Part 2 - Promoting Sound Risk Management
In the previous part of this series, we mentioned that the COVID-19 pandemic exhibits how interconnected our financial system is to other sectors in the economy.
Some of PIDM’s member institutions are highly interconnected, and financial institutions play an important role in the economic development of the country. As financial intermediaries, member institutions are exposed to various types of risks. The failure of a member institution could pose a contagion risk on the financial system. Similar to the current health crisis, the ultimate cost could be massive. As such, taking proactive measures to identify, assess, control and monitor such risks at the onset is a worthwhile investment.
Bank Negara Malaysia is the primary supervisor and regulator of financial institutions in Malaysia. What PIDM does is to complement Bank Negara Malaysia, especially through incentivising sound risk management in the financial system and promoting confidence in the stability of the financial system.¹ Its resolution planning activities will also enhance PIDM’s preparedness as it formulates possible resolution strategies and actions for troubled member institutions.
At its inception in 2005, PIDM charged a flat-rate premium of 0.06% of total insured deposits to all member banks under its deposit insurance system. While the flat-rate system was relatively easy to understand and administer, its inherent weakness was its inability to differentiate member banks based on their risk profiles. The flat-rate premium system was replaced with the Differential Premium Systems (DPS) in 2008 to achieve the following objectives:
- To provide incentives for member banks to adopt sound risk management practices, such as managing their risk profiles better, avoiding excessive risk-taking and addressing factors that would lead to a better rating, resulting in a lower premium rate;
- To differentiate member banks according to their risk profiles by adopting appropriate criteria and factors, so that the system is able to clearly differentiate the risk profiles of member institutions; and
- To introduce more fairness into the premium assessment process by making member institutions with a higher risk profile pay higher premiums than member institutions with a lower risk profile.
Based on the same approach and objectives, differential levy systems were introduced for conventional insurer members and takaful members in 2013 and 2016 respectively. Under both systems, insurer members with a higher risk profile would be charged higher levies than those with lower risk profiles to encourage insurer members to improve their risk management practices.
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