New perspectives on bank risk in Malaysia

Abstract

Stable banks in individual ASEAN countries are essential to the economic stability of the ASEAN region as these countries move towards the goal of greater financial integration in the region. This study comprehensively explores bank risk in Malaysia as compared to the ASEAN region over an 18-year period which includes the Asian and Global Financial Crises. Metrics used include non-performing loans (NPLs), conditional distance to default (CDD which focuses on tail risk of asset volatility and is the authors own measure of bank default based on an extension to the Merton distance to default (DD) model) and a tail risk (TR) measure being the difference between DD and CDD asset volatility. DD is usually applied to corporate customers of banks but has been applied in the literature to banks themselves, which is the approach used for CDD in this study. Multiple regression analysis is undertaken to assess the impact of CDD on returns. The regression and default results are compared between small and large banks. Malaysian banks were found to have consistently lower risk than the ASEAN region, with smaller Malaysian banks exhibiting greater risk than larger banks during non-crisis periods, but to a lesser degree during crisis periods.

Keywords:

• Malaysian banks
• ASEAN
• conditional distance to default
• non-performing loans

Subject classifications:

• G1
• G2

Public Interest Statement

The ASEAN economic community is moving towards an ASEAN Banking Integration framework. This could provide benefits to the banking industry in the form of increased market opportunities, economies of scale, cost reduction and improved banking services. In such an integrated environment, it is important to understand the risks of the countries involved. This article focuses on the bank risk of one of the major countries in the region, Malaysia, in comparison to the ASEAN region over a period which includes the Asian and global financial crises. Metrics used are NPLs and the author’s own metrics CDD and TR which measure extreme fluctuations in market asset values. Substantial improvements in default risk are shown by Malaysian banks over the period and market asset value volatility is consistently lower than the ASEAN region. Smaller banks in Malaysia are found to have higher risks than larger banks in non-crisis periods but this difference narrows in crisis periods.

Acknowledgements

The author thanks the editor and two anonymous referees for their very helpful comments in improving the paper.

Additional information

Notes on contributors

R.J. Powell

R.J. Powell is an associate professor in Finance at Edith Cowan University. He has a PhD and lectures and researches in banking and finance. He is a director of the Markets and Services Research Centre, a cross-disciplinary centre researching in services industries, marketing, tourism and finance. This paper on Malaysia forms part of a series of projects of extreme risk in equity, commodity and credit markets, with a recent focus on the ASEAN region. He has 20 years banking experience in South Africa, New Zealand and Australia. He has been involved in the development and implementation of several credit and financial analysis models in banks.