HR Thesis

Download as pdf or txt
Download as pdf or txt
You are on page 1of 73

IMPACT OF RISK TOWARD THE PERFORMANCE

OF BANK IN MALAYSIA

CHIA WEI CHUAN


HENG KEH CHUN
LAU WEN CONG
POH JIA HAO
TAN HONG RUII

BACHELOR OF BUSINESS ADMINISTRATION


(HONS) BANKING AND FINANCE

UNIVERSITI TUNKU ABDUL RAHMAN

FACULTY OF BUSINESS AND FINANCE


DEPARTMENT OF FINANCE

MAY 2017
Impact of Risk Toward the Performance of Bank in Malaysia

IMPACT OF RISK TOWARD THE PERFORMANCE OF


BANK IN MALAYSIA

BY

CHIA WEI CHUAN


HENG KEH CHUN
LAU WEN CONG
POH JIA HAO
TAN HONG RUII

A research project submitted in partial fulfilment of the


requirement for the degree of

BACHELOR OF BUSINESS ADMINISTRATION


(HONS) BANKING AND FINANCE

UNIVERSITI TUNKU ABDUL RAHMAN

FACULTY OF BUSINESS AND FINANCE


DEPARTMENT OF FINANCE

MAY 2017

i
Impact of Risk Toward the Performance of Bank in Malaysia

Copyright @ 2018

ALL RIGHT RESERVED. No part of this paper may be reproduced, stored in a


retrieval system, or transmitted, photocopying, recording, scanning, or otherwise,
without the prior consent of the authors.

ii
Impact of Risk Toward the Performance of Bank in Malaysia

DECLARATION

We hereby declare that:

1. This undergraduate research project is the end result of our own work and that
due acknowledgement has been given in the references to ALL sources of information
be they printed, electronic, or personal.
2. No portion of this research project has been submitted in support of any
application for any other degree or qualification of this or any other university, or other
institutes of learning.
3. Equal contribution has been made by each group member in completing the
research project.
4. The word count of this research report is 11076 .

Name of Student: Student ID: Signature:

1. CHIA WEI CHUAN 14ABB05520 _________________

2. HENG KEH CHUN 14ABB03039 _________________

3. LAU WEN CONG 14ABB02887 _________________

4. POH JIA HAO 14ABB02890 _________________

5. TAN HONG RUII 14ABB02981 _________________

Date: _________________

iii
Impact of Risk Toward the Performance of Bank in Malaysia

ACKNOWLEDGEMENT

This research project would not be possible without the help and assistance of a few
authorities. In this respect, we would like to acknowledge a few parties for their
contribution.

First of all, we would like to express our sincere gratitude to our supervisor Dr. Ahmad
Nazri Bin Wahiduduin that helped and assisted us in the completion of this research
project. The help and guidance given by him enable us to solve problems regarding the
project and also completed in the time. We would like to thank him again for all of his
time, effort and patience that he has sacrificed to guide us.

Lastly, a great applause would be given to our entire group members in contributing
their ideas, time and effort in completing our final project.

iv
Impact of Risk Toward the Performance of Bank in Malaysia

DEDICATION

First of all, we would like to dedicate this research paper to our final year project
supervisor, Dr. Ahmad Nazri Bin Wahiduduin because he has provided us guidance
and help during the project period.

Moreover, we would like to dedicate this final year project to our team members, family
and friends that encouraged and supported u along the way.

Lastly, we would like to dedicate this study to those future researchers who interested
in this study and can take this as a reference.

v
Impact of Risk Toward the Performance of Bank in Malaysia

TABLE OF CONTENTS

Page
Copyright Page………………………………………………………………………...ii
Declaration……………………………………………………………………………iii
Acknowledgements…………………………………………………………………...iv
Dedication……………………………………………………………………………..v
Table of Contents…………………………………………………………………vi - ix
List of Graphs………………………………………………………………………….x
List of Tables………………………………………………………………………….xi
List of Figures………………………………………………………………………..xii
Abstract……………………………………………………………………………...xiii

CHAPTER 1 INTRODUCTION………………………………………………...…1 - 9
1.0 Overview…………………………………………………………………..1
1.1 Research Background…………………………………………………..1 - 2
1.2 Problem Statement………………………………………………………...3
1.3 Research Objective………………………………………………...…...3 - 4
1.3.1 General objective……………………………………………..3 - 4
1.3.2 Specific objective……………………………………………......4
1.4 Research Questions…………………………………………....………......4
1.5 Hypothesis of the Study……………………………………………...…4 - 7
1.5.1 Operational Risk…………………………………………………5
1.5.2 Interest Rate Risk……………………………………………...…5
1.5.3 Credit Risk……………………………………………………….6
1.5.4 Liquidity Risk…………………………………………….……...6

vi
Impact of Risk Toward the Performance of Bank in Malaysia

1.5.5 Capital Adequacy Ratio………………………………………6 - 7


1.5.6 Leverage Ratio…………………………………………………..7
1.5.7 Inflation Rate…...………………………………………………..7
1.6 Significant of the Study……………………………………………………8
1.7 Page Layout…………………………………………………...……….…..8
1.7.1 Chapter 1………..………………………………….……………8
1.7.2 Chapter 2………..……………………………………………….8
1.7.3 Chapter 3….……………………………………………………..9
1.7.4 Chapter 4……..………………………………………………….9
1.7.5 Chapter 5……..………………………………………………….9

CHAPTER 2 LITERATURE REVIEW……………………………...……...……9 - 23


2.0 Overview………..……..……………………………………………..……9
2.1 Literature Review for Variables……………................................................9
2.1.1 Return on Equity…………………………….............................10
2.1.2 Operational Risk…………………………………...............11 - 12
2.1.3 Interest Rate Risk…...……………………………...............12 - 13
2.1.4 Credit Risk…….…………………………………..............13 - 14
2.1.5 Liquidity Risk….…………………………………..............15 - 16
2.1.6 Capital Adequacy Ratio...……………………….................16 - 17
2.1.7 Leverage Ratio...…………………………………...............17 - 19
2.1.8 Inflation Rate…………………………………....................19 - 20
2.2 Review of Relevant Theoretical Model……………………………...20 - 21
2.2.1 Finance Distress Theory…….……………………………..20 - 21
2.2.2 Structure-Conduct-Performance (SCP) Paradigm ……………..21
2.3 Proposed of Theoretical / Conceptual Framework………...…………21 - 22
2.4 Conclusion...…………………………..………………………….....22 - 23

CHAPTER 3 METHODOLOGY…………...…………………………………..23 - 32
3.0 Overview………………………………………………………….……...23
3.1 Data Collection Method…………………………....………………...23 - 24

vii
Impact of Risk Toward the Performance of Bank in Malaysia

3.2 Data Analysis…………………………………………………………….25


3.2.1 Diagnostic Test………………………………………………....25
3.2.1.1 Variance Inflation Factor for Multicollinearity……….25
3.2.1.2 White Test for Heteroskedasticity................................26
3.2.1.3 Ramsey RESET Test for Specification Error.........26 - 27
3.2.1.4 Normality Distribution…………………….................27
3.2.2 Likelihood Ratio……………...………………...……...……….28
3.3 Regression Model Applied……………………………………………….29
3.3.1 Panel Data Regression Model…………………………………..29
3.3.2 Pooled Ordinary Least Squares Model…………………….29 - 30
3.3.3 Random Effect Model……………………………………...30 - 31
3.3.4 Fixed Effect Model………………………………………...31 - 32
3.4 Conclusion………………………………………...……………………...32

CHAPTER 4 DATA ANALYSIS…………………………………….…..……..32 - 46


4.1 Economic Model……………………………………………………..32 - 33
4.2 Diagnostic Test……………………………………………………...…....33
4.2.1 Pooled Ordinary Least Squares……………………………33 - 34
4.2.1.1 Multicollinearity…………………..……………..35 - 36
4.2.1.2 Heteroskedasticity……….…………………………...36
4.2.1.3 Specification Error……….………………….…...36 - 37
4.2.1.4 Normality Distribution……………………………….37
4.3 Panel Data Regression……………...……….…………………………....38
4.3.1 Fixed Effect Model (FEM)….…….……………...….…….38 - 39
4.3.2 Likelihood Ratio….……….……….…………………………...39
4.3.3 Significant of Independent Variables……….……..……….......40
4.3.3.1 Operational Risk (OR)……………………...………...40
4.3.3.2 Interest Rate Risk (IRR)……………………...............41
4.3.3.3 Credit Risk (CR).…………………………………......41
4.3.3.4 Liquidity Risk (LR).……………………..............41 - 42
4.3.3.5 Capital Adequacy Ratio (CAR)…..…………..............42

viii
Impact of Risk Toward the Performance of Bank in Malaysia

4.3.3.6 Leverage Ratio (LeR)............................................42 - 43


4.3.3.7 Lagged Inflation Rate (IR_1).…………………..........43
4.3.4 Discussion on Parameter……….……………...…..………43 - 44
4.3.5 Consistency with Theory and Estimation…………………44 - 45
4.4 Conclusion…………………………………………………………...45 - 46

CHAPTER 5 DISCUSSION, CONCLUSION AND POLICY IMPLICATION...46 -52


5.0 Overview…………………………………………....…………………....46
5.1 Summary of Statistical Analysis…………………………………….46 - 49
5.2 Policy Implication of Study……………………….…………………49 - 50
5.3 Limitations of Study…………………………………………………50 - 51
5.4 Recommendation………………………………………………….…51 - 52
5.5 Conclusion………………………………………………………………..52

REFERENCES…………………………………………………………………..53 - 59

ix
Impact of Risk Toward the Performance of Bank in Malaysia

LIST OF GRAPHS

Graph 1.1: Return on Equity of Bank in Malaysia 2

x
Impact of Risk Toward the Performance of Bank in Malaysia

LIST OF TABLES

Table 3.1: Sources of Data 24

Table 4.1 Pooled Ordinary Least Squares produced from Gretl 33 - 34

Table 4.2 Correlation analysis produced from Gretl 35 - 36

Table 4.3 White Test produced from Gretl 36

Table 4.4 Ramsey RESET test produced from Gretl 36 - 37

Table 4.5 Normality for residual test produced from Gretl 37

Table 4.6 Fixed Effect Model produced from Gretl 38 - 39

Table 4.7 Likelihood Ratio produced from Gretl 39

Table 4.8 Significant of Independent Variables 40

Table 4.9 Expected Signs of the Independent Variables 44 - 45

Table 4.10 Actual Signs of the Independent Variables 45

Table 5.1 Summary of Gretl Result 46 - 47

xi
Impact of Risk Toward the Performance of Bank in Malaysia

LIST OF FIGURES

Figure 2.1: Factors affects Return on Equity 23

xii
Impact of Risk Toward the Performance of Bank in Malaysia

ABSTRACT

The effect of banking risk and macroeconomic factor towards the banks’ performance
in Malaysia are discussed in this research. The banking risks such as operation risk,
interest rate risk, credit risk, liquidity ratio, capital adequacy ratio and leverage ratio
had been studied to find out their impacts toward the banks’ performance which
measure by return on equity. Besides from all the banking risks mentioned above,
inflation rate also taken as the macroeconomic factor that can affect the bank
performance. The period of this research has cover from 2007 to 2016 which about 10
years. This study is expected to help improve the understanding of the institutional,
regulatory and supervisory framework of financial institutions about the effect of
banking risk and macroeconomic factors toward the banks’ performance.

The purpose of this study is to examine the factors that influence the banks’
performance in Malaysia over 2007 until 2016. The Pooled Ordinary Least Square
(POLS) and Fixed Effect Model (FEM) is used based on the suggestion of the
Likelihood test. The result show that all factors except liquidity risk (LR) and capital
adequacy ratio (CAR) is having significant relationship with the return on equity. On
the other hands, this research also concludes that operation risk (OR), liquidity risk,
capital adequacy ratio (CAR) and inflation rate (IR) have a negative relationship with
return on equity while the other factors, such as interest rate risk (IRR), credit risk (CR)
and leverage ratio have a positive relationship with return on equity.

xiii
Impact of Risk Toward the Performance of Bank in Malaysia

CHAPTER 1 : INTRODUCTION

1.0 Overview

The main objective for carries out this research is to discuss the impact of risks toward
banks in Malaysia. The microeconomics variable such as operational risk, interest rate
risk, credit risk, liquidity risk, capital adequacy ratio and leverage ratio and
macroeconomics variable, inflation rate, had taken into account in this study. The
overall idea of research which consists of research background, problem statement,
research objective, and research question will be highlighted in Chapter 1. Furthermore,
hypothesis and significance of study will be discussed in the following part of the
chapter.

1.1 Research Background

Risk management of a bank seems to be a significant factor affecting the performance


of banks. The ways to enhance the measurement and management of a particular risk
has become the main focus point in a quantitative risk management. In a more in-depth
level, the exploration on the ways on how to incorporate those risks in a single formula
to investigate the effect on the performance of banks will be more significant. In the
previous study on the risk management, overwhelming majority emphasized on a single
type of risk while neglect the interrelated relationship with other risks (Miller, 1992).
Before the year 1997 which is prior to the germination of Asian Financial Crisis,
Malaysia was recognize generally as ‘miracle economic’ within East Asia with its low
inflation rate, low unemployment rate and high growth rate (Ariff & Abubakar, 1999).
But good time never lasts long, Malaysia was experienced Asian Financial Crisis in the

1
Impact of Risk Toward the Performance of Bank in Malaysia

year 1997. During that time, the value of Malaysia depreciated dramatically against US
dollar. The composite index of KLSE was also affected negatively by the crisis which
dropped significantly from 1077.3 point to 262.7 point within three months which
caused Malaysia to be doubtful whether Wawasan 2020 still accomplishable. Other
than that, non-performing loan of banks increasing by day due to close to the whole of
private companies keep on looking for loans in order to survive. This may cause most
of the banks fall into a tight liquidity condition. From this stage, it shows how important
liquidity to be taken into account to investigate the bank’s performance.

After the Asian Financial Crisis, Malaysia government decided to merge all the small
local banks in Malaysia in order to increase the banks’ compatibility to compete with
foreign banks. Besides that, Malaysia government also come out with several policies
that favourable to the local banks. After all the hard works had been carry out, the return
on equity of Malaysia bank still declined from years to years after the global financial
crisis.

From the graph, we can obviously see that there is a downward sloping within almost
all the banks we involved in this study.

Graph 1.1 Return on Equity of Bank in Malaysia

Source: Annual Report of Selected Banks

2
Impact of Risk Toward the Performance of Bank in Malaysia

1.2 Problem Statement

Banks are a major component of the economic system and provided fund to the market,
so it is essential to keep the bank in good operation. After financial crisis on year 1997,
Malaysia government even comes out with a policy about the merging of the bank in
order to stabilize the banking sector. But nowadays, since the global financial crisis,
the bank’s return of equity had keep decrease from years to years. So, it is essential to
find out the factor that affects the bank performance.

Bank risk management is an essential part for the banking sector. Similar to other
industrial, bank is facing several types of risk daily such as operational risk, interest
rate risk, credit risk and liquidity risk (Hussain, Ihsan and Hussain, 2016). As bank is
part of the virtual economy, so even a single minor error or change will cause a huge
impact toward the bank’s performance.

Besides from the bank risk, macroeconomic factor is also an important factor that
influence the bank performance (Tan, 2015). So, inflation rate had been taken into the
consideration as the macroeconomic factor in this study.

1.3 Research Objectives

1.3.1 General Objective

The main research objective is to figure out how the bank risk affected the bank’s
performance in Malaysia over 2007-2016 periods. Return on equity are used to measure

3
Impact of Risk Toward the Performance of Bank in Malaysia

the bank’s performance and several risks such as operational risk, credit risk, interest
rate risk, liquidity risk and capital adequacy ratio are selected as the determinants.

1.3.2 Specific Objective

● To determine the significance of operational risk towards bank’s return of equity.


● To determine the significance of interest rate risk towards bank’s return of equity.
● To determine the significance of credit risk towards bank’s return of equity.
● To determine the significance of liquidity risk towards bank’s return of equity.
● To determine the significance of capital adequacy ratio towards bank’s return of
equity.
● To determine the significance of leverage ratio towards bank’s return of equity.
● To determine the significance of inflation rate towards bank’s return of equity.

1.4 Research Question

● Does operational risk influence return on equity of bank in Malaysia?


● Does interest rate risk influence return on equity of bank in Malaysia?
● Does credit risk influence return on equity of bank in Malaysia?
● Does liquidity risk influence return on equity of bank in Malaysia?
● Does capital adequacy ratio influence return on equity of bank in Malaysia?
● Does leverage ratio influencing return on equity of bank in Malaysia?
● Does inflation rate influence return on equity of bank in Malaysia?

1.5 Hypothesis of the Study

4
Impact of Risk Toward the Performance of Bank in Malaysia

The return on equity will be selected as dependent variable in this study because it
represents the performance of bank. Besides, there are seven independent variables
have selected which is operational risk, credit risk, interest rate risk, liquidity risk,
leverage ratio, capital adequacy ratio and inflation rate. More detail of those
independent variables will be discussed as follow:

1.5.1 Operational Risk

Operational risk can be defined as a human risk which measures the risk about the
losses caused by human error during business operation. In the research, Risk
Management and Bank Performance in Pakistan, studied by Hussain et al. (2016),
operational risk is significant toward the return of equity of the bank, but the
relationship is different based on the bank size.

H0 = Operational risk has no relationship with bank’s return of equity


H1 = Operational risk has relationship with bank’s return on equity

1.5.2 Interest Rate Risk

Interest rate risk is measuring the change of assets and liabilities value due to the
interest rate change. When the interest rate risk is floating, as some of the bank’s assets
and liabilities are taking floating rate, the bank profitability will also be affected. In the
research, Risk Management and Bank Performance in Pakistan, studied by Hussain et
al. (2016), interest rate risk is negatively significant toward the in large commercial
banks’ return of equity but not significant in small commercial banks.

H0 = Interest rate risk has no relationship with bank’s return of equity


H1 = Interest rate risk has relationship with bank’s return on equity

5
Impact of Risk Toward the Performance of Bank in Malaysia

1.5.3 Credit Risk

Credit risk mean the possibility of borrower unable to repay their banks’ loan. This can
lead to the loss of banks’ principal and affected the profitability of bank. Based on past
research, analysis risk management in banks (Awojobi, Amel & Norouzi, 2011), on
Nigerian bank, credit risk is having positive impact toward the banks’ capital position.
So, we expect that the credit risk is having positively significant relationship toward
the return of equity.

H0 = Credit risk has no relationship with bank’s return of equity.


H1 = Credit risk has relationship with bank’s return of equity.

1.5.4 Liquidity Risk

Liquidity risk refer to risk which a company or business is unable to fulfil their short
term financial obligations and might cause by a company or business who unable to
turn their assets into cash easily without loss in value. According to Arif & Nauman
(2012), liquidity risk has a negative impact towards the performance of banking system.

H0 = Liquidity risk has no relationship with bank’s return of equity.


H1 = Liquidity risk has relationship with bank’s return of equity.

1.5.5 Capital Adequacy Ratio

Capital adequacy ratio refer to a ratio set by central bank which require banks to set an
amount of reserve capital aside in order to prevent from insolvency. The capital

6
Impact of Risk Toward the Performance of Bank in Malaysia

adequacy ratio and return on equity of banks are positive related to each other (Jha &
Hui, 2012).

H0 = Capital adequacy ratio has no relationship with bank’s return of equity.


H1 = Capital adequacy ratio has relationship with bank’s return of equity.

1.5.6 Leverage Ratio

Leverage ratio is showing that how the banks obtain its capital and combination of the
banks’ capital. A high leverage ratio means the bank is more depend on the debt instead
of its equity. In the research of Awojobi et al. (2011), they use market risk which
measure by the bank’s risk exposure to capital market participation as the leverage ratio
and the result show a positive significant relationship.

H0 = Leverage ratio has no relationship with bank’s return of equity


H1 = Leverage ratio has relationship with bank’s return on equity

1.5.7 Inflation Rate

Inflation rate is a macroeconomic factor that can show the purchasing power of the
country. In this research, we use it as the variable to measure the country’s economic
situation. In the research of Tan (2015), there are either positive or negative relationship
between inflation and the banks’ performance.

H0 = Inflation rate risk has no relationship with bank’s return of equity


H1 = Inflation rate risk has relationship with bank’s return on equity

7
Impact of Risk Toward the Performance of Bank in Malaysia

1.6 Significance of the Study

This study can be used to explain the importance of bank’s risk management toward
their performance in Malaysia. This research can give us a clearer picture about the
importance of banks’ risk management and how it affects the banks’ performance.
After doing the survey, we found out that there is lack of research toward the effect of
Malaysia banks’ risk management. This research can be a good refer for those
researchers who want to study further in this topic.

1.7 Page Layout

There are five chapter will be discussed and page layout of the study will be stated
clearly in the following part.

1.7.1 Chapter 1

In this chapter, a brief introduction about our research will be show to let people have
a basic idea about our research. We will go through the background of our research,
objective, hypothesis and significance of our study one by one.

1.7.2 Chapter 2

In this chapter, some literatures that related to our study will be go through and
concluded. This will help in spread some related knowledge to readers for letting them
understand this study easier and better.

8
Impact of Risk Toward the Performance of Bank in Malaysia

1.7.3 Chapter 3

The methodology that by this study are explained under this chapter.

1.7.4 Chapter 4

The chapter will explain about the result and finding of the study. The result of several
tests will be show in this chapter and interpreted.

1.7.5 Chapter 5

In chapter 5, the summary of this study will be concluded. The findings, limitations and
recommendation will be included in this chapter.

CHAPTER 2: LITERATURE REVIEW

2.0 Overview

This part is discussing about all the dependent and independent variables that we had
examined in our research. Return on equity had adopted in our research as the
dependent variable while independent variables were operational risk, interest rate risk,
credit risk, liquidity risk, capital adequacy ratio, leverage ratio and inflation rate.

2.1 Literature Review for Variables

9
Impact of Risk Toward the Performance of Bank in Malaysia

2.1.1 Return on Equity

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 =
𝑠ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝑒𝑞𝑢𝑖𝑡𝑦

Return on equity (ROE) is a type of profitability ratio which measure about how much
the bank can earn by using every single value of capital the shareholders had invested
and also being known as return on net worth. According to Harelimana (2017), ROE is
the most important financial ratio for banks. This is because the investors are trying to
maximize their return with limited investment, bank which have high ROE ratio can let
those investors more confidence about the bank performance.

As mentioned by Tafri, Hamid, Meera, & Omar (2009), there will be some special
reason which may lead to the late response of the bank profitability to its actual
competitive profit. So, they had included one period lagged dependent variable as their
independent variable consists of exogenous shock. This viewpoint had been supported
by Athanosoglou, Brissimis and Delis (2008). In their study about Greek banks within
the period 1985 until 2001, they had made the dependent variable one period lagged as
the independent variable is serially correlated.

Based on the research of Alper and Anbar (2011), return on equity will be affected by
several bank factors and macroeconomic factor. Return of equity is measuring the bank
profitability, any change in the bank or macroeconomic factors will lead to the change
of it. The relationship between all the factors and the banks’ profitability are highly
concerned and it is the main objective for this research to found out it.

2.1.2 Operational Risk

10
Impact of Risk Toward the Performance of Bank in Malaysia

Operational risk has been defined as the risk of loss that probably will happen due to
internal event such as breakdown in computer systems, misconduct by employee, and
insufficient process, or external event such as legal risk and environment risk.
According to Nasserinia, Ariff and Cheng (2017), many banks was close down in last
twenty years and poor management for the cost is one of the reasons for bank collapse.
The effectiveness of cost control will affect the loan become weak caused by lack of
accurate supervision of loans. So, in order to improve the bank performance, the
effective operational management for cost control is needed necessary (Nasserinia et
al, 2017).

According to Saleem and Abideen (2011), they found that the organizations which
manage their risk effectively can get higher performance and this is proved by their
research at 2011. Besides that, Habib, Masood, Hassan, Mubin and Baig (2014) had
studied how operational management will affect the banking sector in Pakistan. Based
on their research, they concluded that the effective operational risk management can
increase the performance of the bank of Pakistan. Laker (2007) stated that operational
risk has become a vital risk factor which encountered by bank due to increase the
requirement on specialized skills, technology and banking complexity.

According to the study conducted by Hussain, Ihsan, Hussain (2016), they concluded
that operational risk has a significant and negative relationship with the return on equity
for large commercial bank but operational risk is significantly and positively affecting
small commercial bank’s return on equity in Pakistan. On the other hand, Owoputi,
Kayode and Adeyefa (2014), found that return on equity and operating expenses
management has a negative relationship at 10% significance level. So, the bank profits
will decrease when the operating expenses increase. Thus, manage operating expenses
efficiently is important to increase the profit of the bank. Athanosoglou et al. reported
operating expenses would affect bank profit negatively.

11
Impact of Risk Toward the Performance of Bank in Malaysia

In the nutshell, most of the researcher such as Hussain et al (2016), Owoputi et al.
(2014), and Brissimis et al (2008) found that operational risk will negatively affect the
bank performance and profitability. Therefore, the lower the operational risk of the
bank, the higher the performance of bank. The bank performance can be increased by
the effective operational management of the expenses, while poor operational expenses
management will probably cause the losses for the bank.

2.1.3 Interest Rate Risk

Interest rate risk is usually representing the losses in net value income and market value
of equity for the bank that might be occurring for the changes in the market interest
rate. According to Khan and Sattar (2014), the performance of the bank can be
influence by the interest rate, so interest rate is an important variable for the bank. The
recession will be happened when interest rate decreases and this will cause the rise of
the losses in loans and slow down the growth in loans. Besides that, the market value
of assets and liabilities will decrease when interest rate grow. The market value of
assets will decrease due to interest rate shocks and this will definitely influence the net
value of assets (Saunders & Cornett, 2003).

According to the result from the study conducted by Tafri et al. (2009), the interest rate
risks have a significantly and negatively relationship with the return on equity of the
bank. Albertazzi and Gambacorta (2009) show that the long-term interest rate will have
lesser influence compare to short term interest rate for the profitability of bank in Italy,
Spain and Portugal. On the other hand, Kanas, Vasiliou and Eriotis (2012) reported that
the profit of the bank will not affected by the short-term interest rate for linear model
but it will affect the bank positively in semi-parametric model. From the research of
Hancock (1985), the result show that the interest rate will positively affect the profit of
bank which means the increase in interest rate will lead to increase in profitability of
bank. According to Hussain et al. (2016), the interest rate risks have a significant and

12
Impact of Risk Toward the Performance of Bank in Malaysia

negative relationship with the ROE for the large commercial bank in Pakistan, while
the interest rate risk is insignificantly and negatively affect the small commercial bank.

In sum, most of the researcher such as Tafri et al. (2009) and Albertazzi et al. (2009)
found that the interest rate risk and bank performance are negatively related. Therefore,
the interest rate risk will ultimately affect the performance of the bank. In order to
obtain a better performance for the bank, the interest rate fluctuation should not be
neglect by the bank and it should be considered seriously.

2.1.4 Credit Risk

Credit risk normally refers to the probability that the borrower unable to repay certain
amount of assets that they required to pay to the lender. It is also known as the
probability of default payment. It would cause the lender to lost part or total amount of
assets that they borrowed and increase the cost of collecting the debts. According to
Awojobi et al. (2011), credit risk in banks term is an idea to clarify likelihood of default
on the bank’s loan portfolio.

A lot of study has shown that credit risk has significant effect towards the bank financial
performance regardless country or bank size. Researchers Adeusi, Akeke, Adebisi and
Oladunjoye (2014) state that credit failure in bank isn’t a new or uncommon event. It
is still one of the biggest threats to any bank performance and is the central reason for
bank failures (Greuning & Bratonovic, 2009). Cooper, Jackson and Patterson (2003)
concluded that the vacillations in credit risk would affect the way bank manage their
loan portfolios which consequently causing impact towards bank’s financial
performance. Other studies that conducted in Jordanian, Ethiopian and Nigerian
banking industry had all found that credit risk has unneglectable relationship towards
the bank’s profitability and performance (Alshatti, 2015; Gizaw, Kbede & Selvaraj,
2015).

13
Impact of Risk Toward the Performance of Bank in Malaysia

In the study done by Hussain et al. (2016), credit risk fundamentally influences the
profitability of both small and large commercial banks that operate in Pakistan as higher
credit risk often leads to lower profitability of bank. They state that both small and big
commercial banks should put their focus on the quality of loan that they disperse and
also make effort to ensure the loan assessment procedure is well regulated and manage
in order to avoid higher probability of default loan and keep up their performance in
the banking industry. Moreover, in Miller & Noulas (1997) studies also proved that
there is a negative relationship between credit risk and the bank’s profitability. As
higher exposure of credit risk is allocated on the bank’s loan, probability that loan turn
into bad debt will be increase as well which at last increase the bank’s loss and lead to
lower profitability of bank. Based on Owojori, Akintoye and Adidu (2011) study,
statistical facts had shown that the primary factor that cause the distress of liquidated
bank in Nigeria is the failure of banks to collect back high-risk debts that disperse to
customer or companies that have relationship with the bank’ top management team.

On the other hand, in the study of Saeed and Zahid (2016), they state that there would
be a positive relationship between the credit risk and the profitability of bank. This is
because when a loan is rated as high-risk loan, bank can charge higher interest rate and
commission on that particular loan, thus, increase their profitability in the end.

In sum, most of the researchers such as Duca et al (1990), Miller et al (1997), et al


agree that the relationship between credit risk and the profitability and performance of
commercial banks is negatively significant regardless the size or the area where banks
operate. Although there is a norm that higher risk often comes with higher return as
reward, however, higher exposure to credit risk often resulting in higher rate of
defaulting. This would cause bank to lose part of their capital and in certain measure,
increase the cost of collecting bad debts and operating expenses which in the end will
harm the bank’s profitability.

2.1.5 Liquidity Risk

14
Impact of Risk Toward the Performance of Bank in Malaysia

Liquidity risk usually refers to the risk which a company or bank has to bear when they
are holding assets that are not easy to be sold or to be converted into liquid assets like
cash. If particular company or bank needs cash to handle short term financing, they
would be force to sell their non-liquid assets under market price to get cash. Awojobi
et al., (2011) state that liquidity as one of the bank-specific factor can indicate how well
the bank response to their short-term commitment. It also represents the capacity of
how quick the bank can transform their assets into cash.

Liquidity risk can be portrayed as the risk of funding an emergency occasion which
includes extensive charge off, loss of confidence from market and national crisis. Bank
would recognize liquidity risk in their risk management and focus on the liquidity
facilities as it is considered one if the challenges for bank. Athanasoglou, Brissimis and
Delis (2008) also claim that liquidity risk will happen when the bank is unable to adapt
to the fluctuations of their liabilities or assets.

According to Guru, Staunton and Shanmugam (2002), since banks are engaging in
business of collecting short term deposits and changing them into long term loan and
advances, maturity mismatch is one of the unavoidable risks that they will be facing
constantly. Therefore, in order to hedge against crisis like liquidity deficit, banks often
hold quite a number of liquid assets that can be easily converted into cash to act as an
emergency fund. However, there is a catch as high liquidity asset often will be given
lower rates of return which indicate lesser profit can be made (Hussain et al., 2016).
Therefore, liquidity has a negative relationship with the profitability of bank.

Other than that, in Hussain et al. (2016) study, they found that liquidity risk can
imposed significant effect towards the profitability of large commercial banks that
operate in Pakistan. Their study result support the hypothesis that liquidity risk has
negative effect on the bank profitability. Other researchers like Molyneux and Thorton
(1992) has also found out that the banks’ liquidity and profitability are negatively
related.

15
Impact of Risk Toward the Performance of Bank in Malaysia

In short, most of the researchers such as Hussain et al (2016) and Thorton (1992) agree
that liquidity risk is negatively related to the banks’ profitability. Therefore,
commercial banks still have to hold liquid assets as an emergency fund to cope with
liquidity crisis even though liquid assets often associated with lower rate of return. This
is because bank would face tremendous consequences like losing confidence from
market and even failure if liquidity crisis could not be solved properly.

2.1.6 Capital Adequacy Ratio

Capital adequacy ratio (CAR) is also known as the capital-to-risk weighted assets ratio
(CRAR) that uses by the bank to measure their capital value and to disclose the
percentage of risk weighted credit exposures of a bank. It is utilized to secure the
depositors of banks and improve the efficiency and stability of the financial systems
over the world.

Formula of Capital Adequacy Ratio (CAR) is show as below:


Capital Adequacy Ratio (CAR) = (Tier One Capital + Tier Two Capital) / Risk
Weighted Assets

Furthermore, capital is measured into two categories which are tier one capital and tier
two capital. Tier one capital refers to the capital which can use to offset the losses
withstand by the bank without being required the bank to terminate the trading such as
the ordinary share capital of a bank. Meanwhile, tier two capital represents the capital
that can offset the losses of the bank that suffered from the event of winding up or lose
up their entire tier one capital and at same time it provides some degree of protection
for the depositors and creditors as the depositors’ fund has higher priority than bank’s
capital.

16
Impact of Risk Toward the Performance of Bank in Malaysia

According to Berger (1995), capital adequacy ratio (CAR) and return on equity (ROE)
are positively related support by the data of banks in U.S with economically and
statistically significant. He also said that by allowing to raise in capital ratio will follow
by an increase in the earning of equity as the expected costs for the event of bankruptcy
will be decreased and the reduction in funds price and amount of required funds to
improve the net interest incomes of the bank. To support that, Keeley (1990) found that
as the increased probability of bank failure or bankruptcy will then cause the decline in
the bank’s capital value in his research as the shareholders or investors will lose
confidence with the bank and withdrawal the funds invested to the bank. Therefore,
banks will have to paid to the shareholders for compensate and appease the shareholder
to keep anticipate with the bank through promise higher required interest rates from the
bank’s capital.

However, in studies done by Almazari (2013) and Almazari and Alamri (2017), they
conclude that there is a negative relationship between the capital adequacy and
profitability of the bank. The reason provided is that although requirement of capital
could reduce risk-related boundaries, it limits the bank’s investment decision in order
to maintain the capital reserve requirement.

In the nutshell, bank with the ability to increase their capital and reduces the risk-
related boundary of having more opportunities to anticipate into others profitable
product lines. Then, the bank will have higher ROE with higher CAR as they able to
generate high revenue by borrowing uninsured funds and higher CAR indicate the safer
bank can be issuing off-balance-sheet guarantees to investors.

2.1.7 Leverage Ratio

Leverage ratio (LeR) is one of the financial measurements that used by the firms to
measure their proportion of equity that comes from the debts or loans and the investors
also used it to evaluate a firm’s ability to cope with the financial obligations. It is vital

17
Impact of Risk Toward the Performance of Bank in Malaysia

to the firms that involved the mixture of debt and equity to finance their businesses by
calculating the amount of debt held by the firms and to assess whether they able to pay
off their debt before the due date. The most common leverage ratio is the debt-to-equity
ratio. The formula is show as below,

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
𝐷𝑒𝑏𝑡 − 𝑡𝑜 − 𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜 = 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦

Return on equity (ROE) is a publicized bank strategy that broadly used in the banking
industry to reach unsustainable and unrealistic values (Pagratis, Karakatsami & Louri,
2014). ROE = ROA x Leverage, where the return on assets is negatively interrelated
with leverage and the return on equity is positively correlated with leverage. The higher
is the leverage, the higher is the ROE. The dynamic use of leverage by banks for
increasing the returns in a low-risk environment. In essence, bank managers are more
encouraged to use ROE as a short-sighted strategy to extent for yield by captivating
more on leverage in good times when the conditions of high ROE competition and low
risk premia (Pagratis et al., 2014).

Based on the researches done by Chen (2013), leverage ratio has defined as a collective
measure of financial well-being by both regulators and bankers towards the sensitivity
measurement on the value of equity ownership with regard to alterations in the bank’s
principal value. Additionally, banks that encompassed with higher leverage are
considered more susceptible with respect to a given change in percentage of the asset
value of a bank would facilitate itself as a higher change in percentage on the equity
value.

With having no information asymmetry or taxes and perfect capital markets, debt
financing has no any viable effect on value. An upsurge in the financial leverage from
a replacement of debt-to-equity may eventually contribute to an increase on the
expected return on capital employed (ROCE), whereby such increase is being
counterbalanced in the valuation that formulated by the reduction in the equity book
value on the increase in the required equity return and the earnings of excess
18
Impact of Risk Toward the Performance of Bank in Malaysia

profitability. Notably, the growth on the required equity return is significant due to an
increased financing risk (Nissim & Penman, 2003).

2.1.8 Inflation Rate

Inflation rate is a type of macroeconomic factor that measure about the change of the
Consumer Price Index (CPI) and effects toward the costs and revenues’ real value.
Generally, it can be divided into two types which are demand-pull and cost-push and it
will result in the decrease of currency’s purchasing power or the increase in the good
and services’ price.

As mention by Tan and Floros (2012), inflation rate is important for developing
countries as it will worsen the credit market friction. As the inflation rate increase, the
financial intermediaries will tend to decrease their investment and the market
productivity will decrease. At the end, the economic activity will be affected and lead
to decrease of the banks’ performance. This result also being supported by Wamucii
(2010) which the inflation rate is negatively affected the bank profitability.

On the other hands, there are many others researches which stand the point that inflation
rate is positively affected the banks’ profitability (Capraru & Ihnatov, 2014; Tan &
Floros, 2012; Tan, Floros & Anchor, 2016). Khan, Shahid, Bari, Anam, Shehzad and
Siddique (2014) had state that when the inflation rate is high, the bank’s saving will
reduce and lead to the decrease in the amount of large loan in order to reduce the credit
risk. As the bank is become more careful and strict in giving out the loan, the bank’s
profitability and performance will increase in the result.

Based on Tan (2015), the inflation rate can either positively or negatively affected the
bank performance. If the inflation rate can be anticipated, banks can improve their
profitability by adjusting the interest rate; but if the inflation rate is unanticipated, the
profitability of bank maybe drops because the increase of cost is faster than the increase

19
Impact of Risk Toward the Performance of Bank in Malaysia

of revenue, ceteris paribus. The viewpoint was supported by Alper and Anbar (2011),
although at the end of their study on 10 Turkey’s banks within 2002 until 2010, they
come out with the conclusion that inflation rate is not an important factor that affect
the bank profitability.

Based on the literature review from the above, the expected sign for inflation rate in
this study will be either positively or negatively affected the banks’ profitability.

2.2 Review of Relevant Theoretical Model

2.2.1 Finance Distress Theory

According to Baldwin and Mason (1983), when a company business gone bad to the
point where it could not cope with its financial obligations, the company is considered
to enter the state of “financial distress”. The first signal of financial distress is usually
started with the failure of making repayment of the company debts and the failure or
reduction in paying dividends to its shareholders. In the long run, some of the
companies that meet financial distress declared bankrupt while some of the companies
able to recover or figure out ways to settle cases against them out of the court.

As Guru et al., (2002) state that maturity mismatch is one of the unavoidable risk met
by bank constantly, liquidity risk is one of the important factor to be considered by
bank to prevent liquid deficit as it would lead to financial distress of bank. Other than
that Baldwin and Manson (1983) state that the poor credit risk of bank would be a
costly mistake of bank as it would cause financial distress to bank as well. Therefore,
liquidity risk and credit risk are including as the independent variables in our study to
study its effect towards the dependent variable, return of equity, of the bank.

20
Impact of Risk Toward the Performance of Bank in Malaysia

2.2.2 Structure-Conduct-Performance (SCP) Paradigm

According to Hannan (1991), the structure-conduct-performance (SCP) paradigm has


been used in many previous researcher’s studies to make prediction on the estimated
relationship between the structure of market, conduct and performance of the bank.
However, there do not have an explicit model that can be apply into the banking sector
and Evanoff and Fortier (1988) also said that there has misspecification on the
relationship with the SCP Paradigm. This is because after the bank carry out the merger
and acquisition will cause overlap or counterproductive on the performances and lead
to the loss on the welfare of economics growth.

SCP Paradigm has a proposed hypothesis that the cost of complicity between the firms
would be lower down with the market concentration and to generate higher profits for
all the participants in the markets. Nonetheless, Weiss (1979) stated that many
researches was found that the market structure and performance measurement have
positive relationship with the application of antitrust policy.

Additional, there have many problems with SCP Paradigm since the changes in
legislation and decisions of the federal bank regulatory changing from time to time and
the effect on the bank’s mergers and acquisitions and many other factors caused
irregularities and paradoxes based on the founding that done by Gilbert (1984) and
Osborne and Wendel (1981).

2.3 Proposed of Theoretical / Conceptual Framework

Figure 2.1: Factors affects Return on Equity

21
Impact of Risk Toward the Performance of Bank in Malaysia

This research’s main objective is to find out how risk management of banks which is
the independent variables, interest rate risk (IRR), credit risk (CR), liquidity risk(LR),
operational risk (OR), capital adequacy ratio (CAR), leverage ratio (LeR) and inflation
rate (IR) will affect the performance of bank which is dependent variables, return on
equity (ROE).

2.4 Conclusion

In Chapter 2, we introduced about the panel data regression model, pooled ordinary
least squares model, fixed effects model and random effects model adopted in this
research. Throughout the literature review, we found that all of our independent
variables (IVs) which include of liquidity risk, credit risk, operational risk, capital
adequacy ratio, inflation rate, interest rate risk and leverage ratio have a significant

22
Impact of Risk Toward the Performance of Bank in Malaysia

effect towards the dependent variables (DV), return on equity of banks. We also
conclude that capital adequacy ratio and leverage ratio have a positive relationship with
return on equity while operational risk, interest rate risk, credit risk and liquidity risk
are negatively related to return on equity. For inflation rate, as there are several studies
support that the inflation can either positively or negatively affected the bank’s
performance, so the expected sign will be either positive or negative.

CHAPTER 3 : METHODOLOGY

3.0 Overview

This chapter intends to convey the methodology of the research that use to conduct the
empirical test based on the data obtained from reliable sources. Many different
hypotheses are form to carry out the empirical test and the results will be analysed and
interpret in the following chapters. This chapter consists of several sections which
include the data collection method, data source, methodology and the conclusion of
this chapter.

3.1 Data Collection Method

This research is mainly study about the impact of risk management towards the
commercial banks performance in Malaysia. The selected banks consist seven well
known banks which are RHB bank, Public bank, Hong Leong bank, May bank, OCBC
bank, HSBC bank and Alliance bank. There are 6 microeconomics and 1
macroeconomics variable selected as independent variables. The microeconomics
variable consists interest rate risk, credit risk, liquidity risk, operational risk, capital
adequacy ratio and leverage ratio, while macroeconomics variable is inflation rate. The

23
Impact of Risk Toward the Performance of Bank in Malaysia

return of equity (ROE) of the bank, in this case, will be the dependent variable in this
study. In order to investigate the significance, effect and relationship between the
dependent variables and independent variables, multiple hypothesis testing will be
carry out in this research.

Secondary data is used in this study and all the data is quantitative data. Secondary data
analysis is analysis of data that done by previous researcher who collect and use the
data for other research purposes. As the data has been collecting and arrange, utilize of
the data would be a suitable choice for researchers that have limited time and resources
to carry out their research.

The sampling period for this study is 10 years, from year 2007 till year 2016. Table 3.1
will show both the sources and the measurement of the data for the variables.

Table 3.1: Sources of Data

VARIABLES SOURCE

Interest rate risk (%) Company’s Annual Reports

Credit risk (%) Company’s Annual Reports

Liquidity risk (%) Company’s Annual Reports

Operational risk (%) Company’s Annual Reports

Capital adequacy ratio (%) Company’s Annual Reports

Leverage ratio (%) Company’s Annual Reports

Inflation rate (%) World Bank Data

Sources: Company’s Annual Report and World Bank (2007 - 2016)

24
Impact of Risk Toward the Performance of Bank in Malaysia

3.2 DATA ANALYSIS

3.2.1 DIAGNOSTIC TEST

In the diagnostic test, we run several tests to ensure the data we use is suitable for the
study and detect any consisting major economic problem which include
multicollinearity problem, heteroskedasticity problem, specification problem, and the
abnormal distribution of error term.

3.2.1.1 Variance Inflation Factor (VIF) For Multicollinearity

Multicollinearity arises from correlation between the explanatory variable or so call


independent variables. When multicollinearity happens, it is hard to explain which
independent variables are truly affecting the dependent variable. As there is no specific
method that is design for detecting multicollinearity, we use one of the rules of thumb
which are through calculating the variance inflation factor (VIF) to detecting the
problem.

The formula of variance inflation factor (VIF) is show below:

VIF(j) = 1/(1 - R(j)^2), where R(j) is the multiple correlation coefficient between
variable j and the other independent variables.

As a rule of thumb, if the value of VIF exceeds 10, the variable will be said to be highly
collinear which lead to multicollinearity.

3.2.1.2 White Test for Heteroskedasticity

25
Impact of Risk Toward the Performance of Bank in Malaysia

Heteroskedasticity refer to the scenario where the error terms of the model are scatter
differently varying depends on the value of independent variables. On the other hand,
if the scatter of the error term remains unchanged regardless the changing of value of
independent variables, the error terms would be considered homoscedasticity. If the
error terms are considering heteroskedasticity, it would cause the estimator of the OLS
method to become inefficient. This is due to the existence of heteroscedasticity would
cause the OLS method to underestimate the variance which consequently lead to
prompting higher value of T statistic and F statistic comparing to the expected value.

In this study, we use white test to detect whether the error terms are homoscedasticity
or heteroscedasticity. The hypothesis testing of white test is show below:

H0: There is no heteroskedasticity problem, the error terms are homoscedasticity.


H1: There is heteroskedasticity problem.

The decision rule for this hypothesis testing is that null hypothesis (H0) will be rejected
if the P-value is lesser than the significance level.

3.2.1.3 Ramsey RESET Test for Specification Error

Specification is a process of transforming a theory into a regression model. However,


there are few circumstances that would cause the specification error from happening.
First type of specification error involves an omitting a relevant independent variable
that would play a big role in affecting dependent variable. On the other hand, the second
type of specification error is including irrelevant independent variables into the
model. The third type of specification error refers to the wrong functional form of
independent variables and dependent variable

26
Impact of Risk Toward the Performance of Bank in Malaysia

In this case, we use Ramsey RESET (Regression Specification Error Test) test to detect
whether there is any existence of specification error in the model.

The hypothesis testing for RESET test is show as below:

H0 : There is no specification error problem


H1 : There is specification error problem

The decision rule for this hypothesis testing is that the null hypothesis will be rejected
if the P value is lesser than the significance level.

3.2.1.4 Normality Distribution

According to the assumptions of CLRM (Classical Linear Regression Model) by


Gauss-Markov theory, the error term has to be normally distributed which refer to
normality distribution in population in order to achieve BLUE (Best, Linear, Unbiased,
Efficient estimator).

In this case, we use normality for residual test produced by Gretl to detect whether the
error terms are normally distributed.

The hypothesis testing for the residual test is show as below:


H0: Error teams are normally distributed
H1: Error teams are not normally distributed

The decision rule for this hypothesis testing is the null hypothesis will be rejecting if
the P- value is less than the significance level.

27
Impact of Risk Toward the Performance of Bank in Malaysia

3.2.2 Likelihood Ratio

Likelihood ratio normally used by the researcher to choose between the Pooled OLS
Model and Fixed Effect Model, from these two model which model will be more
appropriate and more suitable to be used in the empirical analysis. The hypothesis
testing for the Likelihood ratio is show as below:

H0: There is common intercept consists in the seven selected Commercial Bank in
Malaysia.
H1: There is no common intercept consists in the seven selected Commercial Bank in
Malaysia.

In addition, we used the restricted F-test as the test statistic for the hypothesis testing;
the formula is show as below:

F= ( RFEM2 - RPooled OLS2 ) / ( kFEM - kPooled OLS )( 1 - RFEM2 ) / [ n - ( kFEM


+1)]

Decision rule for the hypothesis testing is rejecting the null hypothesis (H0) when the
test statistic is greater than the critical value. Moreover, the other decision rule that can
be used to determine whether to reject the null hypothesis (H0) of the hypothesis testing
is referring to the result generated by using the Gretl as the p-value is less than the
significant level (0.05). Otherwise, the null hypothesis (H0) should not be rejected as
we do not have sufficient evidence to support the decision.

Additionally, the null hypothesis (H0) represented to Pooled OLS Model is more
suitable while the alternative hypothesis (H1) represented to Fixed Effects Model
(FEM) is more preferable to applied in the empirical analysis.

28
Impact of Risk Toward the Performance of Bank in Malaysia

3.3 Regression Model Applied

3.3.1 Panel Data Regression Model

Panel data regressions model also known as the mixture regression model that is usually
used to measure the individual or crossover section units of the economics. The panel
data consists of two different data which is the time series and cross-sectional data. By
using the panel data regression model allow the empirical testing to include a wider
range of hypothesis and larger size of sample data. In the previous researches, the
researchers able to examine the relationship between the return on equity and different
independent variables of the bank over the different period of time with a larger range
of data included. The researchers also can investigate on the transformation in the
cross-sectional units over the different time period.

Moreover, panel data can help us to control for the immeasurable variables of
individual data set that over other individual data but do not different over the time
period. It also can help to differentiate the omitted variable among the large amount of
data and to study the more complexity behavioural models that affect the bank
performances. Generally, the panel data regression model can carry out different
evaluation methods, such as autocorrelation, heteroscedasticity and cross-correlation
over the crossover section units at the same period of time. Fixed effects model (FEM)
and random effect model (REM) are further used in the panel data regression model
and Hausman test will help to choose with model is more appropriate from the both.

3.3.2 Pooled Ordinary Least Squares Model

Pooled ordinary least squares, which also known as POLS model, is one of the basic
estimator for panel data. It can also be called as constant coefficient model. Since

29
Impact of Risk Toward the Performance of Bank in Malaysia

pooled ordinary least squares model is a very common estimator where the result often
will be too basic and not sufficient in making hypothesis, however, it provides a
baseline when making comparison using more complex estimators.

Pooled ordinary least squares are used when there is a combination of cross sectional
data and time series data. There are few requirements that need to be fulfilling when
using this model. First, the characteristics of the data remain the same regardless
country or company. Moreover, there is no time effect on the data that used in the
model. Other than that, the error term is consider normally distributed where all the
independent variables are not relate to the error term where changing values of error
term will not affect the independent variables.

In this study, we use pooled ordinary least squares to study the significance between
the dependent variable, return on equity, and independent variables which include the
credit risk, liquidity risk, operational risk, interest rate risk, capital adequacy ratio,
leverage ratio and inflation risk. In Guru et al. (2002) research, they use POLS model
to study the determinants of commercial bank profitability in Malaysia. POLS model
can also be found in Awojobi et al., (2011) studies where they used this model to study
the relationship between the risk management efficiency and the determinants of bank
performance which include bank specific indicators and business cycles. We also
found POLS model is use in other study like research done by Nasserinia et al. (2017).

3.3.3 Random Effect Model

Random effect model, which can also be call variance components model, is a general
statistical model which usually used by economist but it is seldom used to compare
with fixed effect model. Unlike fixed effect model, random effect model assumes that
changes on the panel data is totally random and has not been fixed. It allows
independent variables to show their individual effects on the dependent variable.

30
Impact of Risk Toward the Performance of Bank in Malaysia

According to Borenstein, Hedges, Higgins and Rothstein (2009), random effect model
tend to study the true effect size on panel data comparing to fixed effect model. When
researchers using random effect model, they believe that the effect size of the
independent variables to be similar but not identical the same. Therefore, the objective
of using the random effect model is not just estimate one true effect, however, to
estimate the mean of a distribution effects. Moreover, the confidence interval of the
random effect model will be much wider comparing to fixed effect model as it includes
the mean of distribution effect.

In general, random effect model is efficient and the result is tending to be reliable if the
assumptions used are satisfied. However, Hausman specification test can be used to
test whether the random effect is unbiased. If the test is rejected, fixed effect will then
be recommended as the correct estimation procedure.

According to Awojobi et al., (2011) study, they choose to use random effect model
comparing to fixed effect model as fixed effect model normally would neglect the
variations in the industry. Moreover, since their data is collected in random sampling
pattern, they have much more preference in using random effect models. Therefore, in
the study, they perform Hausman specification test and in the end the result shows that
random effect model is indeed more preferable.

3.3.4 Fixed Effect Model

According to Bell and Jones (2015), fixed effects model is a method commonly used
both in the panel and time-series-cross-sectional data. It was commonly adopted in the
area of economics and political science (Schurer & Yong, 2012). Most of the time,
fixed effects model is adopted when the explanatory variables include in the model is
in a fixed manner. It was just different with the Random effects model which is adopted
when all or some of its explanatory variables is selected randomly. It was suitable be
used when these three situations were occurred. First of all, it is suitable to be used

31
Impact of Risk Toward the Performance of Bank in Malaysia

when the model including constant slope, different intercept and has time effect.
Second situation is when the model including constant slope, different intercept and
there is no time effect. And lastly, the third situation will be when there is different
slope, different intercept and no time effect.

Additionally, fixed effects model has been adopted by Owoputi et al., to determine the
factors affects banks’ profitability in Nigeria. According to Awojobi et al., (2011),
fixed effects model is more suitable to be used in a model with huge amount of
observations.

3.4 Conclusion

This chapter of methodology is all about explaining the functions, theories of


hypothesis testing and regression model applied that will be further testing in the next
chapter, Chapter 4, which will carry out the data analysis for the research. Therefore,
numerous type of empirical testing will form in order to confirm the reliability of the
empirical results and to be interpreted and analyse in Chapter 4.

Chapter 4 : Data Analysis

4.1 Economic Model

The economic model that used is regressing all the tests in this study is shown as
following:
l_ROEit = β0 + β1ORit + β2IRRit + β3CRit + β4LRit + β5 CARit + β6LeRit + β7 IR_1t + εit
i = 1,2,3,4,5,6,7 types of commercial banks
t = 2007, 2008, 2009… 2016

32
Impact of Risk Toward the Performance of Bank in Malaysia

Where:
l_ROEi = Log nature of Return on equity of a commercial banki
β0 = y-intercept of economic model
ORi = Operational risk of a commercial banki
IRRi = Interest rate risk of a commercial banki
CRi = Credit risk of a commercial banki
LRi = Liquidity risk of a commercial banki
CARi = Capital adequacy ratio of a commercial banki
LeRi = Leverage ratio of a commercial banki
IR_1 = Lagged inflation rate of Malaysia
εi = Error term for a commercial banki
i = 1 refer to RHB Bank
= 2 refer to Maybank
= 3 refer to Public Bank
= 4 refer to OCBC Bank
= 5 refer to Hong Leong Bank
= 6 refer to HSBC Bank
= 7 refer to Alliance Bank
t = Annual data which is started from 2007 to 2016

4.2 Diagnostic Test

4.2.1 Pooled Ordinary Least Squares

Table 4.1 Pooled Ordinary Least Squares produced from Gretl


Model 1: Pooled OLS, using 63 observations
Included 7 cross-sectional units
Time-series length = 9

33
Impact of Risk Toward the Performance of Bank in Malaysia

Dependent variable: l_ROE

Coefficient Std. Error t-ratio p-value

const −1.28972 0.221560 −5.821 <0.0001 ***

OR −0.324738 0.0443349 −7.325 <0.0001 ***

IRR 7.19923 3.45416 2.084 0.0418 **

CR 8.13145 1.28575 6.324 <0.0001 ***

LR −0.326707 0.143224 −2.281 0.0264 **

CAR −1.13658 0.843428 −1.348 0.1833

LeR 0.0543357 0.00934371 5.815 <0.0001 ***

IR_1 −0.0121439 0.00943439 −1.287 0.2034

Mean dependent var −1.049794 S.D. dependent var 0.230561

Sum squared resid 0.596523 S.E. of regression 0.104144

R-squared 0.819006 Adjusted R-squared 0.795970

F(7, 55) 35.55393 P-value(F) 3.32e-18

Log-likelihood 57.38969 Akaike criterion −98.77938

Schwarz criterion −81.63430 Hannan-Quinn −92.03613

rho 0.426402 Durbin-Watson 0.900114

Significant at : * 10 percent, ** 5 percent, *** 1 percent

34
Impact of Risk Toward the Performance of Bank in Malaysia

4.2.1.1 Multicollinearity

Table 4.2 Correlation analysis produced from Gretl


Correlation coefficients, using the observations 1:01 - 7:10
5% critical value (two-tailed) = 0.2352 for n = 70

OR IRR CR LR CAR LeR IR

1.0000 0.2651 0.5584 0.2003 0.0885 -0.2123 -0.3032 OR

1.0000 0.4843 -0.2288 -0.2867 0.5794 -0.0022 IRR

1.0000 0.0265 -0.1319 0.0513 -0.0773 CR

1.0000 0.2653 -0.2688 -0.1395 LR

1.0000 -0.3514 -0.1424 CAR

1.0000 0.0071 LeR

Variance Inflation Factors (VIF)


Minimum possible value = 1.0
Values > 10.0 may indicate a collinearity problem

OR 1.552

IRR 2.116

CR 1.587

LR 1.217

CAR 1.190

LeR 1.884

35
Impact of Risk Toward the Performance of Bank in Malaysia

IR_1 1.106

VIF (j) = 1/ (1 - R (j) ^2), where R (j) is the multiple correlation coefficient between
variable j and the other independent variables

4.2.1.2 Heteroskedasticity

Table 4.3 White Test produced from Gretl


White's test for heteroskedasticity -
Null hypothesis: heteroskedasticity not present
Test statistic: LM = 54.9667
With p-value = P (Chi-square (35) > 54.9667) = 0.017078

H0: No heteroskedasticity problem


H1: Heteroskedasticity problem
α: 0.10
Decision Rule: Reject Ho if p-value is less than α.
P-value: 0.017078
Decision Making: Since the p-value (0.017078) is smaller than α (0.10), so we reject
H0.
Conclusion: We have enough evidence to prove that heteroskedasticity problem happen
in this model at a significant level of 10%.

4.2.1.3 Specification Error

Table 4.4 Ramsey RESET test produced from Gretl


RESET test for specification -
Null hypothesis: specification is adequate

36
Impact of Risk Toward the Performance of Bank in Malaysia

Test statistic: F (2, 53) = 0.481625


With p-value = P (F (2, 53) > 0.481625) = 0.620456

H0: There is no specification error problem


H1: There is specification error problem
α: 0.10
Decision Rule: Reject Ho if p-value is less than α.
P-value: 0.620456
Decision Making: Since the p-value (0.620456) is greater than α (0.10), so we do not
reject H0.
Conclusion: We have enough evidence to prove that there is no specification error
problem in this model at a significant level of 10%.

4.2.1.4 Normality Distribution

Table 4.5 Normality for residual test produced from Gretl


Test for normality of residual -
Null hypothesis: error is normally distributed
Test statistic: Chi-square (2) = 2.42531
With p-value = 0.297407

H0: Error teams are normally distributed


H1: Error teams are not normally distributed
α: 0.10
Decision Rule: Reject Ho if p-value is less than α.
P-value: 0.297407
Decision Making: Since the p-value (0.297407) is greater than α (0.10), so we do not
reject H0.
Conclusion: We have enough evidence to prove that the error terms are normally
distributed in this model at a significant level of 10%.

37
Impact of Risk Toward the Performance of Bank in Malaysia

4.3 Panel Data Regression

4.3.1 Fixed Effect Model (FEM)

Table 4.6 Fixed Effect Model produced from Gretl


Model 3: Fixed-effects, using 63 observations
Included 7 cross-sectional units
Time-series length = 9
Dependent variable: l_ROE
Robust (HAC) standard errors

Coefficient Std. Error t-ratio p-value

Const −2.25347 0.297541 −7.574 0.0003 ***

OR −0.223661 0.0248065 −9.016 0.0001 ***

IRR 9.71072 3.44737 2.817 0.0305 **

CR 5.77992 1.20963 4.778 0.0031 ***

LR 0.308111 0.195288 1.578 0.1657

CAR −1.13219 0.741459 −1.527 0.1776

LeR 0.0777894 0.0145718 5.338 0.0018 ***

IR_1 −0.00464603 0.00178765 −2.599 0.0407 **

Mean dependent var −1.049794 S.D. dependent var 0.230561

38
Impact of Risk Toward the Performance of Bank in Malaysia

Sum squared resid 0.160238 S.E. of regression 0.057185

LSDV R-squared 0.951381 Within R-squared 0.919326

Log-likelihood 98.79511 Akaike criterion −169.5902

Schwarz criterion −139.5863 Hannan-Quinn −157.7896

Rho 0.003206 Durbin-Watson 1.720040

Significant at : * 10 percent, ** 5 percent, *** 1 percent

4.3.2 Likelihood Ratio

Table 4.7 Likelihood Ratio produced from Gretl


Fixed effects estimator allows for differing intercepts by cross-sectional unit -

Residual variance: 0.160238/ (63 - 14) = 0.00327016


Joint significance of differing group means:
F (6, 49) = 22.2357 with p-value 1.92057e-012

H0: Pooled Ordinary Least Squares model is adequate


H1: Pooled Ordinary Least Squares model is not adequate
α: 0.10
Decision Rule: Reject Ho if p-value is less than α.
P-value: 1.92057e-012
Decision Making: Since the p-value (1.92057e-012) is smaller than α (0.10), so we
reject H0.
Conclusion: We have enough evidence to prove that Pooled Ordinary Least Squares
model is not adequate. Therefore, we prefer to use Fixed Effects Model (FEM).

39
Impact of Risk Toward the Performance of Bank in Malaysia

4.3.3 Significant of Independent Variables

Table 4.8 Significant of Independent Variables

Coefficient Std. Error t-ratio p-value

Const −2.25347 0.297541 −7.574 0.0003 ***

OR −0.223661 0.0248065 −9.016 0.0001 ***

IRR 9.71072 3.44737 2.817 0.0305 **

CR 5.77992 1.20963 4.778 0.0031 ***

LR 0.308111 0.195288 1.578 0.1657

CAR −1.13219 0.741459 −1.527 0.1776

LeR 0.0777894 0.0145718 5.338 0.0018 ***

IR_1 −0.00464603 0.00178765 −2.599 0.0407 **

Significant at : * 10 percent, ** 5 percent, *** 1 percent

4.3.3.1 Operational Risk (OR)

H0: β1 = 0
H1: β1 ≠ 0
α: 0.10
Decision Rule: Reject Ho if p-value is less than α.
P-value: 0.0001
Decision Making: Since the p-value (0.0001) is smaller than α (0.10), so we reject H0.
Conclusion: We have enough evidence to prove that there is a significant relationship
between operational risk (OR) and return on equity (ROE) at a significant level of 10%.

40
Impact of Risk Toward the Performance of Bank in Malaysia

4.3.3.2 Interest Rate Risk (IRR)

H0: β2 = 0
H1: β2 ≠ 0
α: 0.10
Decision Rule: Reject Ho if p-value is less than α.
P-value: 0.0305
Decision Making: Since the p-value (0.0305) is smaller than α (0.10), so we reject H0.
Conclusion: We have enough evidence to prove that there is a significant relationship
between interest rate risk (IRR) and return on equity (ROE) at a significant level of
10%.

4.3.3.3 Credit Risk (CR)

H0: β3 = 0
H1: β3 ≠ 0
α: 0.10
Decision Rule: Reject Ho if p-value is less than α.
P-value: 0.0031
Decision Making: Since the p-value (0.0031) is smaller than α (0.10), so we reject H0.
Conclusion: We have enough evidence to prove that there is a significant relationship
between credit risk (CR) and return on equity (ROE) at a significant level of 10%.

4.3.3.4 Liquidity Risk (LR)

H0: β4 = 0
H1: β4 ≠ 0

41
Impact of Risk Toward the Performance of Bank in Malaysia

α: 0.10
Decision Rule: Reject Ho if p-value is less than α.
P-value: 0.1657
Decision Making: Since the p-value (0.1657) is greater than α (0.10), so we do not
reject H0.
Conclusion: We have enough evidence to prove that there is no significant relationship
between liquidity risk (LR) and return on equity (ROE) at a significant level of 10%.

4.3.3.5 Capital Adequacy Ratio (CAR)

H0: β5 = 0
H1: β5 ≠ 0
α: 0.10
Decision Rule: Reject Ho if p-value is less than α.
P-value: 0.1776
Decision Making: Since the p-value (0.1776) is greater than α (0.10), so we do not
reject H0.
Conclusion: We have enough evidence to prove that there is no significant relationship
between capital adequacy ratio (CAR) and return on equity (ROE) at a significant level
of 10%.

4.3.3.6 Leverage Ratio (LeR)

H0: β6 = 0
H1: β6 ≠ 0
α: 0.10
Decision Rule: Reject H0 if p-value is less than α.
P-value: 0.0018
Decision Making: Since the p-value (0.0018) is smaller than α (0.10), so we reject H0.

42
Impact of Risk Toward the Performance of Bank in Malaysia

Conclusion: We have enough evidence to prove that there is a significant relationship


between leverage ratio (LeR) and return on equity (ROE) at a significant level of 10%.

4.3.3.7 Lagged Inflation Rate (IR_1)

H0: β7 = 0
H1: β7 ≠ 0
α: 0.10
Decision Rule: Reject Ho if p-value is less than α.
P-value: 0.0407
Decision Making: Since the p-value (0.0407) is smaller than α (0.10), so we reject H0.
Conclusion: We have enough evidence to prove that there is a significant relationship
between lagged inflation rate (IR_1) and return on equity (ROE) at a significant level
of 10%.

4.3.4 Discussion on Parameter

β1 (OR) = −0.223661
When operational risk (OR) increases by 1%, on average, the return on equity of the
bank will decreases by 0.223661%, holding other variables constant.

β2 (IRR) = 9.71072
When interest rate risk (IRR) increases by 1%, on average, the return on equity of the
bank will increases by 9.71072%, holding other variables constant.

β3 (CR) = 5.77992
When credit risk (CR) increases by 1%, on average, the return on equity of the bank
will increases by 5.77992%, holding other variables constant.

43
Impact of Risk Toward the Performance of Bank in Malaysia

β6 (LeR) = 0.0777894
When leverage ratio (LeR) increases by 1%, on average, the return on equity of the
bank will increases by 0.0777894%, holding other variables constant.

β7 (IR_1) = −0.00464603
When inflation rate (IR) increases by 1%, on average, the return on equity of the bank
will decreases by 0.00464603%, holding other variables constant.

4.3.5 Consistency with Theory and Estimation.

Table 4.9 Expected Signs of the Independent Variables.

Variable Coefficient Sign Consistent With


Operational Risk β1 Negative Hussain et al. (2016) and et al
(OR)
Interest Rate Risk β2 Negative Tafri et al. (2009) and et al
(IRR)
Credit Risk (CR) β3 Positive Saeed and Zahid (2016)
or Duca et al. (1990)
Negative and et al
Liquidity Risk (LR) β4 Negative Guru et al. (2002) and et al
Capital Adequacy β5 Positive Berger (1995) and Keeley (1990)
Ratio (CAR) or
Negative Almazari (2013) and Almazari and
Alamri (2017)
Leverage Ratio β6 Positive Pagratis et al. (2014) and et al
(LeR)
Lagged Inflation β7 Positive Capraru and Ihnatov, (2014) and et al
Rate (IR_1)

44
Impact of Risk Toward the Performance of Bank in Malaysia

or Yong Tan and Christos Floros (2012)


Negative and Wamucii (2010)

Table 4.10 Actual Signs of the Independent Variables


Variable Coefficient Sign
Operational Risk (OR) -0.127677 Negative
Interest Rate Risk (IRR) 3.64956 Positive
Credit Risk (CR) 2.63313 Positive
Liquidity Risk (LR) -0.121739 Negative
Capital Adequacy Ratio (CAR) -0.534548 Negative
Leverage Ratio (LeR) 0.0169530 Positive
Lagged Inflation Rate (IR_1) -0.00521550 Negative

Table 4.9 shows the expected signs of independent variables which we estimate the
signs based on the theories in literature review. Table 4.10 shows the actual signs of
the independent variables that obtain from the result of our best model which is FEM.

4.4 Conclusion

From the part 4.2 showed that, we have use many tests to ensure our data is not faced
any major economic problem such as heteroskedasticity, multicollinearity,
specification error and normality distribution. When testing our data, we found that
heteroskedasticity problem is happen in our data and in order to solve this problem we
decide to use robust (HAC) standard errors. Since using panel data, so we are using
cluster-robust standard error which is introduced by Arellano (1987) to fixed effect
estimator. The purpose to use this estimator is to solve the autocorrelation problem and
heteroskedasticity problem in the error term of the model.

Throughout the empirical results from all the tests above, it shows that except the
liquidity risk and capital adequacy ratio, these two independent variables in this study
45
Impact of Risk Toward the Performance of Bank in Malaysia

are not significant. On the other hand, the other five independent variables (operational
risk, interest rate risk, credit risk, leverage ratio and lagged inflation rate) are
significantly affecting the dependent variable (return on equity). Furthermore, the
interest rate risk, credit risk, and leverage ratio have a positive relationship with return
on equity which shown by the result above, while the operational risk, liquidity risk,
capital adequacy ratio and lagged inflation rate are negatively affected banks’ return on
equity.

CHAPTER 5 : DISCUSSION, CONCLUSION AND


POLICY IMPLICATION

5.0 Overview

In this chapter will conclude and discuss about the major findings from the researches
we have done and also summarize down the previous chapters. Furthermore, in this
chapter included the summary of statistical analysis, policy implication, limitation of
study and some suggestion is given for the future research in the recommendation.

5.1 Summary of Statistical Analysis

Table 5.1 Summary of Gretl Result

Variable Expected Sign Actual Sign Result

OR Negative Negative Significant***

IRR Negative Positive Significant**

46
Impact of Risk Toward the Performance of Bank in Malaysia

CR Positive / Negative Positive Significant**

LR Negative Negative Insignificant

CAR Positive / Negative Negative Insignificant

LeR Positive Positive Significant***

IR_1 Positive / Negative Negative Significant**

Significant at : * 10 percent, ** 5 percent, *** 1 percent

Since the risk management will bring the huge effect to the performance of the bank,
the relationship between the risk and bank performance is very important for the bank
to take an early action in order to improve their profitability and avoid all uncertainty.

The general objective for conducting this research is to find out how the bank risk
management influence the profitability of bank in Malaysia from year 2007 to year
2016. The determinants that used for risk management include microeconomic factors,
such as operational risk, interest rate risk, credit risk, liquidity risk, capital adequacy
ratio, leverage ratio, and macroeconomic factor, such as lagged inflation rate. Based on
the result from Gretl, we can find out the relationship, whether positive or negative
between the variable and bank performance.

According to Chapter 4 above, we found that operational risk has a significantly and
negatively relationship with the return on equity of the bank. This result is proved by
Olawale Femi et al. (2014) who state that the bank profitability will be decreased when
the operational risk increase. The bank has effective operational risk management able
to control their operational expenses more effective and this will lead to increase in
bank’s profitability.

Besides that, we found there is a positive relationship between interest rate risk and
performance of the bank at 10% significance level. This result is different from the
result in literature review. The reason why the results is different from what we
47
Impact of Risk Toward the Performance of Bank in Malaysia

expected is because the formula that we using is different from other researchers such
as Tafri et al. (2009) and Albertazzi et al. (2009). As our formula for interest rate risk
is using interest income divided by the total loan, the classic earning assets for the bank
include all type of personal and commercial loans. This formula is known as yield on
earning assets and it consistent with the study conducted by Ghebregiorgis and
Atewebrhan (2016). Usually the higher yield on earning assets for bank is affected by
higher loan to asset ratio and the reason for high yield on earning assets is because bank
use their loans to generated large amount of dividend. This is a good sign for the bank
since they confirming that their loans are properly priced. Therefore, positive
relationship between the interest rate risk and the profitability of bank is form.

Based on the result we obtained from Chapter 4, it shows that credit risk and
profitability of banks has positive relationship. The result is different from the expected
result. According to Saeed and Zahid (2016) studies, it shows that although credit risk
may cause bank failure, some of the commercial banks still disperse high credit risk
loan to customer as bank could enjoy benefit from higher interest rate charges, fees and
commission which ultimately improve the bank’s profitability.

Based on the result of our research, a negative relationship had been found between the
liquidity risk and the performance of the bank but it is insignificant relationship. This
result is similar with the study which conducted by Hussain et al. (2016) state that the
low rates of return will be given due to high liquidity assets which mean the bank will
make less profit. However, according to the result of our research, liquidity risk will
not significantly affect the bank’s performance. One of the possible reason for this
result is that the liquid assets is not the main income sources for the bank.

Moreover, the capital adequacy ratio has a negative relationship with the return on
equity of the bank in Malaysia and this is the result for our research. The actual sign of
the variable is dissimilar with the expected sign stated in Chapter 4. Based on the study
conducted by Almazari (2013) and Almazari and Alamri (2017), the negative
relationship between capital adequacy and profitability has been proved. The

48
Impact of Risk Toward the Performance of Bank in Malaysia

requirement of capital adequacy ratio will limit the risk of investment that bank willing
to take in order to influence the ability of the bank to reach the target level of
profitability. Therefore, the core function of the capital adequacy is to improve the
profit of bank and lower the expected cost for financial distress (Almazari, 2013).

Leverage ratio is significant to the performance of the bank and it is consistent with our
research hypothesis. The actual sign of the variable is same with the expected sign
which has positive relationship between leverage ratio and return on equity of bank.

Furthermore, the result from our research show that there is a significant and negative
relationship between inflation rate and the bank’s performance. The study of Wamucii
(2010) conducted in Kenya can prove that inflation rate has a negative relationship with
the profit of the bank. Therefore, increase in inflation rate will lead to the decrease of
the market productivity and decrease of financial intermediaries’ investment and this
will cause the bank profitability decrease and affect the economic activity.

5.2 Policy Implication of Study

The purpose of this study is to investigate the impact of risks toward the seven selected
commercial banks that only operating in Malaysia, which is RHB Bank, Maybank,
Public Bank, OCBC Bank, Hong Leong Bank, HSBC Bank and Alliance Bank. The
branch of these bank that operating other than in Malaysia do not included in this
research. Regarding to the results of this research, it had shown that there are only five
independent variables chosen are significantly affect these banks performance. From
this research, the result that computed hopefully that it can providing some valuable
information to support users such as policy makers, central bank, company managers,
and academicians, in order for them to have a better understanding to the impacts of
risk toward the banks’ performance. As the effort that contributed to this research

49
Impact of Risk Toward the Performance of Bank in Malaysia

hoped it able to provide a bit support to the users and to have better idea on developing
appropriate policy implications.

If these independent variables are not being manage well, could potentially cause the
bank’s performance toward under-perform. The banks can apply the workflow
automation as it able to creating new workflows, providing alternative rules and
monitoring the new business operating process by keeping new information up to date
to minimize the operational risk that could be occur in the progress compared to
manually it can be more efficiency and save cost.

Other than that, firms should be focusing more on their organization structure policy
rather than look toward the monetary tool created by the government to against the
long-term unseen challenge as the bank can reflect more quickly to the changes of
interest rate. Moreover, the bank should fully contribute in utilizing the credit
derivatives as it can help to explore to a wider range of the combination of risk and
return and the mixed underlying risk in order to improve the liquidity of capital market.

Government can be more strictly on regulating of the Basel II requirement to decrease


the inequality competition advantage among the large banks over small banks as to
limit the percentage of leverage ratio for the large banks to be tighter which only can
increase their assets that Government permitted. Lastly, the inflation rate can be
improved or appropriate as the increases the interest rate to increases the borrowing
costs in the monetary policy making and to order to slow down the spending.
Government itself also should be more anticipate by lowering the government spending
and impose higher income tax to citizen in their fiscal policy.

5.3 Limitation of Study

50
Impact of Risk Toward the Performance of Bank in Malaysia

We have been trying to complete this study in the past few months, however, during
the progress, we did confront with some obstacles and uncontrollable factor that limit
this study.

The first limitation in this study is the scarce of data. We use two main data source
which are world bank and the annual report from respective commercial bank. In this
study, we using only data from 2007 till 2016 because most of the data before year
2007 is incomplete. We are unable to obtain annual report earlier than year 2007 from
some of the banks as the banks only providing their record of annual report starting
from year 2007. Therefore, this had limit us from increasing the length of the timeframe
and taking more data into this study.

Other than that, due to the unavailability of data, there is only numbers of commercial
banks that are selected in our study. This is due to some of the banks could not provide
complete record of their annual report during year 2007 till 2016 as there will be some
missing annual report from time to time. Therefore, we might omit some of the
commercial banks which would cause the generalizability of the study to be limited.

The next limitation is that most of the study done by previous researchers regarding
this topic usually focus on western country and middle east country which include
Nigeria and Pakistan. There is only limited research that focus on Asian country which
make us hard to find more information and example regarding banking industry in
Southeast Asia region.

5.4 Recommendation

From the analysis above, there are some recommendation for the researchers who
interested in further study in this topic. Firstly, researchers can include more variables
that might not include in this study. This would improve the effectiveness and accuracy

51
Impact of Risk Toward the Performance of Bank in Malaysia

of the research as by adding more variables, the result would be more convincing as
more info would be shown.

Next, future researchers can include more banks which not only commercial, but also
Islamic bank since Islamic bank is one of the major player in the banking industry
especially in middle east country. Therefore, future researchers can study how risk
management would affect the profitability of Islamic bank and how Islamic bank
organize their risk management.

Other than that, future researchers are recommend to expand their research into foreign
countries. For example, expand their study from Asian country to western country such
as Europe. This is because Europe consists many developed countries while a lot of
Asian are still developing countries. Hence, the researchers could get different result
on studying more developed countries.

5.5 Conclusion

In this chapter 5, the interpretation for all the research result had been included follow
with the suggestion of policy implementation. Besides that, the limitations for this
research also been listed out at part 5.3. Last but not least, at the recommendation part,
we had also provided some suggestion for the researchers who willing to carry this
research to a deeper level.

52
Impact of Risk Toward the Performance of Bank in Malaysia

References

Adeusi, S. O., Akeke, N. I., Adebisi, O. S., & Oladunjoye, O. (2014). Risk management
and financial performance of banks in Nigeria. European Journal of Business and
Management, 6(31).

Albertazzi, U., & Gambacorta, L. (2009). Bank profitability and the business cycle.
Journal of Financial Stability, 5, 393-409.

Almazari, A. A. (2013). Capital Adequacy, Cost Income Ratio and the Performance of
Saudi Banks. International Journal of Academic Research in Accounting, Finance and
Management Sciences, 3(4), 284-293.

Almazari, A. A., & Alamri, A. M. (2017). The Effect of Capital Adequacy on


Profitability: A Comparative Study Between Samba and Saab Banks of Saudi Arabia.
International Journal of Economics, Commerce and Management, 5(11), 86-102

Alshatti, A. S. (2015). The effect of credit risk management on financial performance


of the Jordanian commercial banks. Investment Management and Financial
Innovations, 12(1), 338-345.

Anbar, A., & Alper, D. (2011). Bank specific and macroeconomic determinants of
commercial bank profitability: Empirical evidence from Turkey.

Ang, J.C., Chua, J.H. and McConnell, J.J. (1982). The Administrative Costs of
Corporate Bankruptcy: A Note. Journal of Finance, 37(1), 219-226.

Arellano, M. (1987). PRACTITIONERS’CORNER: Computing Robust Standard


Errors for Within-groups Estimators. Oxford bulletin of Economics and Statistics,
49(4), 431-434

53
Impact of Risk Toward the Performance of Bank in Malaysia

Arif, A., & Nauman Anees, A. (2012). Liquidity risk and performance of banking
system. Journal of Financial Regulation and Compliance, 20(2), 182-195.

Ariff, M., & Abubakar, S. Y. (1999). The Malaysian financial crisis: Economic impact
and recovery prospects. The Developing Economies, 37(4), 417-438.

Athanasoglou, P. P., Brissimis, S. N., & Delis, M. D. (2008). Bank-specific, industry-


specific and macroeconomic determinants of bank profitability. Journal of
international financial Markets, Institutions and Money, 18(2), 121-136.

Awojobi, O., Amel, R., & Norouzi, S. (2011). Analysing risk management in banks:
Evidence of bank efficiency and macroeconomic impact.

Baldwin, C. Y., & Mason, S. P. (1983). The resolution of claims in financial distress
the case of Massey Ferguson. The Journal of Finance, 38(2), 505-516.

Bell, A., & Jones, K. (2015). Explaining fixed effects: Random effects modelling of
time-series cross-sectional and panel data. Political Science Research and Methods,
3(1), 133-153.

Berger, Allen N. (1995). The Relationship between Capital and Earnings in Banking.
Journal of Money, Credit and Banking, 27(2), 432-456.

Borenstein, M., Hedges, L. V., Higgins, J., & Rothstein, H. R. (2009). A basic
introduction to fixed‐effect and random‐effects models for meta‐analysis. Research
synthesis methods, 1(2), 97-111.

Chen, S. C. (2013). How do leverage ratios affect bank share performance during the
financial crises: The Japanese experience of the late 1990s. Journal of The Japanese
and International Economies, 30, 1-18.

54
Impact of Risk Toward the Performance of Bank in Malaysia

Cooper, M. J., Jackson III, W. E., & Patterson, G. A. (2003). Evidence of predictability
in the cross-section of bank stock returns. Journal of Banking & Finance, 27(5), 817-
850

Evanoff, D.D., & Fortier, D. L. (1988). Reevaluation of the Structure-Conduct-


Performance Paradigm in Banking. Journal of Financial Services Research, 1, 277-
294.

Ghebregioris, F., & Atewebrhan, A. (2016). Measurement of Bank Profitability, Risk


and Efficiency: The Case of the Commercial Bank of Eritrea and Housing and
Commerce Bank of Eritrea. African Journal of Business Management, 10(22), 554-
562.

Gilbert, R. A. (1984). Bank Market Structure and Competition. Journal of Money,


Credit and Banking, 16(4), 617-645.

Greuning, H.V. & Bratanovic, S. B. (2009). Analyzing Banking Risk: A Framework


for Assessing Corporate Governance and Risk Management. 3rd Edition. The World
Bank. Washington, USA.

Gizaw, Million., Matewos, Kebede and Selvaraj, Sujata. (2015). The impact of credit
risk on profitability performance of commercial banks in Ethiopia. African Journal of
Business Management, 9(2), 59-66.

Guru, B. K., Staunton, J., & Balashanmugam, B. (2002). Determinants of commercial


bank profitability in Malaysia. Journal of Money, Credit, and Banking, 17(1), 69-82

Habib, S., Masood, H., Hassan, S.T., Mubin, M. & Baig, U. (2014). Operational risk
management in corporate and banking sector of Pakistan. Information and Knowledge
Management, 4(5), 58-66.

55
Impact of Risk Toward the Performance of Bank in Malaysia

Hancock, D. (1985). Bank profitability, interest rates, and monetary policy. Journal of
Money, Credit and Banking, 17(2), 189-202.

Hannan, T.H. (1991). Foundation of the Structure-Conduct-Performance Paradigm in


Banking. Journal of Money, Credit and Banking, 23(1), 68-84.

Harelimana, J. B. (2017). The Role of Risk Management on Financial Performance of


Banking Institutions in Rwanda. Global Journal of Management and Business
Research.

Hussain, A., Ihsan, A., & Hussain, J. (2016). Risk Management and Bank Performance
in Pakistan. NUML International Journal of Business & Management, 11(2), 68-80.

Jha, S., & Hui, X. (2012). A comparison of financial performance of commercial banks:
A case study of Nepal. African Journal of Business Management, 6(25), 7601-7611.

Kanas, A., Vasiliou, D., & Eriotis, N. (2012). Revisiting bank profitability: A
semiparametric approach. Journal of International Financial Markets, Institutional &
Money, 22(4), 990-1005.

Keeley, Michael C. (1990). Deposit Insurance, Risk, and Market Power in Banking.
American Economic Review, 80, 1183-1200.

Khan, W. A., & Sattar, A. (2014). Impact of interest rate changes on the profitability
of four major commercial banks in Pakistan. International Journal of Accounting and
Financial Reporting, 4(1), 142.

Khan, W. A., Shahid, M., Bari, R., Anam, W., Shehzad, N., & Siddique, S. (2014).
Impacts of Inflationary Trends on Banks' Performance (Large Banks Segment) in
Pakistan. International Journal of Accounting and Financial Reporting, 4(1), 296.

56
Impact of Risk Toward the Performance of Bank in Malaysia

Laker, J. (2007). The evolution of risk and risk management–a prudential regulator’s
perspective. THE STRUCTURE AND RESILIENCE OF THE FINANCIAL SYSTEM,
300.

Miller, K. D. (1992). A framework for integrated risk management in international


business. Journal of international business studies, 23(2), 311-331.

Miller, S. & Noulas, A. (1997). Portfolio mix and large-bank profitability in the USA.
Applied Economics 29(4), 505-512.

Molyneux, P., & Thornton, J. (1992). Determinants of European Bank Profitability: A


Note. Journal of Banking and Finance, 16(6), 1173-1178.

Nasserinia, A., Ariff, M., & Fan-Fah, C. (2017). Relationship between Participation
Bank Performance and Its Determinants. Pertanika Journal of Social Sciences &
Humanities, 25(2).

Nissim, D. & Penman, S. H. (2003). Financial Statement Analysis of Leverage and


How It Informs About Profitability and Price-to-Book Ratios. Review of Accounting
Studies, 8, 531–560.

Osborne, D. K., & Wendel, J. (1981). A Note on Concentration and Checking Account
Prices. The Journal of Finance, 36(1), 181-186.

Owojori, A. A., Akintoye, I. R., & Adidu, F. A. (2011). The challenge of risk
management in Nigerian banks in the post consolidation era. Journal of Accounting
and Taxation, 3(2), 23-31.

57
Impact of Risk Toward the Performance of Bank in Malaysia

Owoputi, J. A., Kayode, O. F., & Adeyefa, F. A. (2014). Bank specific, industry
specific and macroeconomic determinants of bank profitability in Nigeria. European
Scientific Journal, 10(25).

Pagratis, S., Karakatsani, E. & Louri, H. (2014). Bank Leverage and Return on Equity
Targeting: Intrinsic Procyclicality of Short-Term Choices. Bank of Greece, Working
Paper 189.

Saleem, S., & Abideen, Z. U. (2011). Do effective risk management affect


organizational performance? European Journal of Business and Management, 3(3),
258-268.

Saunders, A., & Cornett, M.M. (2003). Financial Institutions Management: A Risk
Management Approach. (4th edn). New York: McGraw-Hill/Irwin.

Saeed, M. S., & Zahid, N. (2016). The impact of credit risk on profitability of the
commercial banks. Journal of Business & Financial Affairs, (5), 192.

Schurer, S., & Yong, J. (2012). Personality, well-being and the marginal utility of
income: What can we learn from random coefficient models?

Tafri, F. H., Hamid, Z., Meera, A. K. M., & Omar, M. A. (2009). The impact of
financial risks on profitability of Malaysian commercial banks: 1996-2005. Strategies,
232, 2111.

Tan, Y. (2015). The impacts of risk and competition on bank profitability in China.
Journal of International Financial Markets, Institutions and Money, 40, 85-110

Tan, Y., & Floros, C. (2012). Bank profitability and inflation: the case of China.
Journal of Economic Studies, 39(6), 675-696

58
Impact of Risk Toward the Performance of Bank in Malaysia

Tan, Y., Floros, C., & Anchor, J. (2016). The profitability of Chinese banks: impacts
of risk, competition and efficiency. Review of Accounting and Finance, 16(1), 86-105.

Wamucii, J. C. (2010). The Relationship Between Inflation and Financial Performance


of Commercial Banks in Kenya.

Weiss, L.W. (1979). The Structure-Conduct-Performance Paradigm and Antitrust.


University of Pennsylvania Law Review, 127(4), 1104-1140.

59

You might also like