Non-performing loans sensitivity to macro variables: panel evidence from Malaysian commercial banks

Credit risk is one of the most important kinds of risk in banking sector. The relationship between business cycle and banks’ loan losses was one of the hot debates in recent economic literature especially with respect to financial stability analysis. The quality of loans can be one of the factors that limit the banks' loan supply and affect on investment spending. Although banks have a significant role in transmission of monetary policy; in the meantime their performance is strongly influenced by monetary and fiscal policies that are effective in recession and prosperity and thereby affect bank performance; in other words, macroeconomic variables can effect in/directly on banks loans quality and their transitional role. Thus policy makers and bankers are always concerned with the financial stability and are always looking for tools to better manage banks’ credit risk. One of the risk indicators that are used in literature of banks’ credit risk is Non-Performing Loans (NPL). Hence themain objective of thisstudy is to analyze relationship between banks loans quality and macroeconomic variables by using a dynamic panel data model on Malaysian commercial banking system for the 1997-2012 periods. The results show that there is a strong evidence of cyclical sensitivity of loan quality in Malaysia’s commercial banking system. Based on the results lending interest rate and FDI-net outflow (% GDP) are the most effective factors on NPL ratio with simultaneous positive effects and a reverse effect with one-year delay. It can be said that the impact of external shocks on the domestic banking system is more than internal shocks. The result of this study can be helpful to bank supervisory and economists to adjust banking system stability and economic policies

Macroeconomics shocks and stability in Malaysian banking system; a structural VAR model

Negative effects of 1997 financial crisis in Malaysia, such as other emerging countries, led to the development and restructuring of financial system in this country. Hence many big firms and corporations to provide their required funds shift towards newly established markets like stock and bond markets. Under these conditions, many banks maintained their profitability by attracting new customers especially Small and Medium size Entrepreneurs (SMEs) and increased their loans and credits to the household sector. Now a significant share of loans has been given to the household sector and SMEs and this feature caused the banking system to become more vulnerable against external and internal shock. So, increasing unemployment and reducing income for any reason will be a threat for banks by Default risk. Thus, anticipated effects of macro-economic shocks on banks’ operation are more important to policy makers and bankers. Hence in this study, a Structural Vector Autoregressive (SVAR) model is employed to show how a macroeconomic shock effects on Non-Performing Loan changes (NLP) as a credit risk indictor in Malaysian commercial banking system for period of 1997-2012. The designed Model is called AB model that is limited based on IS-LM theory. According to results the demand and supply shock have negative and monetary shock has positive effects on NPL ratio. Mean while simultaneous effects of monetary and demand shocks are more than supply shocks effects but the supply shocks’ impact is more persistent. Comparison response of NPL ratio with capital ratio shows that the commercial banks against domestic shocks are safe and adequate capital to deal with the risks arising from internal shocks in the economy are considered. The results of this study can help policy makers to pursue suitable monetary policies and decrease banks failing in front of any macroeconomic shocks

Capital adequacy, default risk and macroeconomic shocks in commercial banks in East Asian emerging countries

Evidence from bank failures due to different types of crises over the past decade has led to banks' capital metrics process to be challenging. One of the most challenging processes is to measure default risk and optimum capital. Market asset value is used to measure default risk and optimum capital to test the health of the banking system. The effect of economic shocks on banks’ default risk is the other issue related to the health of banks, which has been strongly considered in developed countries. In the literature related to these topics, there is a gap in East Asian emerging countries. In this study, the probability of default is primarily estimated based on market information with a Merton’s Option Pricing Model for commercial banks in five emerging countries (Malaysia, Singapore, Korea, Thailand, and Indonesia) for the period of 1995-2013. The estimated default risk varies according to economic conditions and increases noticeably in the disaster time. It also consists of asset qualities such as non-performing loans. The default risk in Indonesia and Korea are always more than the other countries while Singapore has the lowest risk. To meet the second objective, a Global Vector Auto Regressive (GVAR) Model has been used to measure the effects of macroeconomic internal and external shocks on domestic macroeconomic risk factors. The shocks up to 3 standard deviations of variables have been imposed to GVAR Model. Bootstrap median estimation of generalized impulse response functions show that weak exogenous foreign countryspecific variables have significant effects on their domestic corresponding variable. Meanwhile the equity price, real GDP, and real exchange rate are the main transmission channel of shocks’ effects on the domestic macro risk factors. Finally, this study estimates the relationship between the probability of default and macroeconomic risk factors using a dynamic panel data model with a Least Square Dummy Variable Bias Correction (LSDVBC) estimator. The empirical outcome shows that the default risk is explained with different combinations of variables in each country. Meanwhile the equity piece, real exchange rate, real output, and oil price are the most effective variables on the probability of default. The bank size and asset return ratio is the other effectual bank-specific variables on default risk. Based on the impulse response functions, the default risk has been affected by macroeconomic shocks in Malaysian banks more than the other countries. The banks in Indonesian, Korea, Thailand, and Singapore have less been influenced respectively. The banks’ capital conditions is different in these countries and the impact of shocks on the probability of default definitely depends on the initial conditions in terms of capital and market value of their assets as well as their equity volatility, bank size, and asset return ratio. Banks in Singapore have the best condition as the suggested adequate capital ratio is 18.5 percent, which requires a 14 percent increase in capital. In Indonesia, the banks’ capital is not in well status and the capital ratio has to be 24.2 percent due to 51.4 percent increasing in the capital. Korea, Malaysia, and Thailand have relatively been in better and somewhat similar conditions. Hence, they need to improve their adequate capital ratio to 20.6, 20.1, and 21.2 percent while the required capital increase equals 34, 37 and 39.7 percent in average respectively. Therefore following the macroprudential policy and forward-looking approach, it is suggested that the banks' capital to be strengthened before a sudden shock leads to a financial crisis