdul Ghani: Role of development financial institutions in
the financial system
Speech by Datuk Zamani Abdul Ghani, Deputy Governor of the Central Bank of Malaysia, at
the International CEO Forum of the Development Finance Institutions 2005, Kuala Lumpur,
12 September 2005.
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I would like first of all to express my sincere appreciation to the Association of Development
Finance Institutions of Malaysia for inviting me to say a few words this morning on "The Role
of Development Financial Institutions (or DFIs) in the Financial System". It is indeed an
honour to address such a distinguished gathering of CEOs and senior officials of DFIs from
many parts of the world. Before going further into the subject at hand, allow me to
congratulate the organisers for jointly putting up this international forum. This forum provides
a platform for CEOs and senior officials to exchange views and ideas on SME development
and just as important, the roles of DFIs in this endeavour. I would also like to specifically
welcome the foreign participants to Malaysia and wish that you will have a pleasant and
enjoyable stay in Kuala Lumpur.
My remarks this morning will consist of three parts. The first provides an overall perspective
on the universal establishment of DFIs in many parts of the world; the second will look at the
prospects and some of the challenges for DFIs in carrying out their roles; and the final part
will provide an insight into the roles of DFIs from the Malaysian perspective.
There are at present approximately 550 DFIs worldwide. These are special financial
institutions established and mostly owned by governments aimed at promoting and
supporting national economic development agenda. Indeed, o ver the years, history has
shown, and reinforced the view, that DFIs do have an important role to play in a country's
socio-economic development. For instance, in Europe, the advent of development banking
can be traced back to the mid-nineteenth century, and was established to meet the increased
demand for medium to long-term capital by new and emerging enterprises during the
industrial revolution. The years following World War II saw the establishment of DFIs in many
developing countries to provide, in particular, medium and long-term financing that was
identified to be so critical in supporting the economic development agenda of these
countries.
In a laissez-faire economy, an efficient financial intermediation system mobilises and
allocates scarce resources towards activities that would optimise the rates of return. On this
basis, the commercially-driven and profit-maximising banking institutions would often tend to
take a short-term view and consider solely the private benefit of a project, at the expense of
the potential long-term social benefit that could be derived from financing a particular project.
This has, therefore, created a gap in the market place whereby certain segments of the
economy have been underserved by the banking system. These include development
projects which involve high potential risk and long gestation period, but yet have significant
long-term benefits to the overall economic development of a country. Similarly, there are also
some sectors or groups of businesses which, due to their business characteristics and lack
of track record, limited credit history and inadequate collateral, do not have adequate access
to financing from the banking system. These are clearly instances of market failure, and the
establishment of the DFIs is indeed an attempt to rectify this shortcoming.
In this regard, in achieving national policies for economic and social development, the DFIs
are established as a strategic conduit to bridge the gaps in the supply of financial services,
by channelling the resources and funds in the financial system to areas and sectors that are
deemed as strategic for long-term economic development purposes. In essence, the DFIs
are complementing the banking institutions in meeting the financing requirements of the
economy, particularly in supporting the economic and social development of a nation. The
establishment of DFIs is part of the national development plan itself.
As policy-based financial institutions, the DFIs have roles and mandates which are linked
closely to the country's national development objectives. This is evidenced from the
establishment of DFIs with specific purposes to promote development of identified sectors,
ranging from industrial and agriculture sectors to areas such as export promotion,
infrastructure development as well as the small and medium enterprises (SMEs).
It is notable that the roles of DFIs have evolved in the course of a country's economic
development and transformation. This is important in ensuring that the DFIs remain relevant
to support the changing financing needs of the economy. In some instances, the DFIs have
widened and diversified their scope of activities, to cater to the financial needs of new growth
areas, such as information and communication technology (ICT), and biotechnology. Many of
them have expanded their financial products to include providing short-term working capital
loans, equity participation and investment banking. While operating with the widened scope
of activities, it is observed that the majority of DFIs continue to maintain the provision of
medium to long-term finance and project finance as the core of their activities. At the same
time, the DFIs still fundamentally remain complementary, especially in supporting strategic
sectors such as the SMEs and agriculture.
As reflected by the term, "development financial institution", DFIs are not only expected to
provide development finance for nation building, but also to undertake a higher degree of
developmental role to nurture and develop the targeted sectors. With regard to this, the DFIs
have been demonstrating outstanding performance in their developmental role. For instance,
the KfW Mittelstandbank, a prominent DFI in fostering SME development in Germany, is
providing credit facilities to not only the established SMEs but also the new start-ups.
Another example is the Organisation for SMEs and Regional Innovation of Japan which
focuses on providing advisory and consultancy services, and training to nurture and develop
the SMEs.
Let's now look at the prospects and challenges for DFIs, i.e., the second part of this
presentation.
With the growing and changing global economy, I have no doubt that DFIs will remain
important and relevant to meet the increasing developmental needs of their respective
countries. This development, indeed, presents both opportunities and challenges to the DFIs
in the way forward. While the expanding economies, both in the developed and developing
countries, would create greater business activities for the DFIs, this also means that they
have to remain innovative in their products and services by exploring new ways of doing
business, to be able to respond effectively to the different financing and developmental
requirements. DFIs must continuously evolve and review their areas of comparative
advantage in order to remain relevant, effective and strategic.
To drive performance, one important aspect is to clearly identify key performance indicators
for the DFIs, in order to measure efficiency and effectiveness in performing their mandated
roles. Recognising DFIs' developmental role, the performance measurement of a DFI should
go beyond the standard financial measurement to encompass quantitative and qualitative
non-financial indicators that evaluate the economic and social contribution of DFIs,
consistent with their objectives of establishment. For DFIs that are involved in SME
development, the key performance indicators should include the number of new start-ups
financed, the extent of borrowers receiving advisory services and the number of SMEs that
have "graduated" from the DFIs.
An important aspect to highlight is the need for DFIs to be financially sound and sustainable
in their operations. This is critical so that the DFIs could fulfill their roles without continuously
drawing resources from the government and the public sector. It is indeed heartening to note
that many DFIs have been successful in balancing the challenge to fulfill developmental
roles, while ensuring that their operations are financially sustainable. For instance, the
Development Bank of Japan, which is focusing on the provision of supplement long-term
funding to qualified infrastructure projects, has shown favourable financial performance with
a return on equity of 6.5% in 2004. Similarly, the Business Development Bank of Canada, a
leading SME development bank in the country, has also recorded encouraging performance
with an average return on equity of 7.1% in the past five years.
The experiences of these DFIs have proven that despite the specific mandates to finance
development activities, business operations of DFIs can be financially sustainable. These
success stories essentially share several key factors, including a high focus on their
mandates; dynamic leadership and proper accountability within the DFIs; continuous
development of human resource capability; intensive use of information technology to
improve efficiency; and last, but not least, the adoption of sound and prudent financial
principles as well as best practices in their operations.
At the same time, given their relatively limited access to funds, it is recognised that financial
support from the Government is important to enable the DFIs to play their role on a
sustainable basis. This, however, does not mean that DFIs should solely rely on government
funding. In order to remain relevant and effective in meeting the growing financial needs of
an expanding economy, DFIs need to increasingly draw funds from alternative sources, such
as the capital market. Sourcing funds directly from the market would also help instil certain
form of discipline on the operations of the DFIs.
Allow me this opportunity to now share with you an overview on the roles and developments
of DFIs in Malaysia. There are currently 14 DFIs in Malaysia. Like those found in other
countries, the DFIs were established and funded by the Government to develop and promote
identified strategic sectors, in line with the overall industrialisation and economic
development objectives of Malaysia. The first DFI was the Malaysian Industrial Development
Finance Berhad (MIDF), which was established in 1960, to provide medium to long-term
financing to promote the development of private industrial enterprises. Subsequently, several
major DFIs were established, including Bank Pertanian Malaysia (or the Agriculture Bank of
Malaysia) to promote agricultural development, Bank Pembangunan Malaysia Berhad (or the
Development Bank of Malaysia) to promote Bumiputera indigenous community development
in commerce and industry, Bank Industri Malaysia Berhad (or the Industrial Bank of
Malaysia) to support development in the industrial and manufacturing sectors, as well as the
Export-Import Bank of Malaysia (EXIM Bank) and the Malaysia Export Credit Insurance
Berhad (MECIB) to promote international trade and support export diversification and
expansion, especially to the non-traditional markets.
Over the years, the DFIs in Malaysia have evolved in tandem with the country's economic
transformation, especially to support developments in the strategic and new growth areas
such as high technology, infrastructure, SME development and micro finance. Bank
Pembangunan was entrusted by the Government to support infrastructure development in
expediting economic recovery following the financial crisis in 1997. Likewise, in line with the
strategy to promote capital-intensive and high technology industries, Bank Industri was
entrusted with the task of supporting advanced industrial development, such as engineering
activities and computer software development.
In the Malaysian financial system, the banking institutions form the largest component of the
financial system, constituting about 51% and 78%, respectively, of the total assets and loans
of the financial system. In contrast , the total assets and loans of DFIs as a group,
respectively accounts for about 5% of the financial system. Nevertheless, these DFIs have
been instrumental in providing the complementary financial services needed to support
development of the targeted sectors and activities.
One particular notable development is the support provided by the DFIs for SMEs. Like many
other economies, in Malaysia, the SMEs form the backbone of the economy with high
potential in fostering the forward and backward linkages of activities along the value chain.
While SMEs constitute about 90% of total establishments in the manufacturing sector, at the
moment they only provide about 30% of employment in the sector and contribute about 6%
to Malaysia's GDP. Clearly, there is room to further unlock the potential of SMEs in Malaysia.
While the banking system remains the main provider of funds to support the activities of the
SMEs, there is the tendency for this system to focus on the more established SMEs. It can
also be argued that the banking institutions also lack the appropriate skills and experience to
develop and nurture the SMEs. This is where the presence of DFIs is so critical, that is to
provide the complementary services, both financial and non-financial, particularly to support
viable but smaller SMEs which are unable to obtain financing from the banking institutions.
In Malaysia, there are at present two major DFIs specialising in supporting the development
of the SMEs. These are Bank Pembangunan dan Infrastruktur Malaysia Berhad and the
Credit Guarantee Corporation (CGC). Each of these DFIs has been assigned the specified
mandated roles in assisting the SMEs in Malaysia. Bank Pembangunan is entrusted with the
mandate of promoting entrepreneurial development by not only providing financial services to
the SMEs, but also assume the nurturing and developmental role through the provision of
advisory and consultancy services to this targeted group.
Meanwhile, the CGC is mandated to assist the SMEs that lack track record and collateral to
have access to financing, by providing credit guarantees to enhance the SMEs' accessibility
to credit facilities. To supplement its guarantee schemes, the CGC, under its Business
Advisory Service Entity programme, has identified and engaged a panel of consultants to
assist the SMEs, particularly in drawing up business plans and other financial documents.
Bank Negara Malaysia recognises the important complementary role of DFIs in the financial
system and their developmental role in supporting the national socio-economic agenda. As
such, Bank Negara Malaysia in its Financial Sector Masterplan (FSMP) has drawn out the
roadmap on the development of the DFIs, with the objective of developing a group of DFIs
that are able to perform their mandates in an effective and efficient manner at minimal cost to
the Government. In order to achieve this objective, three broad development thrusts have
been outlined for the DFIs, namely, strengthening of the regulatory and supervisory
framework of the DFIs, capacity and capability building as well as institutional efficiency
enhancement of DFIs. A total of eight recommendations have been formulated premised on
these development thrusts.
One of the significant milestones in the strategies to strengthen the DFIs is the enactment of
the Development Financial Institutions Act 2002 (DFIA). The Act provides a comprehensive
regulatory and supervisory framework for DFIs, with the primary objective of ensuring that
the DFIs perform their mandated roles and that their activities are carried out prudently,
effectively and efficiently. Bank Negara Malaysia was appointed as the single regulatory and
supervisory body for DFIs under the Act. In carrying out the regulatory and supervisory
function, the Central Bank's focus is primarily to promote the development of sound and
robust DFIs capable of performing their mandated roles effectively. Seven DFIs are currently
placed under the purview of the Act.
Recognising the unique characteristics of each DFI, regulations and policies have largely
been tailored-made to suit the different roles and functions of each DFI with the view of
facilitating and strengthening their operations. In general, the DFIs are required to ensure
that their operations and activities are in line with their mandated roles, underpinned by good
corporate governance and best practices. They are required t o operate with transparency,
especially with regard to information disclosure on their corporate performance, in order to
enhance credibility and to harness greater confidence from the public that they serve as well
as from the Government.
Strategies formulated have also been focussed on enhancing the clarity in the roles and
functions of the DFIs, with a view of minimising the overlapping of functions and increasing
DFIs' effectiveness in serving the targeted sectors. This has led to a number of initiatives to
realign and enhance the strategic focus through the restructuring of selected DFIs. One is
the merger of the EXIM Bank and MECIB to enhance their synergy in export promotion. The
other important initiative is the rationalisation of Bank Pembangunan and Bank Industri,
which will result in the establishment of an SME Bank. The SME Bank, a specialised agency
dedicated to the promotion of SME development, will commence operations in October 2005
and is envisaged to better serve the needs of SMEs through the provision of a
comprehensive range of financial and non-financial services. In particular, the SME Bank will
focus on nurturing the SMEs and promoting entrepreneural development, through the
provision of financial and business advisory services, including financial management,
business diagnosis and marketing support.
Recognising the importance of human resource development as part of the capacity and
capability enhancement strategy, several initiatives have also been undertaken to enhance
the skills of DFIs, particulary in the provision of advisory services and micro financing. In
collaboration with the Japan International Cooperation Agency, Bank Negara Malaysia is
currently embarking on a project to enhance the capabilities of DFIs in providing advisory
services to the SMEs. It is envisaged that the provision of quality advisory support can be
used to supplement the financial services of DFIs, in order to enhance their effectiveness in
supporting the development of the SMEs. In addition, Bank Negara Malaysia has developed
and distributed a set of micro finance manuals to DFIs engaging in the provision of micro
finance, for use as reference to acquire the knowledge of micro finance principles and best
practices. This is to ensure a sustainable provision of micro finance by these DFIs.
Going forward, the role of DFIs would not diminish, but continue to remain important and
relevant, providing greater complementary and developmental role in addressing the nation's
development strategies. Nevertheless, it is envisaged that the DFIs are expected to evolve
from being the direct financiers to function as a strategic conduit to facilitate financing by the
banking system, especially through the provision of credit enhancement. In addition, the DFIs
would also increasingly become specialised institutions to render advisory and business
support services, in order to increase their effectiveness in meeting the financing and
developmental needs.
At the same time, the need for DFIs to remain financially sustainable while performing their
mandated roles cannot be over-emphasised. This would require continuous capacity and
capability enhancement of the DFIs, especially the strengthening of human capital skills and
institutional efficiency, together with the adoption of good corporate governance and best
practices by the DFIs. In addition, to ensure that available resources are channeled
adequately and appropriately to support the targeted sectors, DFIs would need to
strategically reduce the channeling of funds to the sectors and businesses that have matured
and, on their own, would be able to obtain financial resources from the banking institutions or
the capital market.
In conclusion, I must say that the theme for today's forum on "Revving up the SMEs as the
engine of growth" is both timely and appropriate given the importance and potential
economic contributions of SMEs, particularly in the developing countries. Therefore, it is
important that the SME sector continues to receive adequate and appropriate financial and
ancillary support to ensure their sustainable development towards meeting a nation's
development objectives. In this regard, the DFIs play an important role in providing the
necessary financial and developmental support to complement the banking institutions in the
promotion of SME development.
I am pleased to note that we have distinguished speakers and panellist here to share their
views on various issues relating to DFIs and their roles in SME financing. I am confident that
your endeavour to learn and share, as well as to exchange views on areas that are of
particular interests and benefits to you, will, in the final analysis, be very rewarding.