In a hyper-competitive commerce world, income or earnings became excessively essential for the government or a firm, or even an individual. Thus, investment became a significant element to produce additional returns which increase a firm or an individual's assets. Generally, investment has fears most investors from the past because of its high risks and fluctuation of interest rates. However, there is a market that deals with short-term, low risk and highly liquid securities, which known as the money market. In this assignment, we would discuss about the Malaysian money market. Besides, the purpose of existence of money market is very prominent to be known by the market participants as well. Market participants are the key players which involved in the money market. Finally, the local money market would be compared with a foreign money market so that investors would have better understanding about the differences of money market abroad.
Introduction to Malaysian Money Market
1.1 Definition of Money Market
Lin and Chung (1995) stated that the money market consists of instruments and intermediaries for short term debts which create an integral part of Malaysia's financial system. It consists of financial institutions and corporations who are willing to borrow or lend money to market participants. Those intermediaries comprise of banks, mutual funds, pension funds, insurance companies, collective investment schemes and investment clubs. Money market instruments are tools used by participants to invest in the money market. There were a few money market instruments such as banker's acceptance; treasury bills (US), certificate of deposit, Eurodollars and repos.
From Investopedia (2010), money market is a subsection of the fixed income market. This fixed income is actually a bond in other words. In reality, the difference between money market and bond market is that money market focuses on short-term debt securities which mature in less than a year while the bond market usually lasts more than a year. Companies or investors that invest in money market investments are called cash investment due to their short maturity.
Source: http://www.investopedia.com/university/moneymarket/moneymarket1.asp
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1.2 Characteristics of Money Market
Mishkins and Eakins (2009) stated that money market securities are safe investments because it returns a moderately low interest rate which is suitable for temporary cash storage or short-term horizons.
According to Investor Glossary (n.d), the money market does not have one physical location or rather, the trading of this market instruments usually take place in large financial centers like New York, Manhattan and London. Most companies including Malaysia often use money market securities as temporary 'parking places' to store cash. Although the returns are relatively low, they are one of the safest types of investment.
Source: http://www.investorglossary.com/money-market.htm
Other than that, Mishkins and Eakins (2009) also pointed out that the securities that are provided in the money market have high liquidity and low default risk. In addition, the money market securities also mature in a year or less from the original date of issuance. It is also known that most of the money market instruments often mature in less than 120 days. Furthermore, the money market also functions as wholesale markets. This is because most of the transactions involve are very large and may exceed $1 million.
1.3 Participants in the Money Market
Players who are involved in the money market can play the role as the lender or borrower. These people can be the government, businesses, banks, investment companies, commercial leasing companies, insurance companies or pension fund providers.
Businesses often raise funds in the money market by issuing commercial paper which is secured by the guarantee of eligible assets. Examples of eligible assets are residential mortgage loans, credit card receivables and auto loans. In addition, international trade businesses will raise funds through banker acceptance. With this, the bank may choose to hold the acceptance or sell it in the secondary markets.
The local governments may raise funds in the money market by issuing municipal paper while the Malaysian Treasury may fund the public debt by issuing Treasury bills.
However, the money market usually depends on brokers and dealers because they are ones who have to market new issues of money market instruments and provide it in the secondary markets. These people also perform as intermediaries between other participants in the markets when they connect the borrowers and lenders in the market.
Source: http://www.applied-islamicfinance.com/sp_money_market_1.htm
The Role of Bank Negara Malaysia
In Malaysia, the Bank Negara Malaysia is the central bank that constitutes and conducts the apex of the monetary policy and banking structure. The Central Bank of Malaysia Act 1958 defines the roles of Bank Negara as a currency issuer, safeguard of reserves and assets, financial advisor to the Government, and a central bank that promotes monetary stability. Due its stability to issue currency, the central bank is responsible to ensure domestic prices remain stable.
Source: Bank Negara Malaysia Kuala Lumpur (1999)
Reason why the money market exist in the financial system
2.1 The Purpose of the Money Markets
According to Miskins and Eakins (2009), the main purpose of the money markets is to provide short-term funding to institutions or intermediaries who need the funding. This also includes the government. This is where investors warehouse their surplus funds in the money market for a short period of time. The investors with surplus funds are those who "provide" these funds and do not need it until later. Through the money market, the investors indirectly "lends" the money to others and at the same time earning them a small return which is higher than keeping the money idle in bank accounts. Bad economic conditions may be one of the reasons that prevent the firm with more money to buy more stocks because they may not be able to sell it off. Leaving the money idle will not help generate any income either. The idle cash then becomes an opportunity cost in terms of lost interest income. The money market provides a place to invest the money in a short amount of time to reduce the opportunity cost.
For the borrowers, the money market provides them with a low-cost source of temporary funds. They will be able to get a sum of money they need in a shorter amount of time and pay less interest compared to bank loans and other type of loans. Because the timing of cash inflows and outflows are not synchronized, cash-timing problems occur. Big corporations and the government take advantage of the money market to help solve these cash-timing problems.
2.2 Advantage & Importance of the Money Market
Due to the nature of the short-term nature of the money market, it is of high liquidity and thus allows the users to withdraw the money at any time. On top of that, there are unlikely any penalty in forms of interests. Besides that, the money market is backed against default by the government like in the United States. That makes it one of the lowest risk investments available. That though will provide a lower rate of return compared to other higher risk investment but much safer and is of short term.
According to Ding (2009), the money market also plays a role in determining the structure of short-term investment rates. The yield rates and instruments of different maturities are determined. Through the money market, financial institutions are allowed to achieve optimum level of mixture of assets and liabilities. Transactions made here are of low cost and it serves as a place for financial institutions to lay off interest rate risks.
In the modern world today, the money market can be easily created on the internet. It is easy to create and use. Most money market today does not set a minimum level of deposits allowing investors to deposit however much they like. Internet money markets instruments also provide higher yields of return compared to the typical instruments because they incur lower overhead costs compared to money markets available before this.
Source: http://www.expss.com/MoneyMarket/advantages.htm
Major developments in the Malaysian Money Market
3.1 History of the Malaysian Money Market
According to Markham (2002), the money market fund was first introduced in the United States in the early 1970s by Bruce R Bent and Henry B R Brown. In 1971, they established the first of the fund in the United States and they named the fund, the Reserve Fund. However, Capital Flow Analysis (n.d.) stated that in 1968, three years prior to the introduction of the Reserve Fund, Conta Garantia was invented by John Oswin Schroy in Brazil. It is the first money market fund to be ever used. It was used to help the sale of letras de câmbio (low denomination commercial paper certificates) to small investors. The letras de câmbio is purchased short-term by investors and will mature within a year.
Source: http://books.google.com.my/books?id=hZ9frnkOTsQC&pg=PA6&lpg=PA6&dq=Bruce+R.+Bent+and+Henry+B.+R.+Brown&source=bl&ots=pmgQmmDg7o&sig=JOpTh9Dr9NAweQZeGYnbxOFGJUE&hl=en&ei=7bN4TOGBHo2lcZ6whZQG&sa=X&oi=book_result&ct=result&resnum=8&ved=0CC0Q6AEwBw#v=snippet&q=Reserve%20Fund&f=false
http://www.capital-flow-analysis.info/investment-tutorial/case_1k.html
However, it wasn't clear when exactly was the money market implemented in Malaysia. It was probably slowly spreading and seeping to the Asian countries in the late 1970s. According to Lin and Chung (1995), it is clear that the money market existed in Malaysia from the year 1980 onwards. A money market operations account (MMO) is created in the year 1981. Bank Negara Malaysia (BNM) used the MMO to shift government deposits to and from the commercial banks and the government's current account in the central bank. The central bank was authorised to recycle the funds in the MMO account. This allowed more control over the use of MMO for short-term liquidity management by the central bank.
Source: http://books.google.com/books?id=yfGGBqyna1sC&pg=PA52&sig=oUTBdBGJWCU3U4Sd92c03SS0E64&hl=en#v=onepage&q&f=false
According to Handbook of Islamic Banking (n.d.), Malaysia's money market took another step forward in January 1994. The Malaysian Islamic Inter-bank Money Market (IIMM) was introduced. The objective of the IIMM was to create a money market that has the ability to adjust their portfolios through a funding facility in the short term. The IIMM encourages banks with surplus to channel their funds to banks with deficits. This helps maintaining the funding and liquidity of the money market to better the stability of the system.
Source: http://www.slideshare.net/ashikiqbal/handbook-of-islamic-banking
The Malaysian money market, until today, is still controlled by Bank Negara Malaysia (BNM). It has always been under their control since the introduction of the money market in the country. There are a few major developments of the Malaysian money market and will be discussed in the next part of this report.
3.2 What Bank Negara did to improve Malaysia's Money Market
There are some developments in Malaysia's money market that can be highlighted in the recent years. For instance, according to the Siaran Akhbar (2010), the total deposits being stored in the banking system has increased tremendously as an effort by Bank Negara by RM 19 billion in June 2010 as in the month-on-month basis from the previous month May 2010 with only RM 3.2 billion. If compared in annual basis, the total deposits have risen by 9% in June 2010 as compared to the previous month. This is due to the reason that most business enterprises are starting to deposit money in the banking system following the payment of outlays by the government. In addition, other developments in Malaysia's money market also include the Islamic banking system deposits, the foreign exchange market (Forex) and even interbank deposits. As can be referred to table 1.1 (please refer to Appendix A), the total interbank deposits in the money market have increased by 10.84% from year 2006 to 2009. All these developments have improved the money market condition in Malaysia which subsequently promotes economic growth.
Source: http://www.bnm.gov.my/view.php?dbIndex=0&website_id=1&id=796
Besides that, in March 1998, the Bank Negara Malaysia (BNM) has introduced a new monetary policy with changes in direct instrument to indirect instruments which is a way to develop the country's money market. These indirect instruments include open market operations using short-term instruments such as the Bank Negara bills, Treasury bills, and negotiable certificates of deposits. In addition, as stated by Daquila (2007) during September 1998, the Bank Negara has reduced its 3 months intervention rate from 9.5% to 8% and finally to 7.5%. They have also lower down the reserve requirements for banks from 6% to 4% for commercial banks in order to further enhance the country's liquidity system. This has enabled investors and business persons to take up higher bank loans to further boost the economic growth. Furthermore, the interest on treasury bills issued by the Bank Negara was once peaked at 7.426% as shown in table 1.2 (please refer to Appendix B) which shows the high level of stability in terms of the central bank's cash flow.
Source: http://books.google.com/books?id=ueZep3kr3o0C&pg=PA99&sig=fU5oKBuPk2ehwOX9IHQptJ0jv3c&hl=en#v=onepage&q&f=false
In addition, as a central bank in an emerging and improving economy, the Bank Negara has developed the necessary market infrastructures to strengthen the financial system which contributes to the betterment of the money market economy. As a way in strengthening the financial market infrastructures, Bank Negara has developed a strong and efficient payment system. This payment system is constantly upgraded to channel the impact of the technology for the benefit to the banking system. An example of this system is that the Bank Negara operates a system known as the Central Credit Reference Information (CCRI) to gather and convey credit information on borrowers. Therefore, this enables all financial institutions to facilitate and make informed decisions on the loan applications. This would certainly enhance the money market industry after knowing the credibility of their clients and giving the loan to them for investments as a way to promote economic growth.
In the more recent period, the Bank Negara has given great attention to the small and medium-sized enterprises (SMEs). As a method to enhance the contribution of the SMEs, the central bank has produced a comprehensive report on the ways to develop their business enterprise. Following Bank Negara's effort, various funds have been made available by the country's central bank to further improve and develop the selected sectors which subsequently enhances the money market system as more funds can be lend out to borrowers. This allows the SMEs to be able to apply for higher loans to increase their working capital.
Source: http://www.bankinginfo.com.my/_system/media/downloadables/bnm_eng.pdf
4. The comparison between the Malaysian money market and United States of America money market
According to Mishkin and Eakins (2009), money market is a misnomer. Basically, the securities in the money market are traded as short-term debt and they are highly liquid. As the money securities are very close to being money, they are widely used in the worldwide market. However, participants of the money market have to be aware that there are several differences in the money markets of some countries. Based on this assignment, one of the foreign money markets, the United States of America was chosen to judge against the Malaysian money market. These both countries' money markets can be compared in term of structure, money securities and money market participants.
4.1 Money Market Structure
In money market, there should be a structure to regulate and manage the money securities. Without any existence of the financial system, the market would be soon to be deteriorated. A brilliant participant of the money market would identify the differentiation of the regulatory system of various countries.
Malaysian Money Market
U.S. Money Market
In Malaysia, the foremost players of the money market are Bank Negara Malaysia (BNM), commercial banks, Bank Islam Malaysia Berhad, businesses, finance companies, merchant banks and discount houses.
The main players in U.S. money market are the U.S. Treasury, Federal Reserve System, investment banks, pension funds, businesses, finance companies and commercial banks.
The Bank Negara Malaysia, as the central bank is responsible to administer the money market because of its purpose to endorse the economic growth with price stability and sustaining monetary and financial stability. By law, the introduction of the Banking and Financial Institutions Act 1989 (BAFIA) on 1st October 1989 has extended BNM's powers for the supervision and regulation of financial institutions and deposit-taking institutions who are also engaged in the provision of finance and credit.
Since 1983, the money market funds have been governed very effectively by the Securities and Exchange Commission (SEC) under the Investment Company Act of 1940. The mission of the U.S. Securities and Exchange Commission is to shield investors for having fair, order and efficient markets and facilitate capital formation.
Based on the law, the BNM is eligible to create short term loans to commercial banks as an alternative to fund temporarily liquidity to them. The central bank uses these funds to invest in gold and foreign exchange market to reinforce the confidence in the Malaysian currency (Lee 1990).
The SEC oversees the registered investment companies to safeguard the performance in the money market. Hence, SEC has been using Rule 2a-7 which limits a money market fund's exposure to credit risk and market risk. As a result, SEC is capable to supervise the credit quality, diversification, and maturity of the money market securities invested in the portfolio.
The central bank has established a controlled regulatory framework (Central Bank of Malaysia Act 2009) for funds and debt securities. This is to ensure that the central bank or any individuals authorised by the central bank to facilitate the transferring, payment and settlement of funds and debt securities to be done based on the directed laws.
SEC has crafted the Investment Company Act strictly that exceeded the disclosure and anti-fraud requirements which are characteristic of the other federal securities laws by commanding substantive requirements and prohibitions on the structure and daily activities of money market.
The controlled financial system of money market has promoted the chance for the emergence of diverse financial institutions in terms of size and branch network (Lin and Chung 1995). Now, most of the local commercial banks are able to hold hefty deposit base because they had a wide range of branch network. On the other hand, smaller commercial banks tend to have partial chances to attract deposits. Meaning that, financial institutions are encouraged to develop bigger size and branch networks to gain more deposit capacity which may improve the growth of money market.
Due to the framework of Rule 2a-7, demand of short-term securities from small businesses and other small institutions have pushed the growth in money market. Between the years of 1974 to 1986, assets in money market were grown when bank deposit rate ceiling was imposed. At this period, banks were not controlled on the rates that they could pay for deposits. Thus, they offer rates below market interest rates on accounts to gain more returns. This incident has lead to the increasing growth of money market in size relative to bank deposits.
In order to improve the structure of the money market, the central bank has to play another role to supply information to any person relating to the money market or to the tender, issue, trading and offer, or bid prices of debt securities (Central Bank of Malaysia 2009). By having such information, players could make any short-term investment planning in the money market with the least financial risks.
On the other hand, SEC also enforced the rule under Investment Company Act that investors must receive sufficient information about the funds.
4.2 Money Market Securities
As the transaction of trading of funds, financial markets are responsible to transfer funds from lenders to borrowers. Hence, money market instruments are the main tools for the players to purchase or sell to the other market players. These instruments are acted as a form of investment and they have a maturity period of not less than a year.
Malaysian Money Market
U.S Money Market
Banker's Acceptance
A Bankers Acceptance (BA) is a short-term investment drawn and accepted by finance intermediaries on behalf of their clients' trade financing. A BA basically allows clients to use the banks credit rating to finance their transaction. The customer will owe the face value of the BA to the bank before it is redeemed by the vendor or seller.
Certificates of Deposits
It is a time deposit at a bank with a precise maturity date and
large-denomination certificates of deposits can be sold ahead of maturity.
Repurchase Agreement
It is a short-term loans which generally for less than two weeks. Short-term loans can be approved by selling securities to an investor with an
agreement to repurchase them at a specific price on a specific date.
Commercial Paper
An unsecured promissory notes with a rigid maturity of one
to 270 days. Commercial paper is usually sold at a discount from principle value.
Money Mutual Funds
It has short maturity and high value investments
which buy money securities on behalf of retail or institutional investors.
Foreign Exchange Swap
It means exchanging a deposit of currencies in spot date and the
reversal of the exchange of currencies at a prearranged time in future.
Treasury Bills
It is issued to finance national debt. Besides, T-bills are highly liquid security and it is broadly held. In fact, the government does not pay interest on T-bills but they are issued at a discount from face value.
Federal Funds
It is an interest-bearing deposits that held by banks and other financial institutions at the
Federal Reserve. They are instantly obtainable funds that institutions borrow or lend based on a period of one day. They are lent for federal funds rate.
Federal Agency Short-Term Securities
Short-term securities issued
by government sponsored enterprises
such as the Farm Credit System, the
Federal Home Loan Banks and
Federal National Mortgage Association.
Municipal Notes
Short-term notes issued by municipalities in
expectation of tax receipts or other
revenues.
4.3 Money Market Participants
Every game need some players to involve in the game process, otherwise there is no alternative ways to conclude the winning and losing parties. Likewise, the money market requires diverse players to engage in the trading of short-term funds. In this case, it is important to identify the various types of players in different countries' money market.
Malaysian Money Market
U.S Money Market
Commercial Banks
The commercial banks represent the largest component in the financial system. They usually supply normal banking services and they are also able to present a wider range of ancillary facilities. In addition, commercial banks responsible to deal with foreign exchange which made them to be an important agent to improve the country's economic development.
Finance Companies
They operate in the medium-term credit market and obtain their resources mainly from savings and fixed deposits. They are restricted to accept demand deposits and fixed deposits of less than three months' maturity, trading gold and foreign exchange and granting overdraft. They raise funds in the money market by selling commercial paper. They then lend the funds to consumers for the purchase of durable goods.
Businesses
Many businesses buy and sell securities in the money market to boost short-term funds and warehouse surplus funds. But, this activity is limited to foremost corporations because of hefty dollar amounts required.
Bank Negara Malaysia
BNM act as a central bank and accepts reserve deposits from financial institutions. It is also a financial adviser to the government. It also supervises and regulates the other financial institutions in the financial system.
U.S Treasury Department
It is a demander of money market funds and not a supplier. It is also the main of all money market borrowers worldwide. Short-term issues permit the government to raise funds until tax revenues are received.
Bank Islamic Berhad
Bank Islamic Berhad is formed for Malaysian Muslims who do not want to compensate or receive any interest. Islamic banks offer banking services based on Islamic principles and is also required to maintain statutory reserves with the central bank. However, the bank does not contribute directly in the money market because money market operates on the basis of interest rates.
Federal Reserve System
It is the Treasury's agent for the distribution of all government securities. The Fed holds immense quantities of Treasury securities that it sells if it believes that money supply should be reduced. Likewise, the Fed will buy Treasury securities if it expects that money supply should be expanded.
Merchant Banks
Merchant banks are licensed as specialised financial intermediaries in the money market. They are responsible for trading of money market instruments in secondary markets and related banking functions. They are authorised to issue negotiable certificates of deposits. They are important market player because of their money market activities and providing loans to customers.
Investment Companies
A company that holds securities of other companies for investment purposes. The money that receives from investors on a collective basis will be invested by the company. The money of the investors will be invested by the company on behalf of its shareholders who in return shares in profits and losses. There are 3 types of investment companies which are Open-End Management Investment Companies(Mutual Fund), Closed-End Management Companies(Closed-end Funds) and UINTs(Unit investment Trusts)
Discount Houses
Discount Houses borrow and invest short-term money, mainly buying treasury bills at a discount from the government. In Malaysia, there were seven discount houses that accept short term funds and are permitted to invest funds such as Treasury bills, banker's acceptance, government securities, Negotiable certificates of deposits and private debt securities.
Pension Funds
Pension Funds is a fund which provides retirement income to employees when they are going to commence retirement.
