Banking institutions are facing competition not only from each other but also from non-traditional competitors such as non-bank financial intermediaries as well as from alternative sources of financing, such as the capital markets. Indeed, the Malaysian capital markets have broadened and deepened, and are now playing a more pronounced role than before in the financial intermediation process. In this respect, the challenges to the banking sector are manifold. On the funding side, consumers' continued interest in diversifying their investments in search of higher returns, have seen funds flowing directly into the financial markets instead of going into banking institutions' deposits. At the same time, companies are increasingly meeting their financing needs in the equity and bond markets, thereby reducing their reliance on banking institutions. This is evidenced by the growth of outstanding private debt securities or PDS in the market by 10.7% to RM160 billion as at end of 2004, accounting for approximately 25% of the total financing channeled to the economy. The challenge to banking institutions is to enhance their competitive edge by being cost efficient without compromising on the quality of their services. On the other hand, the disintermediation process also offers opportunities to banking institutions. In particular, they can enhance their income by cross-selling mutual funds products and increasing their role as advisors, arrangers, underwriters and brokers for corporate financing arrangements. There is also bancassurance and bancatakaful in the area of cross-selling.

Given the importance of SMEs to the economy, a number of initiatives are being taken to foster the development of SMEs and improve their access to financing. In this respect, banking institutions have provided considerable support in terms of financing to the SME sector. Moving forward, the banking industry is expected to play a greater role in the development of SMEs, such as by offering a complete financial services solution as part of and in conjunction with their financing programs. Aside from the SME sector, banking institutions should explore other potential growth areas such as microcredit and agro-based financing, which are generally perceived as riskier and more costly than lending to larger firms. The challenge is for banking institutions to innovate and develop new form of financing arrangements and business models to exploit the opportunities offered by these market sectors. Strategic opportunities are also available from a larger marketplace as economic integration and regional linkages of markets in the East Asian region gather pace, driven by increasing regional trades and investment flows. In this regard, banking institutions should broaden their strategic outlook and expand their presence in the region to support Malaysian businesses and investors as they venture into new activities and expand their geographical profiles. Another strategic challenge facing banking institutions today is the growing and changing needs and expectations of consumers in tandem with increased education levels and growing wealth. Consumers are becoming increasingly discerning and have become more involved in their financial decisions.