AGENCY PROBLEM THE CASE OF BANK RAKYAT

GROUP 2 RUSNI BT MOHAMED (P12D188F) NURUL NAZWA BINTI MOHAMED AZIZ (P12D184F) ATIYYAH MUMTAZAH NAWAWI(P12D234F)

Introductions According to economic definition, Principal-agent problem is a particular game-theoretic description of a situation. There is a player called a principal, and one or more other players called agents with utility functions that are in some sense different from the principal's. Conflicts of interest and moral hazard issues arise when a principal hires an agent to perform specific duties that are in the best interest of the principal but may be costly, or not in the best interests of the agent. The principal-agent problem develops when a principal creates an environment in which an agent has incentives to align its interests with those of the principal, typically through incentives. Principals create incentives for the agent to act as the principal wants because the principal faces information asymmetry and risk with regards to whether the agent has effectively completed a contract. Our group has selected Bank Rakyat to illustrates the case study on issues regarding example of principle and agent problem in Malaysia government own company. Bank Rakyat Background Bank Rakyat was established in September 1954 under the Cooperative Ordinance 1948, following an expansion of the cooperative movement in Peninsular Malaysia. In order to facilitate the expansion of the cooperative movement, the cooperatives set up their respective union banks provide financial needs to their members. On 28 September 1954, 11 of these union banks decided to merge and form Bank Agong (Apex Bank). Bank Rakyat or Bank Agong as it was initially known has roots in the development of cooperative to meet the financial needs of members who were largely the rural poor in Malaysia. In 1967, Bank Kerjasama Malaysia Berhad replaced Bank Agong with its membership opened not only to the cooperatives, but also to individuals. This milestone chartered the path for the bank to open its activities, be it sourcing of funds or financing to non- members. Subsequent changes in the by-laws also resulted in the creation of its subsidiary companies and opening of branches to serve customers as well as members. In the early seventies, the bank continued support to the rural farming by allocating RM12 million to facilitate padi planting through financing of equipment and provision of funds. This is in tandem with government efforts to modernise farming and increasing productivity of a agricultural activities. The state and federal government provided support by pledge of government deposits. In 1972, Dato Harun Idris, the then Chief Minister of Selangor was appointed as the Chairman of the bank. On 6 January 1973, the name was
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changed to Bank Kerjsama Rakyat Malaysia Berhad or better known as Bank Rakyat Bank Rakyat is governed by its by laws and Bank Kerjasama Rakyat (M) Berhad Act 1978 (Special Provision 202). The government then launched the New Economic Policy to improve the Bumiputras share of the economic pie and thus narrow inter ethnic imbalance. The era of seventies also saw the government increased focus on developing entrepreneurs, generally on manufacturing. Bank Rakyat as government agency was urged to participate in this economic revolution. Bank Rakyat showed its commitment to the government policy by investing in United Manufactures Sdn. Bhd, Hotel Holiday Inn, Asean Chemical Fertilizer Sdn. Bhd., Pulp and Paper Industries Sdn. Bhd., Angkasa Raya Development Sdn. Bhd., Aman Properties Sdn. Bhd., Shahnaz Travel And Tour Sdn. Bhd. In 1974, Rakyat first Merchant Bankers Berhad joint venture with First National City Bank of New York was formed. By 1975, Bank Rakyat was insolvent and had accumulated losses of RM65 million. The Chairman, Managing Director and Bank Secretary were subsequently charged and convicted of breach of trust. Issues In Bank Rakyat 1975 was appeared to be the peak of the Bank Rakyat performance. An announcement of a surplus of RM235 million was made and later in the same year at the annual general meeting an announcement of a dividend payment of 10% and 12% for each of the preceding two years respectively was made. What is unknown to many bank members was a brewing scandalous losses over RM65 million as a result of corrupt practises of the key officers of the bank. This included: i. Advances made to individuals to purchase properties which the bank subsequently purchased at a hefty profit, giving the individual profit without them having to put any capital outlay; According to Section 2.12 of the Price Water House Report, in 1973 the Bank Rakyat made an advanced of RM570,238 to Encik Abdul Aziz bin Haji Idris and Encik Mohamed Noor bin Mohamed for the purchase of three pieces of land in Kajang, which also cost RM570,238. Subsequently, the Bank purchased from Encik Abdul Aziz bin Haji Idris and Encik Mohamed Noor bin Mohamed the three pieces of land concerned for RM751,006 leaving Encik Abdul Aziz
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and Encik Mohamed Noor with a profit of RM180,769, without having to spend a single cent, on a transaction financed wholly by the Bank ii. There were instances where the bank its subsidiaries would buy companies at losses, giving profits to individuals; Section 13.10, reported that Rakyat Corporation Sdn. Bhd, a wholly owned subsidiary of Bank Raykat, acquired a piece of land at Sungai Petani for a housing project at RM435,149 on 3rd August 1973 from registered proprietor, Chin Tet Yen@Cheng Tee Lian @Ow Siew Pun, who bought the land three weeks before that on 28th June 1973 for RM110,000. However, only one day before the land being purchased by Chin Tet Yen@Cheng Tee Lian @Ow Siew Pun, on 27th June 1973, Bank Rakyat Sungai Petani Branch Manager, Muhsain bin Mohamed, wrote to the Bank Rakyat General Manager on the purchase of the land. And it was after the Directors of Bank Rakyat Corporation Sdn. Bhd. on 7th June 1973, by principle agreed to purchase the land at RM435,149. The land was registered on the names of Chin Tet Yen@Cheng Tee Lian @Ow Siew Pun on 18th July 1973. From this transaction, Chin Tet Yen@Cheng Tee Lian @Ow Siew Pun made a profit of RM325,149 in a matter of six weeks. In other cases, out of it 10 subsidiaries, Bank Rakyat has run up losses amounting to RM37,948 million.

iii.

Loans were made to not credit worthy customers who were related to certain officers resulting in default and losses to the bank. Outstanding debtors balance as at 31st December 1975 amounting to RM48,976,654 from 5,514 accounts. Out of that only 2,406 debtors confirmed their balances to Price Waterhouse. There is no reply received from 3,108 loan debtors who owed the amount of RM30,916,913. There are many loans outstanding as at 31st December 1975 had higher balance outstanding at 31st December 1977 which showed that there is either been no repayment during this period or the repayment made were insufficient to repay the interest charged during the period. Bank Rakyat write off the staggering sum of RM19.39 million for doubtful and bad loans.
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Among the list of loan defaulters were Malacca Chief Minister, Mohd Adib Bin Haji Mohd Adam and many others UMNO members.

iv.

Chairman of Bank Rakyat and also Menteri Besar of Selangor, Datuk Harun Bin Idris misused Bank Rakyat fund totalling RM7.5million to finance the Muhammad Ali Joe Bugne fight in Kuala Lumpur. He was convicted on charges of forgery and criminal breach of trust.

Price Waterhouse Report also stated that the transactions of Bank Rakyat were carried out to the benefit of individuals rather than the Bank and its member. The betrayal of the Bank Rakyat, in particular, the betrayal of the 27,314 members and the 1,000 cooperative members must be mercilessly exposed and condemned, for it constitutes one of the greatest betrayals of the New Economic Policy. The members were mostly from the low-income group comprising farmers, fisherman, petty traders and low rung government servants. Bank Rakyat is an example of how those in control agent of a company could create wealth and instant million not only for them but also for their relatives and close friends. Agency Problem Issues According to the agency theory, the shareholders are the principle because they are the owners receiving the company profit or bear it loss. The agents are the management because they are employed by the shareholders to run the day to day task of the company and paid salaries for their services. In the case of Bank Rakyat, the principles are the government, 27,314 members and 1,000 cooperative members while the agents are the CEO and managements of Bank Rakyat. In principle, the agents are supposed to make decisions in the best interest of the principle. To ensure that, principle need to monitor the agents effectively. The principle agent problem can be reduced by better monitoring and establishing more appropriate incentives for managers. However the problem arises when the company is own by the government. As the owner, the Government control the company through the policy, rules and law. In Malaysia, there is a close relationship between the business and governments. According to Gomez (1990), the close relationship can no longer split the business and politics as two different entities, but make them indispensable and dependable on each other. This relationship can easily cause fraud and corruption. According to Tan (2006), bank fraud happen frequently in Malaysia because of the greater seriousness of the principle agent problem. Many major banks in

Malaysia are government owned, and as such the management of those banks could be viewed as agents without a principle. The concept of ownership and control are important to ensure the company practices check and balance system between the owner and the company managements. The owner of the company or shareholders has the rights to obtain accurate information which will enable them to be comfortable with the companys operation and be sure on return of their investment. They also have the right to offer their opinion and suggestion to the companys management in improving certain actions that need to be taken by the companys management or object upon any decision, which they believe inappropriate or unprofitable to the company. The directors of the companies have to prove their abilities in making the right decisions especially decision related to investment and loan in order to preserve the interest of shareholders and other stakeholders. (Nor Azizah, 2007). Suspicions regarding the financial standing of Bank Rakyat were raised at its 19th Annual General Meeting, when it tabled its 1973 and 1974 accounts, both of which did not have the prior approval of the Registrar General of Cooperatives. The 1973 and 1974 accounts showed that the Banks performance was profitable when in fact the Bank suffered substantial losses for those years. The Registrar General of Cooperatives then conducted an enquiry into the Bank and at the same time the police also investigated its affairs. Anticipating a run on the bank, the Government came up with a guarantee that deposits in the bank were safe. There is no evidence that proper monitoring has been conducted by Government in the capacity as the owner of the bank. There are loopholes in the policy, rules and law, and these include: The accounts of Bank Rakyat should be audited by the Auditor General or any other auditor appointed by the Board with the approval of the Minister given with the concurrence of the Minister of Finance. The Auditor General responsible to carry out an audit of the Bank and to make report on its annual balance-sheet and profit and loss accounts including its consolidated balance-sheet and consolidated profit and loss account. However the 1978 Act is silent with regards to the accounting principles and standards to be followed in the preparation of the financial statements of Bank Rakyat. The White Paper on Bank Rakyat revealed that loans were approved even though beyond the level of the authority of the Managing Director or the committee of bank officials. There were no minutes to indicate the loan committee had ever met and its decisions were evident only by signature on the loan approval forms. There were
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instances where the applications, approvals and disbursements were made on the same day. In other instances loan disbursements were made prior to approval. Sometimes loans were made in excess of the value of the security, and a number of loans which were approved were neither processed nor secured by any collateral. In one case, the borrowers who could not repay the loans ended up with a profit of RM180,769 because Bank Rakyat bought the two lands charged to the Bank from the borrowers. Recovery of the loans was hampered by the fact that most of the borrowers were not creditworthy in the first place. In some instances, recovery was hindered by missing loan files. As at 31 December 1975, several members of the Board and their immediate families had loans outstanding with Bank Rakyat amounting to RM1.13 million. Out of this amount RM1.02 million were in arrears. 3 of the borrowers never made any repayment at all on their loans. The White Paper largely attributed the malpractices to the Managing Director and certain officers of the Bank. However if there is proper monitoring and the Chairman, the Board of Directors, the Registrar General of Cooperatives Societies and the external auditor had properly discharged their functions and responsibilities, they could have prevented the management from perpetuating the malpractices and thereby reduced the losses of the bank. How Does Company Overcome The Issue Bank Rakyat was formed as a cooperative with social objectives of eradicating rural poverty by providing financial assistance to rural farmers and others who dont have any avenues. Then, it started to open its business to non-members with strong support from the government in terms of changing the relevant regulatory provision and placing government fund as deposits. In 1981, Bank Rakyat reduced its shareholding in Rakyat First Merchant Bankers. A new joint venture with largest cooperative bank in Germany Duetsche Genossenchafts Bank was formed providing the Bank Rakyat with access to international business. In 1982, a new logo and corporate song were introduced. The eighties saw the first profit reported after the scandal. 1983 reported a modest profit of RM5.85 million. The reported profit for 1984 recorded at RM18.52 million. In year 1986, Bank Rakyat introduced its first Islamic financial product children deposit account while still operating as a conventional bank. In 1990, a dividend payment of 22% was announced after 16 years. In 1993, it introduced a novel Islamic pawn broking Ar
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Rahnu. In 1997, the bank became a second full-fledged Islamic bank in Malaysia and managed to completely expunged the unIslamic elements of its operation in 2001. To achieve, what and where they are now, Bank Rakyat have undergone transformation process not only by introducing new strategies but also amended the acts, rules and regulations in order to tighten up the control. The following are the various act and law which govern various aspect of Bank Rakyat: i. Bank Kerjasama Rakayat Malaysia (Special Provisions) Act 1978 Provides provision on appointment of the chairman and board members; Provides authorizations on powers, functions, duties and responsibilities of the Bank. The Act also stated that Bank Rakyat is under the supervision of Minister of Domestic Trade, Co-operatives and Consumerism; Makes provision with regards to statutory reserve requirement, accounts and audit of Bank Rakyat accounts.

ii.

Cooperative Act 1993 This Act replaced the previous series of cooperative ordinance. It generally provides for the general conduct of Bank Rakyat as a cooperative for example, administrative procedures regarding registration, meetings, membership, keeping of accounts, requirement for audit and dissolution.

Bank Rakyat recovered from the financial disaster and evolved into a modern retail bank based on the Islamic principles. Its strategies for rebranding, from conventional to Islamic bank and for repositioning in the personal financing sector, also with better governance check and balance form the government have transformed the bank from a bank riddled with mismanagement and corruption into one of the most successful Islamic bank. How Our Group Solve The Problem The Bank Rakyat story is only one example of the mismanagement, malpractices, fraud and corrupts cases that happened in Malaysia. Among famous cases of bad financial management were Bumiputra Malaysia Finance, Perwaja, Renong, MAS and PKFZ. All of these companies share similar characteristic that they owned by the government and the CEO of the company appointed by ruling political parties among political figure or somebody link to them. Mismanagement had caused wastage of public funds and resources, reduced economic growth and undermined the government credibility and efficiency. We believe that laws and regulations
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along with adequate oversight and enforcement as well as good governance and ethics from both the principle and agent can deter many acts of fraud. This includes: i. There is a need to separate the close relationship between the government, political party and business. According to Gomez (1990), the close relationship between business and politics can no longer be split as two different entities but make them indispensable and dependable on each other. As such, the management of these companies can be viewed as agent without principle. Therefore, the relationship can easily cause fraud and corruption as its offer freedom to the CEO or management to act above law. We believe that, this relationship is unhealthy as the CEO was not appointed based on individual competency and credibility but on political link. In the case of Bank Rakyat, Datuk Harun Bin Idris, the former Chief Minister of Selangor was appointed as the CEO. There is a need for the principle, whom the government or appointed board of directors to develop mitigation control to address fraud risk. While the agent responsible to ensure that the control are execute effectively and meet the objective. One way of having this is by setting an effective internal audit. Internal Audit functions can help organisations address fraud. Although management and the board are ultimately responsible for fraud deterrence, internal auditors can assist the board by determining whether the organisation has adequate internal controls and fosters an adequate control environment. Thus internal auditing can add value to the organisations fraud risk management efforts through its assurance and consulting activities. In the Bank Rakyat obviously there is no internal control as there were instances where the applications, approvals and disbursements were made on the same day, loan disbursements were made prior to approval, loans were made in excess of the value of the security and a number of loans which were approved were neither processed nor secured by any collateral.

ii.

In conclusion, principle and agents are both responsible to ensure that accountability, integrity and efficiency are in place. As such adequate internal control and monitoring aspect are important and crucial. Bank Rakyat had learned from their passed experienced and now moving towards excellence. However, mismanagement and fraud still happen in Malaysia. Why? When you make a mistake, don't look back at it long. Take the reason of the thing into your mind and then look forward. Mistakes are lessons of wisdom. The past cannot be changed. The future is yet in your power.

References Latif, R. A. (n.d.). Bank Kerjasama Rakyat Malaysia Berhad. A Case of a Cooperative Islamic Bank in Malaysia . Available at http://www.wbiconpro.com/605-Radziah.pdf . 7th April 201 Accessed date

The Bank Rakyat BERTAYAL - THE GREAT SABOTEURS OF NEP http://agency problem 2/History of cooperative scandals.htm

Shiong, T. T. Why Bank Scandals Happened Frequently In Malaysia

Zainal Abidin, N.A. Cooperate Governance In Malaysia: The Effect Of Corporate Reforms And State Business Relatonship in Malaysia

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http://www.bankrakyat.com.my/web/guest/sejarah. 7th April 2013: 11:21 a.m Lim., K. S. The Bank Rakyat Betrayal The Great Saboteurs of NEP. Available at http://bibliotheca.limkitsiang.com/category/ecomomic-policies/page/11/. Accessed date 7th April 2013.