In light of recent international experiences of bank failures, the traditional intervention criterion of lending to “solvent but illiquid” banks has been put to the test as it becomes increasingly difficult to determine the necessity for intervention as well as the method and timing of such measures. The extension of such support will therefore be based on a careful balance of various considerations, which include amongst others, its potential systemic implications, the cost of the intervention, the cost of failures, avoiding disruptions in the functioning of markets and finally its potential social implications. In order to avoid long term moral hazard, the lender of last resort is based on the rigorous application of viability tests and the “first loss principle”, where losses are borne by the shareholders of the financial institutions. The operational framework also needs sufficient flexibility, in terms of policy instruments, acceptable collateral and range of counterparties, to deal with exceptional market conditions. Going forward, cooperation arrangements for dealing with crises will continue to be further enhanced. This includes further strengthening current cooperation arrangements among the various regulatory agencies in Malaysia, as well further advancing cross-border cooperation in the region. Indeed, significant strides have already been taken to strengthen the cooperative framework between central banks and supervisory agencies in the region to promote financial stability at the regional level. These have included the establishment of various regional mechanisms for cooperation and coordination in surveillance, information sharing and crisis management.
4  BIS Review 71/2008  The recent crisis also brought to light the critical importance of coordinated and prompt response by regulators in dealing with crises, whether through market interventions or in the resolution of banking institutions that are experiencing difficulty. Coordinated actions by the Central Banks in Europe and the United States have relieved the liquidity tensions in the financial markets. However, national arrangements for dealing with problem banking institutions are being severely tested. Decisive action is vital to ensure the continued intermediation process to stem the spread of the financial crisis within the financial system and to the real sector. Such early action will also reduce the cost of the crisis. For Malaysia the cost of the crisis ten years ago was less than 5% of GDP. Danamodal in fact recorded a pre-tax profit of RM200 million upon full repayment from the recapitalised institutions. More recently, additional initiatives have been taken to strengthen the safety net, interagency coordination arrangements and the legal framework for interventions. Today, we have a holistic financial safety net framework in Malaysia which includes a lender of last resort framework and a comprehensive deposit insurance system. The regulatory and supervisory framework is also supported by enhanced intervention framework for dealing with banks under financial stress. The enhanced supervisory intervention powers is to be embodied in the amendments to the various legislations administered by the Central Bank. The provision of liquidity support by Bank Negara Malaysia for financial institutions in distress is a key component of the safety net.