The Modern Finance

THE Fall Season of 2008 marks the end of an era in American and European banking environment. For so many years, their respective government have been stood at the sideline from the finance business, but now have  been forced to step in to rescue banking systems and the markets. In America, the bulwark of free enterprise, and in Britain, the pioneer of privatisation, financial firms have had to accept rescue and part-ownership by the state. 

The changing scenarios of the finance or banking world has evolved for the past decades. Expansion and diversification of finance/banking players and products has change the finace landscape from the conventional finance to the new finance or modern finance. Technological advancements have changed the face of the world of finance. It is today more a world of transactions than a world of relations. Most relations have been transactionalised. Modern finance its widest sense implies every such process which converts a financial relation into a transaction. 

The financial derivatives that is already hard to grasp for a layman such as option, future contracts, interest rate and currency swaps has become more complex such as credit-default swap (CDS).

Securitization which began with a stright forward of bundling loans into packages that are then sold to outside investors, with the first big market was for American mortgages. These asset-backed securities became ever more complex. Securitisation eventually gave rise to collateralised debt obligations (CDO), sophisticated instruments that bundled together packages of different bonds and then sliced them into tranches according to investors’ appetite for risk. Securitisation opened a new route to growth for banks. They will no longer dependent on the slow, costly business of attracting retail deposits. Securitisation allowed them to borrow in the markets. In 2007 Northern Rock, a British mortgage lender, was the first spectacular casualty of this false assumption; many more banks have been caught out in 2008.

The end results of modern finance saw the dismantling of the fundamental finance with plenty of cautionary lessons to be drawn -- recklessness, greed, ridiculous lending standards, the disappearance of risk management ...and so on.

Do we in Malaysia have been aware of the modern or structure finance products.

I have been out of finance industry since the Asian Monetary crisis of 1997, but I am aware that some of the dervatives products such as option, futures and swaps are being offered but public participation is at minimal level. 

Malaysia’s securitization product originated in 1986 when the Government set up a mortgage financing body called National Mortgage Corp  (Cagmas Bhd) formed on the model of Fannie Mae and Freddie Mac of USA. As Cagamas bond expanded and with  have full recourse to the originators of the loans, the market has not reached a maturity stage where it can stand on the rating of the underlying portfolios unlike the USA counterpart.

The introduction of new securitization instruments (such as asset-backed securities-ABS), and improvements to the regulatory structure such as the 2004 Bank Negara Malaysia’s revised guidelines on the Offering of Asset-Backed Securities and the 2006 issuance of  additional guidelines for bond pricing agencies and electronic booking systems and the 2007, revised its Guidelines on the Offering of Structured Products contributed to a vibrant market. Fortunately our securitization plays is mainly Islamic finance centric. For example, the first Islamic sovereign securitization in Malaysia was issued in February 2005 by Pasir Gudang Local Authority as a mudharabah sukuk and  Time Engineering Bhd  issuing the first ABS using the Musyarakah - or joint venture – concept in the world.

Furthermore, the  banks mainly had the upper hand over the  “classical”  real estate and as for the other types of securitizable credits (mostly ABS) is still low and these products moreover ran a lower risk than their American counterparts and were traded mainly in the domestic market.

A different securitization structure and that has a significant progress in Malaysia is real estate securitization. Its principle, identical to that of securitization, consists in splitting the real estate portfolios into small parts (securities), to make investment accessible to any type of operator and make transactions easy. The most successful formula is the Real Estate Investment Trusts (REIT), which buys and manages buildings by raising capital at the Stock Exchange. The REITS securities issued by these companies are affordable by any individual.

Not surprisingly the initial REIT funds were raised in the United States, before pursuing their progression in Europe in the 1980s. They penetrated Asia under cover of the 1997 crisis. 

The significant progress of the REITs in Malaysia until 2007 are attributable to the low levels of interest rates and the  growth potential of  Bursa Malaysia where the REITs are listed. Apart from their advantage as alternative investment product, the REITs accounted for a new financial source for property developers, which can henceforth finance a major part of their real estate projects by raising funds at the Stock Exchange.

Will the subprime and credit crisis result in at least an iota of realization on the dangers of securitization in Malaysia ? It is not sure that all the lessons will be taken from the American debacle. Financial players historically have a short memory, for example the Asian Monetary crisis is only a decade old but the same situation is recreated in Eastern Europe and Iceland.

Investment banks with a commercial bank based such as CIMB, Arab-Malaysian and Maybank are currently the major player in the securitization market. Competition and demand might bring in the incompetent non-commercial bank based investment banks into play. Just to get a hint how incompetent those non bank based investment bank is, we peek into their commentaries on current market development. For example, one such investment bank appear amateurish in dishing commentaries on three issues last months;(1) HSBC Holdings plc's willingness to pay a high premium for an Indonesian bank,Bank Ekonomi to justify that Malayan Banking Bhd's  Bank Internasional Indonesia (BII) deal is too pricey, (2) The current fall market fall and to sell on the rebound (the dead cat bounce) and (3) The recovery of current malaise in US stock market   depend on the rebound of property market. This as though the current world market downturn is mainly due to the US property market. This is similar to the simplistic reasoning by the Limp of the impending economic  downturn and uninspiring economic stimulus dished out yesterday. Worst still, he is still in denial stupor.