Malaysia’s bond market imploded in 1998. The problems began when the banks began helping each other out by providing guarantees on bonds, without stress-testing the impact of the contingent liabilities they were taking on their balance sheet. Then the financial crisis hit. A number of companies defaulted on their short-term and long-term papers. Smaller banks began defaulting, too, when they realized that they would blow a massive hole in their capital if they tried to meet their guarantees. Everyone ran for cover. Banks started calling in their credit facilities; those holding papers started selling. The net effect: a frozen market that Malaysia’s regulators had to fix while simultaneously administering to a cashflow crisis among the banks and conglomerates.
In the third of a three-part interview, Chellappah Rajandram – chief of the Corporate Debt Restructuring Committee (CDRC) and head of Rating Agency Malaysia – tells FinanceAsia.com how the authorities are attempting to patch up the local bond market. A big part of the solution, he says, involves getting Malaysia’s banks out of the bond market in some ways.
Q: By 1998, the bond market in Malaysia was a nightmare for both banks and companies. There were defaults on both sides. Fears about the market led to a collapse in trading conditions. Short-term and long-term commercial papers were either solvent but illiquid papers or insolvent paper. How did Malaysia get past this situation?
A: In the past, the public put money into the banks, the banks lent money out. What we wanted to do is to disintermediate the process, go straight to the lender directly, without the banker coming in. What happened when we wanted to develop the bond market is that the bankers wanted to get involved. They said: 'Lending is my forte, how can you take this away from me?' So when the bond market was introduced, they said they want to be involved. They started guaranteeing papers. For a fee of 1% to 2% they were willing to guarantee these papers. When the meltdown came in, most of the liabilities fell to banks.
Q: Yes, there were small banks that got caught out with big exposures.
A: There was a flaw in the system. We have been bringing it to the attention of the authorities long before the crisis: that banks must reduce their exposure and let the bond market grow on its own. But it has become quite a task. The crisis has given us an opportunity, though. The banker can get involved, but they should not guarantee every paper that comes out of the market.
Q: What about these junk bonds that Malaysia is now allowing?
A: It is possible some papers that come out have quite low ratings that require an enhancement. There is nothing wrong with a junk bond, basically it’s a risk but you get a higher yield. If you look at the risk profile, 16% to 20% of junk bonds fail to repay their debt, but that’s the risk you take.
There are people who are willing to buy junk bonds, but we need a credit enhancement. So we have suggested the setting up of the financial guarantee corporation to guarantee these papers. In the US, they have eight institutions. In Singapore, they have Asia Limited. We say that’s the way the market should go.
Q: Do you still want to see banks involved in the process?
A: We would like banks to buy these papers but not to guarantee every paper. That puts all the risk back to banks. When the meltdown [happened], I had to downgrade the banks because they had taken on too many guarantees. And when you do these guarantees, you may not have sufficient capital adequacy to back you up. The guarantee part – in the future – will be taken on by a financial guarantee corporation. The government is looking at these ideas.
Q: So what happened between the implosion of the market in 1998 and now? Did Malaysia have to re-liquefy the market?
A: Part of the debt restructuring that I am doing with CDRC involves these defaulters, some of the defaulted papers, some of the revolving [credit] facilities.
Q: What happened with the trading in the market. Was there any trading during this time?
A: Very little. There was some trading. The market is not that liquid. That’s what the National Bond Committee is doing, trying to create an active [market]. There’s a lot of work to be done. This year, they [the authorities] have moved very fast. Instead of having to go to three to four institutions for debt market related approvals, they have decided that all the functions will be taken over by the Securities Commission. So a lot of changes are taking place in the bond market. We can see a lot of action in the next few months.
Q: Malaysia and Korea’s experience here is very similar in some ways. Korea witnessed the near collapse of its investment trusts, the biggest buyers of bonds and equities; followed by the near collapse of its merchant banks, which were active buyers of Korea’s commercial papers. The bond market basically froze because of this. That’s similar to Malaysia where the bond market’s leading financiers and buyers – the banks – ran into big trouble. The Korean government has turned round to Korea’s commercial banks and said: 'We’d like you to help put up W10 trillion ($8.97 billion) so we can create a bond stabilization fund.' Did Malaysia have to do the same?
A: We didn’t have to do that. We really didn’t have a big bond market. For the individual ones, they went to the CRDC for restructuring. But that’s patchwork at the moment. So we want to do a more permanent bond market. We are addressing the issues one by one. We hope that we will have a more viable bond market in 10 years or so.
