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FACTORS AFFECTING THE PERFORMANCE OF FINANCIAL SECTOR IN MALAYSIA
Bong Lie Lin
BG 173 B713 Corporate Master in Business Administration 2012 2012
Pu J ~ 4
UNJVERSJll - en ~ MALAy LA SARAWAK
PKHIOMAT MAKLUMAT AKAOEMIK
11111 nllfli~rlllllllill 1000246523
FACTORS AFFECTING THE PERFORMANCE OF FINANCIAL SECTOR IN MALAYSIA
BONG LIE LIN
A dissertation submitted in partial fulfillment of the requirements for the degree of Corporate Master in Business Administration
Faculty of Economics and Business UNIVERSITI MALAYSIA SARA W AK
2012
I
ABSTRACT
0his paper is to analyze and detennine the factors that affecting the financial sector
perfonnance in Malaysia for the period of five years from year 2006 to 2011 From
the study the result shows that the perfonnance of Malaysian financial sector is
stable and quite profitable because of systematic Malaysian financial systems
regulations and the strong financial capital However the global financial crisis
occurred during year 2008 to 2009 was affected the financial sector globally and
affected the financial institutions service qualit~ The study will use the financial
ratios and apply the CAMEL Model namely Capital adequacy Asset quality
Management Earnings and Liquidity to detennine the factors affecting the financial
sector perfonnance So in order to identify the detenninants of perfonnance of
Malaysian financial sector during 2006 to 2011 this study has chosen mUltiple
regression analysis Besides that the dependent variables are consisting profitability
ratio which Return on Assets (ROA) and Return on Equity (ROE) then independent
variables are the CAMEL Methods So from the study the results also shows that the
ROA and ROE are depends on the CAMEL Lastly there are a significant
relationship between the dependent variables and the independent variables
ACKNOWLEDGEMENT
My highest and more sincere appreciation goes to my beloved parents and my
families who have always encouraged and guided me to be independent never try to
limit my aspirations
I would like to express my great appreciation to my supervisor Dr Chu Ei Yet for his
understanding attention kindness and encouragement His supervision idea
guidance and critics of the research paper have been an enormous help Words alone
Icannot be expressed my greatest appreciation and thanks to him
I would like to express my high appreciation to my all lectures of Faculty Economics
and Business especially lecturers of Finance Thanks again to everyone including
those who I have probably forgotten to mention here
I
ii
Pusat Khidmat MakJumat Akademik UNlVERSm MALAYSIA SARAWAK
TABLE OF CONTENT
ABSTRACT i
AKNOWLEDGEMENT ii
TABLE OF CONTENT iii
LIST OF FIGURES v
LIST OF TABLES v
LIST OF ABBREVIATIONS vi
1 INTRODUCTION
11 Background 1
111 Malaysian Gross Domestic Product (GDP) 4
112 Malaysian Financial System Challenges in Malaysian Financial
Sector 6
113 Challenges in Malaysian Financial Sector 9
12 Problem Statement 10
13 Theoretical Framework 12
131 Agency Theory 12
132 Characteristics ofAgency Problems in Financial Institutions 13
14 Conceptual Framework 15
15 Scope of the Study 16
16 Research Objectives 17
161 General Objective 17
162 Specific Objectives 18
17 Significance of the Study 18
18 Organization of the Study 19
19 Conclusion 20
2 LITERATURE REVIEW
21 Introduction 21
22 Literature review on CAMEL Approach 22
23 Financial Institutions Rating in Malaysia 24
231 Capital Adequacy 24
232 Asset Quality 26
233 Management 29
iii
234 Earnings 30
235 Liquidity 31
24 Empirical Literature Determinants of Financial Institutions
Profitability 32
3 METHODOLOGY
31 Introduction 34
32 Data 35
33 Sample 35
34 Variables used in the study 36
341 Dependent variables 36
342 Independent variables 36
35 Empirical Model 43
36 Concluding Remarks 44
37 Conclusions 45
4 FINDINGS AND CONCLUSION
41 Introduction 46
42 Descriptive Analysis 46
421 Descriptive Analysisor the Dependent and Independent
Variables 46
422 Trend Analysis 48
4221 Return on Asset (ROA) 48
4222 Return on Equity (ROE) 49
43 Correlation Analysis 49
44 Model Summary and coefficient Analysis 52
441 Model Summary 52
442 Coefficient Analysis 0ROA 53
45 Chapter summary 56
5 CONCLUSION AND RECOMMENDATIONS
51 Introduction 57
52 Summary of Findings 57
53 Recommendations and Suggestions 59
REFERENCES 61
iv
I
LIST OF FIGURE
Figure 1 Malaysia Real Growth Rate 5
Figure 2 Malaysia GDP Per Capita (US$) 5
Figure 3 The Conceptual Framework for Financial Sector Performance 16
Figure 4 Trend Analysis ofROA of Malaysian Financial Sector 48
Figure 5 Trend Analysis of ROE of Malaysian Financial Sector 49
LIST OF TABLES
Table 1 List of Financiallnstitutions as Public Listed in Bursa Saham Malaysia 4
Table 2 The Malaysian Financial System 8
Table 3 Independent Variables and their Proxies 42
Table 4 Descriptive Analysis for the Dependent and Independent Variables 47
Table 5 Correlation between ROA and all ratios 50
Table 6 Correlation between ROE and all ratios 51
Table 7 Summary of Analysis Return on Assets (ROA) and Return on
Equity (ROE) 52
Table 8 Coefficient Analysis and Collinearity Statistic (ROA) 54
Table 9 Coefficient Analysis and Collinearity Statistic (ROE) 55
v
ASST
BNMlGP8
CAP
CTD
EARN
FDI
FDIC
FIs
GDP
LIQ
LPI
LTD
MARC
MBSB
MNGT
MNRB
NPL
OLS
RHB
ROA
ROE
LIST OF ABBREVIATIONS
Asset Quality
Financial Reporting for Licensed Institutions
Capital Adequacy
Cash to Deposit
Earnings
Foreign Direct Investment
Federal Deposit Insurance Corporation
Financial Institutions
Malaysian Gross Domestic Product
Liquidity
Lonpac Insurance
Loan to Deposit
Malaysian Rating Corporation Berhad
Malaysia Building society Berhad
Management
Malaysian Reinsurance Berhad
Not Performing Loan
Ordinary Least Squares
Rashid Hussein Bank
Return on Assets
Return on Equity
vi
1
-==
I
RWCR Risk Weighted Capital Ratio
VIF Variance Inflation Factor
vii
CHAPTER 1
INTRODUCTION
11 Background
The global financial crisis from 2008 t02009 had brought huge impact for the world
economy due to the price of the assets which has been over inflated and caused the
sub-prime mortgage booming and exploding into housing and banking crisis with a
cascading effect on consumer and investment demand In addition the financial market
becomes panic due to the subprime mortgages and the failures of Lehman Brothers
and Washington Mutual in United States The government of United States had
implemented some solutions and actions to reduce the panics during the first half of
October by promoting the liquidity and the solvency of the financial sector reducing
the prices for the asset classes and the commodities the cost of the corporate and the
bank borrowing rose significantly and high volatility in financial market which
increasing infrequently In the case of Malaysian economy the countrys economy was
sheltered from the direct effects of financial exposure because the new derivatives were
not allowed into the country The global financial crisis may result the Governments
plans to achieve vision 2020 being interrupted because of decreasing in the exports and a
slowdown in foreign direct investment (FDI)
The financial services sector is the bedrock of any economy It is the key to the overall
economy by providing various fonns of capital to enable the growth of other
industries in the economy All large and successful economies require strong banks
system vibrant capital markets and well-functioning financial infrastructures
Moreover the sector is also a core component in a services-based economy and a key
growth engine in its own right As demonstrated by the emergence of international
1
___--==========-=-----------=---=------- ---_
II
shy
financial services centres worldwide the financial sector growth comes from serving
domestic businesses and consumers as well as tapping external markets and sources of
funds
Mansor (2007) states that financial liberalization and development has been the major
financial feature in many developing countries Malaysia is a highly open economic
country and it also witnesses a respectable economic growth and rapid financial
development since the introducing of Financial Sector Masterplan in 2001 the
Malaysian financial sector has undergone significant transformation and progress The
banking sector especially has undergone restructuring consolidation and
rationalization Moreover the flexibility and the performance of the financial
landscaping had been improved due to the transformation and deregulation and
liberalization Moreover a stable and effective financial sector will affect the
performance of the financial sector and it will become an important pillar of strength
in our economy
Schumpeter (1911) contends that the services provided by the financial intermediaries
are essential drivers for innovation and growth Well developed financial systems
channel financial resources to the most productive use Malaysias Prime Minister
Dato Sri Mohd Najib bin Tun Hj Abdul Razak states that financial sector in Malaysia
is expected to have a greater role in assisting the economic growth as Malaysia transit
towards achieving a developed economy status by year 2020 The financial sector is
able to assist the economy growth and encourage the economy transformation into the
next phase of development and provide the world class high value added financial
products and services at the competitive prices and speed up the new economic
sectors In order to enhance the economys expansion Government has taken the
2
initiatives to promote structural change within the economy and diversify the sources
of the financial sectors growth by offering liberalisation package from 2009 to 2012
The foreign equity limits of investment banks Islamic banks insurance companies
and Takaful operators had increased from 40 percent to 70 percent The alliances will
strengthen business potential and enhance the growth of the financial institutions
through international expertise and global network foreign shareholders The rapid
growth and the strong financial sector of the country will enable the consumers to get
more infonnation between the financial service providers the regulators and the
authorities will need to provide the conducive environment that raises the consumer
empowennent The more consumers can afford and able to buy the products or
services provided by of the financial institution such as commercial bank investment
company or insurances company will positively affect the perfonnance of the
financial sector
As a result the financial sector plays crucial role for the economic growth and the
countrys development From Table 1 it shows that then financial sector comprises of
26 institution consisting 4 commercial bank 6 insurance company 14 investment
holding companies stock broking companies finance companies and the exchange
holding companies The lists of the financial institutions in Table 1 are public listed
on the Bursa Saham Malaysia
3
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
Pu J ~ 4
UNJVERSJll - en ~ MALAy LA SARAWAK
PKHIOMAT MAKLUMAT AKAOEMIK
11111 nllfli~rlllllllill 1000246523
FACTORS AFFECTING THE PERFORMANCE OF FINANCIAL SECTOR IN MALAYSIA
BONG LIE LIN
A dissertation submitted in partial fulfillment of the requirements for the degree of Corporate Master in Business Administration
Faculty of Economics and Business UNIVERSITI MALAYSIA SARA W AK
2012
I
ABSTRACT
0his paper is to analyze and detennine the factors that affecting the financial sector
perfonnance in Malaysia for the period of five years from year 2006 to 2011 From
the study the result shows that the perfonnance of Malaysian financial sector is
stable and quite profitable because of systematic Malaysian financial systems
regulations and the strong financial capital However the global financial crisis
occurred during year 2008 to 2009 was affected the financial sector globally and
affected the financial institutions service qualit~ The study will use the financial
ratios and apply the CAMEL Model namely Capital adequacy Asset quality
Management Earnings and Liquidity to detennine the factors affecting the financial
sector perfonnance So in order to identify the detenninants of perfonnance of
Malaysian financial sector during 2006 to 2011 this study has chosen mUltiple
regression analysis Besides that the dependent variables are consisting profitability
ratio which Return on Assets (ROA) and Return on Equity (ROE) then independent
variables are the CAMEL Methods So from the study the results also shows that the
ROA and ROE are depends on the CAMEL Lastly there are a significant
relationship between the dependent variables and the independent variables
ACKNOWLEDGEMENT
My highest and more sincere appreciation goes to my beloved parents and my
families who have always encouraged and guided me to be independent never try to
limit my aspirations
I would like to express my great appreciation to my supervisor Dr Chu Ei Yet for his
understanding attention kindness and encouragement His supervision idea
guidance and critics of the research paper have been an enormous help Words alone
Icannot be expressed my greatest appreciation and thanks to him
I would like to express my high appreciation to my all lectures of Faculty Economics
and Business especially lecturers of Finance Thanks again to everyone including
those who I have probably forgotten to mention here
I
ii
Pusat Khidmat MakJumat Akademik UNlVERSm MALAYSIA SARAWAK
TABLE OF CONTENT
ABSTRACT i
AKNOWLEDGEMENT ii
TABLE OF CONTENT iii
LIST OF FIGURES v
LIST OF TABLES v
LIST OF ABBREVIATIONS vi
1 INTRODUCTION
11 Background 1
111 Malaysian Gross Domestic Product (GDP) 4
112 Malaysian Financial System Challenges in Malaysian Financial
Sector 6
113 Challenges in Malaysian Financial Sector 9
12 Problem Statement 10
13 Theoretical Framework 12
131 Agency Theory 12
132 Characteristics ofAgency Problems in Financial Institutions 13
14 Conceptual Framework 15
15 Scope of the Study 16
16 Research Objectives 17
161 General Objective 17
162 Specific Objectives 18
17 Significance of the Study 18
18 Organization of the Study 19
19 Conclusion 20
2 LITERATURE REVIEW
21 Introduction 21
22 Literature review on CAMEL Approach 22
23 Financial Institutions Rating in Malaysia 24
231 Capital Adequacy 24
232 Asset Quality 26
233 Management 29
iii
234 Earnings 30
235 Liquidity 31
24 Empirical Literature Determinants of Financial Institutions
Profitability 32
3 METHODOLOGY
31 Introduction 34
32 Data 35
33 Sample 35
34 Variables used in the study 36
341 Dependent variables 36
342 Independent variables 36
35 Empirical Model 43
36 Concluding Remarks 44
37 Conclusions 45
4 FINDINGS AND CONCLUSION
41 Introduction 46
42 Descriptive Analysis 46
421 Descriptive Analysisor the Dependent and Independent
Variables 46
422 Trend Analysis 48
4221 Return on Asset (ROA) 48
4222 Return on Equity (ROE) 49
43 Correlation Analysis 49
44 Model Summary and coefficient Analysis 52
441 Model Summary 52
442 Coefficient Analysis 0ROA 53
45 Chapter summary 56
5 CONCLUSION AND RECOMMENDATIONS
51 Introduction 57
52 Summary of Findings 57
53 Recommendations and Suggestions 59
REFERENCES 61
iv
I
LIST OF FIGURE
Figure 1 Malaysia Real Growth Rate 5
Figure 2 Malaysia GDP Per Capita (US$) 5
Figure 3 The Conceptual Framework for Financial Sector Performance 16
Figure 4 Trend Analysis ofROA of Malaysian Financial Sector 48
Figure 5 Trend Analysis of ROE of Malaysian Financial Sector 49
LIST OF TABLES
Table 1 List of Financiallnstitutions as Public Listed in Bursa Saham Malaysia 4
Table 2 The Malaysian Financial System 8
Table 3 Independent Variables and their Proxies 42
Table 4 Descriptive Analysis for the Dependent and Independent Variables 47
Table 5 Correlation between ROA and all ratios 50
Table 6 Correlation between ROE and all ratios 51
Table 7 Summary of Analysis Return on Assets (ROA) and Return on
Equity (ROE) 52
Table 8 Coefficient Analysis and Collinearity Statistic (ROA) 54
Table 9 Coefficient Analysis and Collinearity Statistic (ROE) 55
v
ASST
BNMlGP8
CAP
CTD
EARN
FDI
FDIC
FIs
GDP
LIQ
LPI
LTD
MARC
MBSB
MNGT
MNRB
NPL
OLS
RHB
ROA
ROE
LIST OF ABBREVIATIONS
Asset Quality
Financial Reporting for Licensed Institutions
Capital Adequacy
Cash to Deposit
Earnings
Foreign Direct Investment
Federal Deposit Insurance Corporation
Financial Institutions
Malaysian Gross Domestic Product
Liquidity
Lonpac Insurance
Loan to Deposit
Malaysian Rating Corporation Berhad
Malaysia Building society Berhad
Management
Malaysian Reinsurance Berhad
Not Performing Loan
Ordinary Least Squares
Rashid Hussein Bank
Return on Assets
Return on Equity
vi
1
-==
I
RWCR Risk Weighted Capital Ratio
VIF Variance Inflation Factor
vii
CHAPTER 1
INTRODUCTION
11 Background
The global financial crisis from 2008 t02009 had brought huge impact for the world
economy due to the price of the assets which has been over inflated and caused the
sub-prime mortgage booming and exploding into housing and banking crisis with a
cascading effect on consumer and investment demand In addition the financial market
becomes panic due to the subprime mortgages and the failures of Lehman Brothers
and Washington Mutual in United States The government of United States had
implemented some solutions and actions to reduce the panics during the first half of
October by promoting the liquidity and the solvency of the financial sector reducing
the prices for the asset classes and the commodities the cost of the corporate and the
bank borrowing rose significantly and high volatility in financial market which
increasing infrequently In the case of Malaysian economy the countrys economy was
sheltered from the direct effects of financial exposure because the new derivatives were
not allowed into the country The global financial crisis may result the Governments
plans to achieve vision 2020 being interrupted because of decreasing in the exports and a
slowdown in foreign direct investment (FDI)
The financial services sector is the bedrock of any economy It is the key to the overall
economy by providing various fonns of capital to enable the growth of other
industries in the economy All large and successful economies require strong banks
system vibrant capital markets and well-functioning financial infrastructures
Moreover the sector is also a core component in a services-based economy and a key
growth engine in its own right As demonstrated by the emergence of international
1
___--==========-=-----------=---=------- ---_
II
shy
financial services centres worldwide the financial sector growth comes from serving
domestic businesses and consumers as well as tapping external markets and sources of
funds
Mansor (2007) states that financial liberalization and development has been the major
financial feature in many developing countries Malaysia is a highly open economic
country and it also witnesses a respectable economic growth and rapid financial
development since the introducing of Financial Sector Masterplan in 2001 the
Malaysian financial sector has undergone significant transformation and progress The
banking sector especially has undergone restructuring consolidation and
rationalization Moreover the flexibility and the performance of the financial
landscaping had been improved due to the transformation and deregulation and
liberalization Moreover a stable and effective financial sector will affect the
performance of the financial sector and it will become an important pillar of strength
in our economy
Schumpeter (1911) contends that the services provided by the financial intermediaries
are essential drivers for innovation and growth Well developed financial systems
channel financial resources to the most productive use Malaysias Prime Minister
Dato Sri Mohd Najib bin Tun Hj Abdul Razak states that financial sector in Malaysia
is expected to have a greater role in assisting the economic growth as Malaysia transit
towards achieving a developed economy status by year 2020 The financial sector is
able to assist the economy growth and encourage the economy transformation into the
next phase of development and provide the world class high value added financial
products and services at the competitive prices and speed up the new economic
sectors In order to enhance the economys expansion Government has taken the
2
initiatives to promote structural change within the economy and diversify the sources
of the financial sectors growth by offering liberalisation package from 2009 to 2012
The foreign equity limits of investment banks Islamic banks insurance companies
and Takaful operators had increased from 40 percent to 70 percent The alliances will
strengthen business potential and enhance the growth of the financial institutions
through international expertise and global network foreign shareholders The rapid
growth and the strong financial sector of the country will enable the consumers to get
more infonnation between the financial service providers the regulators and the
authorities will need to provide the conducive environment that raises the consumer
empowennent The more consumers can afford and able to buy the products or
services provided by of the financial institution such as commercial bank investment
company or insurances company will positively affect the perfonnance of the
financial sector
As a result the financial sector plays crucial role for the economic growth and the
countrys development From Table 1 it shows that then financial sector comprises of
26 institution consisting 4 commercial bank 6 insurance company 14 investment
holding companies stock broking companies finance companies and the exchange
holding companies The lists of the financial institutions in Table 1 are public listed
on the Bursa Saham Malaysia
3
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
I
ABSTRACT
0his paper is to analyze and detennine the factors that affecting the financial sector
perfonnance in Malaysia for the period of five years from year 2006 to 2011 From
the study the result shows that the perfonnance of Malaysian financial sector is
stable and quite profitable because of systematic Malaysian financial systems
regulations and the strong financial capital However the global financial crisis
occurred during year 2008 to 2009 was affected the financial sector globally and
affected the financial institutions service qualit~ The study will use the financial
ratios and apply the CAMEL Model namely Capital adequacy Asset quality
Management Earnings and Liquidity to detennine the factors affecting the financial
sector perfonnance So in order to identify the detenninants of perfonnance of
Malaysian financial sector during 2006 to 2011 this study has chosen mUltiple
regression analysis Besides that the dependent variables are consisting profitability
ratio which Return on Assets (ROA) and Return on Equity (ROE) then independent
variables are the CAMEL Methods So from the study the results also shows that the
ROA and ROE are depends on the CAMEL Lastly there are a significant
relationship between the dependent variables and the independent variables
ACKNOWLEDGEMENT
My highest and more sincere appreciation goes to my beloved parents and my
families who have always encouraged and guided me to be independent never try to
limit my aspirations
I would like to express my great appreciation to my supervisor Dr Chu Ei Yet for his
understanding attention kindness and encouragement His supervision idea
guidance and critics of the research paper have been an enormous help Words alone
Icannot be expressed my greatest appreciation and thanks to him
I would like to express my high appreciation to my all lectures of Faculty Economics
and Business especially lecturers of Finance Thanks again to everyone including
those who I have probably forgotten to mention here
I
ii
Pusat Khidmat MakJumat Akademik UNlVERSm MALAYSIA SARAWAK
TABLE OF CONTENT
ABSTRACT i
AKNOWLEDGEMENT ii
TABLE OF CONTENT iii
LIST OF FIGURES v
LIST OF TABLES v
LIST OF ABBREVIATIONS vi
1 INTRODUCTION
11 Background 1
111 Malaysian Gross Domestic Product (GDP) 4
112 Malaysian Financial System Challenges in Malaysian Financial
Sector 6
113 Challenges in Malaysian Financial Sector 9
12 Problem Statement 10
13 Theoretical Framework 12
131 Agency Theory 12
132 Characteristics ofAgency Problems in Financial Institutions 13
14 Conceptual Framework 15
15 Scope of the Study 16
16 Research Objectives 17
161 General Objective 17
162 Specific Objectives 18
17 Significance of the Study 18
18 Organization of the Study 19
19 Conclusion 20
2 LITERATURE REVIEW
21 Introduction 21
22 Literature review on CAMEL Approach 22
23 Financial Institutions Rating in Malaysia 24
231 Capital Adequacy 24
232 Asset Quality 26
233 Management 29
iii
234 Earnings 30
235 Liquidity 31
24 Empirical Literature Determinants of Financial Institutions
Profitability 32
3 METHODOLOGY
31 Introduction 34
32 Data 35
33 Sample 35
34 Variables used in the study 36
341 Dependent variables 36
342 Independent variables 36
35 Empirical Model 43
36 Concluding Remarks 44
37 Conclusions 45
4 FINDINGS AND CONCLUSION
41 Introduction 46
42 Descriptive Analysis 46
421 Descriptive Analysisor the Dependent and Independent
Variables 46
422 Trend Analysis 48
4221 Return on Asset (ROA) 48
4222 Return on Equity (ROE) 49
43 Correlation Analysis 49
44 Model Summary and coefficient Analysis 52
441 Model Summary 52
442 Coefficient Analysis 0ROA 53
45 Chapter summary 56
5 CONCLUSION AND RECOMMENDATIONS
51 Introduction 57
52 Summary of Findings 57
53 Recommendations and Suggestions 59
REFERENCES 61
iv
I
LIST OF FIGURE
Figure 1 Malaysia Real Growth Rate 5
Figure 2 Malaysia GDP Per Capita (US$) 5
Figure 3 The Conceptual Framework for Financial Sector Performance 16
Figure 4 Trend Analysis ofROA of Malaysian Financial Sector 48
Figure 5 Trend Analysis of ROE of Malaysian Financial Sector 49
LIST OF TABLES
Table 1 List of Financiallnstitutions as Public Listed in Bursa Saham Malaysia 4
Table 2 The Malaysian Financial System 8
Table 3 Independent Variables and their Proxies 42
Table 4 Descriptive Analysis for the Dependent and Independent Variables 47
Table 5 Correlation between ROA and all ratios 50
Table 6 Correlation between ROE and all ratios 51
Table 7 Summary of Analysis Return on Assets (ROA) and Return on
Equity (ROE) 52
Table 8 Coefficient Analysis and Collinearity Statistic (ROA) 54
Table 9 Coefficient Analysis and Collinearity Statistic (ROE) 55
v
ASST
BNMlGP8
CAP
CTD
EARN
FDI
FDIC
FIs
GDP
LIQ
LPI
LTD
MARC
MBSB
MNGT
MNRB
NPL
OLS
RHB
ROA
ROE
LIST OF ABBREVIATIONS
Asset Quality
Financial Reporting for Licensed Institutions
Capital Adequacy
Cash to Deposit
Earnings
Foreign Direct Investment
Federal Deposit Insurance Corporation
Financial Institutions
Malaysian Gross Domestic Product
Liquidity
Lonpac Insurance
Loan to Deposit
Malaysian Rating Corporation Berhad
Malaysia Building society Berhad
Management
Malaysian Reinsurance Berhad
Not Performing Loan
Ordinary Least Squares
Rashid Hussein Bank
Return on Assets
Return on Equity
vi
1
-==
I
RWCR Risk Weighted Capital Ratio
VIF Variance Inflation Factor
vii
CHAPTER 1
INTRODUCTION
11 Background
The global financial crisis from 2008 t02009 had brought huge impact for the world
economy due to the price of the assets which has been over inflated and caused the
sub-prime mortgage booming and exploding into housing and banking crisis with a
cascading effect on consumer and investment demand In addition the financial market
becomes panic due to the subprime mortgages and the failures of Lehman Brothers
and Washington Mutual in United States The government of United States had
implemented some solutions and actions to reduce the panics during the first half of
October by promoting the liquidity and the solvency of the financial sector reducing
the prices for the asset classes and the commodities the cost of the corporate and the
bank borrowing rose significantly and high volatility in financial market which
increasing infrequently In the case of Malaysian economy the countrys economy was
sheltered from the direct effects of financial exposure because the new derivatives were
not allowed into the country The global financial crisis may result the Governments
plans to achieve vision 2020 being interrupted because of decreasing in the exports and a
slowdown in foreign direct investment (FDI)
The financial services sector is the bedrock of any economy It is the key to the overall
economy by providing various fonns of capital to enable the growth of other
industries in the economy All large and successful economies require strong banks
system vibrant capital markets and well-functioning financial infrastructures
Moreover the sector is also a core component in a services-based economy and a key
growth engine in its own right As demonstrated by the emergence of international
1
___--==========-=-----------=---=------- ---_
II
shy
financial services centres worldwide the financial sector growth comes from serving
domestic businesses and consumers as well as tapping external markets and sources of
funds
Mansor (2007) states that financial liberalization and development has been the major
financial feature in many developing countries Malaysia is a highly open economic
country and it also witnesses a respectable economic growth and rapid financial
development since the introducing of Financial Sector Masterplan in 2001 the
Malaysian financial sector has undergone significant transformation and progress The
banking sector especially has undergone restructuring consolidation and
rationalization Moreover the flexibility and the performance of the financial
landscaping had been improved due to the transformation and deregulation and
liberalization Moreover a stable and effective financial sector will affect the
performance of the financial sector and it will become an important pillar of strength
in our economy
Schumpeter (1911) contends that the services provided by the financial intermediaries
are essential drivers for innovation and growth Well developed financial systems
channel financial resources to the most productive use Malaysias Prime Minister
Dato Sri Mohd Najib bin Tun Hj Abdul Razak states that financial sector in Malaysia
is expected to have a greater role in assisting the economic growth as Malaysia transit
towards achieving a developed economy status by year 2020 The financial sector is
able to assist the economy growth and encourage the economy transformation into the
next phase of development and provide the world class high value added financial
products and services at the competitive prices and speed up the new economic
sectors In order to enhance the economys expansion Government has taken the
2
initiatives to promote structural change within the economy and diversify the sources
of the financial sectors growth by offering liberalisation package from 2009 to 2012
The foreign equity limits of investment banks Islamic banks insurance companies
and Takaful operators had increased from 40 percent to 70 percent The alliances will
strengthen business potential and enhance the growth of the financial institutions
through international expertise and global network foreign shareholders The rapid
growth and the strong financial sector of the country will enable the consumers to get
more infonnation between the financial service providers the regulators and the
authorities will need to provide the conducive environment that raises the consumer
empowennent The more consumers can afford and able to buy the products or
services provided by of the financial institution such as commercial bank investment
company or insurances company will positively affect the perfonnance of the
financial sector
As a result the financial sector plays crucial role for the economic growth and the
countrys development From Table 1 it shows that then financial sector comprises of
26 institution consisting 4 commercial bank 6 insurance company 14 investment
holding companies stock broking companies finance companies and the exchange
holding companies The lists of the financial institutions in Table 1 are public listed
on the Bursa Saham Malaysia
3
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
ACKNOWLEDGEMENT
My highest and more sincere appreciation goes to my beloved parents and my
families who have always encouraged and guided me to be independent never try to
limit my aspirations
I would like to express my great appreciation to my supervisor Dr Chu Ei Yet for his
understanding attention kindness and encouragement His supervision idea
guidance and critics of the research paper have been an enormous help Words alone
Icannot be expressed my greatest appreciation and thanks to him
I would like to express my high appreciation to my all lectures of Faculty Economics
and Business especially lecturers of Finance Thanks again to everyone including
those who I have probably forgotten to mention here
I
ii
Pusat Khidmat MakJumat Akademik UNlVERSm MALAYSIA SARAWAK
TABLE OF CONTENT
ABSTRACT i
AKNOWLEDGEMENT ii
TABLE OF CONTENT iii
LIST OF FIGURES v
LIST OF TABLES v
LIST OF ABBREVIATIONS vi
1 INTRODUCTION
11 Background 1
111 Malaysian Gross Domestic Product (GDP) 4
112 Malaysian Financial System Challenges in Malaysian Financial
Sector 6
113 Challenges in Malaysian Financial Sector 9
12 Problem Statement 10
13 Theoretical Framework 12
131 Agency Theory 12
132 Characteristics ofAgency Problems in Financial Institutions 13
14 Conceptual Framework 15
15 Scope of the Study 16
16 Research Objectives 17
161 General Objective 17
162 Specific Objectives 18
17 Significance of the Study 18
18 Organization of the Study 19
19 Conclusion 20
2 LITERATURE REVIEW
21 Introduction 21
22 Literature review on CAMEL Approach 22
23 Financial Institutions Rating in Malaysia 24
231 Capital Adequacy 24
232 Asset Quality 26
233 Management 29
iii
234 Earnings 30
235 Liquidity 31
24 Empirical Literature Determinants of Financial Institutions
Profitability 32
3 METHODOLOGY
31 Introduction 34
32 Data 35
33 Sample 35
34 Variables used in the study 36
341 Dependent variables 36
342 Independent variables 36
35 Empirical Model 43
36 Concluding Remarks 44
37 Conclusions 45
4 FINDINGS AND CONCLUSION
41 Introduction 46
42 Descriptive Analysis 46
421 Descriptive Analysisor the Dependent and Independent
Variables 46
422 Trend Analysis 48
4221 Return on Asset (ROA) 48
4222 Return on Equity (ROE) 49
43 Correlation Analysis 49
44 Model Summary and coefficient Analysis 52
441 Model Summary 52
442 Coefficient Analysis 0ROA 53
45 Chapter summary 56
5 CONCLUSION AND RECOMMENDATIONS
51 Introduction 57
52 Summary of Findings 57
53 Recommendations and Suggestions 59
REFERENCES 61
iv
I
LIST OF FIGURE
Figure 1 Malaysia Real Growth Rate 5
Figure 2 Malaysia GDP Per Capita (US$) 5
Figure 3 The Conceptual Framework for Financial Sector Performance 16
Figure 4 Trend Analysis ofROA of Malaysian Financial Sector 48
Figure 5 Trend Analysis of ROE of Malaysian Financial Sector 49
LIST OF TABLES
Table 1 List of Financiallnstitutions as Public Listed in Bursa Saham Malaysia 4
Table 2 The Malaysian Financial System 8
Table 3 Independent Variables and their Proxies 42
Table 4 Descriptive Analysis for the Dependent and Independent Variables 47
Table 5 Correlation between ROA and all ratios 50
Table 6 Correlation between ROE and all ratios 51
Table 7 Summary of Analysis Return on Assets (ROA) and Return on
Equity (ROE) 52
Table 8 Coefficient Analysis and Collinearity Statistic (ROA) 54
Table 9 Coefficient Analysis and Collinearity Statistic (ROE) 55
v
ASST
BNMlGP8
CAP
CTD
EARN
FDI
FDIC
FIs
GDP
LIQ
LPI
LTD
MARC
MBSB
MNGT
MNRB
NPL
OLS
RHB
ROA
ROE
LIST OF ABBREVIATIONS
Asset Quality
Financial Reporting for Licensed Institutions
Capital Adequacy
Cash to Deposit
Earnings
Foreign Direct Investment
Federal Deposit Insurance Corporation
Financial Institutions
Malaysian Gross Domestic Product
Liquidity
Lonpac Insurance
Loan to Deposit
Malaysian Rating Corporation Berhad
Malaysia Building society Berhad
Management
Malaysian Reinsurance Berhad
Not Performing Loan
Ordinary Least Squares
Rashid Hussein Bank
Return on Assets
Return on Equity
vi
1
-==
I
RWCR Risk Weighted Capital Ratio
VIF Variance Inflation Factor
vii
CHAPTER 1
INTRODUCTION
11 Background
The global financial crisis from 2008 t02009 had brought huge impact for the world
economy due to the price of the assets which has been over inflated and caused the
sub-prime mortgage booming and exploding into housing and banking crisis with a
cascading effect on consumer and investment demand In addition the financial market
becomes panic due to the subprime mortgages and the failures of Lehman Brothers
and Washington Mutual in United States The government of United States had
implemented some solutions and actions to reduce the panics during the first half of
October by promoting the liquidity and the solvency of the financial sector reducing
the prices for the asset classes and the commodities the cost of the corporate and the
bank borrowing rose significantly and high volatility in financial market which
increasing infrequently In the case of Malaysian economy the countrys economy was
sheltered from the direct effects of financial exposure because the new derivatives were
not allowed into the country The global financial crisis may result the Governments
plans to achieve vision 2020 being interrupted because of decreasing in the exports and a
slowdown in foreign direct investment (FDI)
The financial services sector is the bedrock of any economy It is the key to the overall
economy by providing various fonns of capital to enable the growth of other
industries in the economy All large and successful economies require strong banks
system vibrant capital markets and well-functioning financial infrastructures
Moreover the sector is also a core component in a services-based economy and a key
growth engine in its own right As demonstrated by the emergence of international
1
___--==========-=-----------=---=------- ---_
II
shy
financial services centres worldwide the financial sector growth comes from serving
domestic businesses and consumers as well as tapping external markets and sources of
funds
Mansor (2007) states that financial liberalization and development has been the major
financial feature in many developing countries Malaysia is a highly open economic
country and it also witnesses a respectable economic growth and rapid financial
development since the introducing of Financial Sector Masterplan in 2001 the
Malaysian financial sector has undergone significant transformation and progress The
banking sector especially has undergone restructuring consolidation and
rationalization Moreover the flexibility and the performance of the financial
landscaping had been improved due to the transformation and deregulation and
liberalization Moreover a stable and effective financial sector will affect the
performance of the financial sector and it will become an important pillar of strength
in our economy
Schumpeter (1911) contends that the services provided by the financial intermediaries
are essential drivers for innovation and growth Well developed financial systems
channel financial resources to the most productive use Malaysias Prime Minister
Dato Sri Mohd Najib bin Tun Hj Abdul Razak states that financial sector in Malaysia
is expected to have a greater role in assisting the economic growth as Malaysia transit
towards achieving a developed economy status by year 2020 The financial sector is
able to assist the economy growth and encourage the economy transformation into the
next phase of development and provide the world class high value added financial
products and services at the competitive prices and speed up the new economic
sectors In order to enhance the economys expansion Government has taken the
2
initiatives to promote structural change within the economy and diversify the sources
of the financial sectors growth by offering liberalisation package from 2009 to 2012
The foreign equity limits of investment banks Islamic banks insurance companies
and Takaful operators had increased from 40 percent to 70 percent The alliances will
strengthen business potential and enhance the growth of the financial institutions
through international expertise and global network foreign shareholders The rapid
growth and the strong financial sector of the country will enable the consumers to get
more infonnation between the financial service providers the regulators and the
authorities will need to provide the conducive environment that raises the consumer
empowennent The more consumers can afford and able to buy the products or
services provided by of the financial institution such as commercial bank investment
company or insurances company will positively affect the perfonnance of the
financial sector
As a result the financial sector plays crucial role for the economic growth and the
countrys development From Table 1 it shows that then financial sector comprises of
26 institution consisting 4 commercial bank 6 insurance company 14 investment
holding companies stock broking companies finance companies and the exchange
holding companies The lists of the financial institutions in Table 1 are public listed
on the Bursa Saham Malaysia
3
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
Pusat Khidmat MakJumat Akademik UNlVERSm MALAYSIA SARAWAK
TABLE OF CONTENT
ABSTRACT i
AKNOWLEDGEMENT ii
TABLE OF CONTENT iii
LIST OF FIGURES v
LIST OF TABLES v
LIST OF ABBREVIATIONS vi
1 INTRODUCTION
11 Background 1
111 Malaysian Gross Domestic Product (GDP) 4
112 Malaysian Financial System Challenges in Malaysian Financial
Sector 6
113 Challenges in Malaysian Financial Sector 9
12 Problem Statement 10
13 Theoretical Framework 12
131 Agency Theory 12
132 Characteristics ofAgency Problems in Financial Institutions 13
14 Conceptual Framework 15
15 Scope of the Study 16
16 Research Objectives 17
161 General Objective 17
162 Specific Objectives 18
17 Significance of the Study 18
18 Organization of the Study 19
19 Conclusion 20
2 LITERATURE REVIEW
21 Introduction 21
22 Literature review on CAMEL Approach 22
23 Financial Institutions Rating in Malaysia 24
231 Capital Adequacy 24
232 Asset Quality 26
233 Management 29
iii
234 Earnings 30
235 Liquidity 31
24 Empirical Literature Determinants of Financial Institutions
Profitability 32
3 METHODOLOGY
31 Introduction 34
32 Data 35
33 Sample 35
34 Variables used in the study 36
341 Dependent variables 36
342 Independent variables 36
35 Empirical Model 43
36 Concluding Remarks 44
37 Conclusions 45
4 FINDINGS AND CONCLUSION
41 Introduction 46
42 Descriptive Analysis 46
421 Descriptive Analysisor the Dependent and Independent
Variables 46
422 Trend Analysis 48
4221 Return on Asset (ROA) 48
4222 Return on Equity (ROE) 49
43 Correlation Analysis 49
44 Model Summary and coefficient Analysis 52
441 Model Summary 52
442 Coefficient Analysis 0ROA 53
45 Chapter summary 56
5 CONCLUSION AND RECOMMENDATIONS
51 Introduction 57
52 Summary of Findings 57
53 Recommendations and Suggestions 59
REFERENCES 61
iv
I
LIST OF FIGURE
Figure 1 Malaysia Real Growth Rate 5
Figure 2 Malaysia GDP Per Capita (US$) 5
Figure 3 The Conceptual Framework for Financial Sector Performance 16
Figure 4 Trend Analysis ofROA of Malaysian Financial Sector 48
Figure 5 Trend Analysis of ROE of Malaysian Financial Sector 49
LIST OF TABLES
Table 1 List of Financiallnstitutions as Public Listed in Bursa Saham Malaysia 4
Table 2 The Malaysian Financial System 8
Table 3 Independent Variables and their Proxies 42
Table 4 Descriptive Analysis for the Dependent and Independent Variables 47
Table 5 Correlation between ROA and all ratios 50
Table 6 Correlation between ROE and all ratios 51
Table 7 Summary of Analysis Return on Assets (ROA) and Return on
Equity (ROE) 52
Table 8 Coefficient Analysis and Collinearity Statistic (ROA) 54
Table 9 Coefficient Analysis and Collinearity Statistic (ROE) 55
v
ASST
BNMlGP8
CAP
CTD
EARN
FDI
FDIC
FIs
GDP
LIQ
LPI
LTD
MARC
MBSB
MNGT
MNRB
NPL
OLS
RHB
ROA
ROE
LIST OF ABBREVIATIONS
Asset Quality
Financial Reporting for Licensed Institutions
Capital Adequacy
Cash to Deposit
Earnings
Foreign Direct Investment
Federal Deposit Insurance Corporation
Financial Institutions
Malaysian Gross Domestic Product
Liquidity
Lonpac Insurance
Loan to Deposit
Malaysian Rating Corporation Berhad
Malaysia Building society Berhad
Management
Malaysian Reinsurance Berhad
Not Performing Loan
Ordinary Least Squares
Rashid Hussein Bank
Return on Assets
Return on Equity
vi
1
-==
I
RWCR Risk Weighted Capital Ratio
VIF Variance Inflation Factor
vii
CHAPTER 1
INTRODUCTION
11 Background
The global financial crisis from 2008 t02009 had brought huge impact for the world
economy due to the price of the assets which has been over inflated and caused the
sub-prime mortgage booming and exploding into housing and banking crisis with a
cascading effect on consumer and investment demand In addition the financial market
becomes panic due to the subprime mortgages and the failures of Lehman Brothers
and Washington Mutual in United States The government of United States had
implemented some solutions and actions to reduce the panics during the first half of
October by promoting the liquidity and the solvency of the financial sector reducing
the prices for the asset classes and the commodities the cost of the corporate and the
bank borrowing rose significantly and high volatility in financial market which
increasing infrequently In the case of Malaysian economy the countrys economy was
sheltered from the direct effects of financial exposure because the new derivatives were
not allowed into the country The global financial crisis may result the Governments
plans to achieve vision 2020 being interrupted because of decreasing in the exports and a
slowdown in foreign direct investment (FDI)
The financial services sector is the bedrock of any economy It is the key to the overall
economy by providing various fonns of capital to enable the growth of other
industries in the economy All large and successful economies require strong banks
system vibrant capital markets and well-functioning financial infrastructures
Moreover the sector is also a core component in a services-based economy and a key
growth engine in its own right As demonstrated by the emergence of international
1
___--==========-=-----------=---=------- ---_
II
shy
financial services centres worldwide the financial sector growth comes from serving
domestic businesses and consumers as well as tapping external markets and sources of
funds
Mansor (2007) states that financial liberalization and development has been the major
financial feature in many developing countries Malaysia is a highly open economic
country and it also witnesses a respectable economic growth and rapid financial
development since the introducing of Financial Sector Masterplan in 2001 the
Malaysian financial sector has undergone significant transformation and progress The
banking sector especially has undergone restructuring consolidation and
rationalization Moreover the flexibility and the performance of the financial
landscaping had been improved due to the transformation and deregulation and
liberalization Moreover a stable and effective financial sector will affect the
performance of the financial sector and it will become an important pillar of strength
in our economy
Schumpeter (1911) contends that the services provided by the financial intermediaries
are essential drivers for innovation and growth Well developed financial systems
channel financial resources to the most productive use Malaysias Prime Minister
Dato Sri Mohd Najib bin Tun Hj Abdul Razak states that financial sector in Malaysia
is expected to have a greater role in assisting the economic growth as Malaysia transit
towards achieving a developed economy status by year 2020 The financial sector is
able to assist the economy growth and encourage the economy transformation into the
next phase of development and provide the world class high value added financial
products and services at the competitive prices and speed up the new economic
sectors In order to enhance the economys expansion Government has taken the
2
initiatives to promote structural change within the economy and diversify the sources
of the financial sectors growth by offering liberalisation package from 2009 to 2012
The foreign equity limits of investment banks Islamic banks insurance companies
and Takaful operators had increased from 40 percent to 70 percent The alliances will
strengthen business potential and enhance the growth of the financial institutions
through international expertise and global network foreign shareholders The rapid
growth and the strong financial sector of the country will enable the consumers to get
more infonnation between the financial service providers the regulators and the
authorities will need to provide the conducive environment that raises the consumer
empowennent The more consumers can afford and able to buy the products or
services provided by of the financial institution such as commercial bank investment
company or insurances company will positively affect the perfonnance of the
financial sector
As a result the financial sector plays crucial role for the economic growth and the
countrys development From Table 1 it shows that then financial sector comprises of
26 institution consisting 4 commercial bank 6 insurance company 14 investment
holding companies stock broking companies finance companies and the exchange
holding companies The lists of the financial institutions in Table 1 are public listed
on the Bursa Saham Malaysia
3
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
234 Earnings 30
235 Liquidity 31
24 Empirical Literature Determinants of Financial Institutions
Profitability 32
3 METHODOLOGY
31 Introduction 34
32 Data 35
33 Sample 35
34 Variables used in the study 36
341 Dependent variables 36
342 Independent variables 36
35 Empirical Model 43
36 Concluding Remarks 44
37 Conclusions 45
4 FINDINGS AND CONCLUSION
41 Introduction 46
42 Descriptive Analysis 46
421 Descriptive Analysisor the Dependent and Independent
Variables 46
422 Trend Analysis 48
4221 Return on Asset (ROA) 48
4222 Return on Equity (ROE) 49
43 Correlation Analysis 49
44 Model Summary and coefficient Analysis 52
441 Model Summary 52
442 Coefficient Analysis 0ROA 53
45 Chapter summary 56
5 CONCLUSION AND RECOMMENDATIONS
51 Introduction 57
52 Summary of Findings 57
53 Recommendations and Suggestions 59
REFERENCES 61
iv
I
LIST OF FIGURE
Figure 1 Malaysia Real Growth Rate 5
Figure 2 Malaysia GDP Per Capita (US$) 5
Figure 3 The Conceptual Framework for Financial Sector Performance 16
Figure 4 Trend Analysis ofROA of Malaysian Financial Sector 48
Figure 5 Trend Analysis of ROE of Malaysian Financial Sector 49
LIST OF TABLES
Table 1 List of Financiallnstitutions as Public Listed in Bursa Saham Malaysia 4
Table 2 The Malaysian Financial System 8
Table 3 Independent Variables and their Proxies 42
Table 4 Descriptive Analysis for the Dependent and Independent Variables 47
Table 5 Correlation between ROA and all ratios 50
Table 6 Correlation between ROE and all ratios 51
Table 7 Summary of Analysis Return on Assets (ROA) and Return on
Equity (ROE) 52
Table 8 Coefficient Analysis and Collinearity Statistic (ROA) 54
Table 9 Coefficient Analysis and Collinearity Statistic (ROE) 55
v
ASST
BNMlGP8
CAP
CTD
EARN
FDI
FDIC
FIs
GDP
LIQ
LPI
LTD
MARC
MBSB
MNGT
MNRB
NPL
OLS
RHB
ROA
ROE
LIST OF ABBREVIATIONS
Asset Quality
Financial Reporting for Licensed Institutions
Capital Adequacy
Cash to Deposit
Earnings
Foreign Direct Investment
Federal Deposit Insurance Corporation
Financial Institutions
Malaysian Gross Domestic Product
Liquidity
Lonpac Insurance
Loan to Deposit
Malaysian Rating Corporation Berhad
Malaysia Building society Berhad
Management
Malaysian Reinsurance Berhad
Not Performing Loan
Ordinary Least Squares
Rashid Hussein Bank
Return on Assets
Return on Equity
vi
1
-==
I
RWCR Risk Weighted Capital Ratio
VIF Variance Inflation Factor
vii
CHAPTER 1
INTRODUCTION
11 Background
The global financial crisis from 2008 t02009 had brought huge impact for the world
economy due to the price of the assets which has been over inflated and caused the
sub-prime mortgage booming and exploding into housing and banking crisis with a
cascading effect on consumer and investment demand In addition the financial market
becomes panic due to the subprime mortgages and the failures of Lehman Brothers
and Washington Mutual in United States The government of United States had
implemented some solutions and actions to reduce the panics during the first half of
October by promoting the liquidity and the solvency of the financial sector reducing
the prices for the asset classes and the commodities the cost of the corporate and the
bank borrowing rose significantly and high volatility in financial market which
increasing infrequently In the case of Malaysian economy the countrys economy was
sheltered from the direct effects of financial exposure because the new derivatives were
not allowed into the country The global financial crisis may result the Governments
plans to achieve vision 2020 being interrupted because of decreasing in the exports and a
slowdown in foreign direct investment (FDI)
The financial services sector is the bedrock of any economy It is the key to the overall
economy by providing various fonns of capital to enable the growth of other
industries in the economy All large and successful economies require strong banks
system vibrant capital markets and well-functioning financial infrastructures
Moreover the sector is also a core component in a services-based economy and a key
growth engine in its own right As demonstrated by the emergence of international
1
___--==========-=-----------=---=------- ---_
II
shy
financial services centres worldwide the financial sector growth comes from serving
domestic businesses and consumers as well as tapping external markets and sources of
funds
Mansor (2007) states that financial liberalization and development has been the major
financial feature in many developing countries Malaysia is a highly open economic
country and it also witnesses a respectable economic growth and rapid financial
development since the introducing of Financial Sector Masterplan in 2001 the
Malaysian financial sector has undergone significant transformation and progress The
banking sector especially has undergone restructuring consolidation and
rationalization Moreover the flexibility and the performance of the financial
landscaping had been improved due to the transformation and deregulation and
liberalization Moreover a stable and effective financial sector will affect the
performance of the financial sector and it will become an important pillar of strength
in our economy
Schumpeter (1911) contends that the services provided by the financial intermediaries
are essential drivers for innovation and growth Well developed financial systems
channel financial resources to the most productive use Malaysias Prime Minister
Dato Sri Mohd Najib bin Tun Hj Abdul Razak states that financial sector in Malaysia
is expected to have a greater role in assisting the economic growth as Malaysia transit
towards achieving a developed economy status by year 2020 The financial sector is
able to assist the economy growth and encourage the economy transformation into the
next phase of development and provide the world class high value added financial
products and services at the competitive prices and speed up the new economic
sectors In order to enhance the economys expansion Government has taken the
2
initiatives to promote structural change within the economy and diversify the sources
of the financial sectors growth by offering liberalisation package from 2009 to 2012
The foreign equity limits of investment banks Islamic banks insurance companies
and Takaful operators had increased from 40 percent to 70 percent The alliances will
strengthen business potential and enhance the growth of the financial institutions
through international expertise and global network foreign shareholders The rapid
growth and the strong financial sector of the country will enable the consumers to get
more infonnation between the financial service providers the regulators and the
authorities will need to provide the conducive environment that raises the consumer
empowennent The more consumers can afford and able to buy the products or
services provided by of the financial institution such as commercial bank investment
company or insurances company will positively affect the perfonnance of the
financial sector
As a result the financial sector plays crucial role for the economic growth and the
countrys development From Table 1 it shows that then financial sector comprises of
26 institution consisting 4 commercial bank 6 insurance company 14 investment
holding companies stock broking companies finance companies and the exchange
holding companies The lists of the financial institutions in Table 1 are public listed
on the Bursa Saham Malaysia
3
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
I
LIST OF FIGURE
Figure 1 Malaysia Real Growth Rate 5
Figure 2 Malaysia GDP Per Capita (US$) 5
Figure 3 The Conceptual Framework for Financial Sector Performance 16
Figure 4 Trend Analysis ofROA of Malaysian Financial Sector 48
Figure 5 Trend Analysis of ROE of Malaysian Financial Sector 49
LIST OF TABLES
Table 1 List of Financiallnstitutions as Public Listed in Bursa Saham Malaysia 4
Table 2 The Malaysian Financial System 8
Table 3 Independent Variables and their Proxies 42
Table 4 Descriptive Analysis for the Dependent and Independent Variables 47
Table 5 Correlation between ROA and all ratios 50
Table 6 Correlation between ROE and all ratios 51
Table 7 Summary of Analysis Return on Assets (ROA) and Return on
Equity (ROE) 52
Table 8 Coefficient Analysis and Collinearity Statistic (ROA) 54
Table 9 Coefficient Analysis and Collinearity Statistic (ROE) 55
v
ASST
BNMlGP8
CAP
CTD
EARN
FDI
FDIC
FIs
GDP
LIQ
LPI
LTD
MARC
MBSB
MNGT
MNRB
NPL
OLS
RHB
ROA
ROE
LIST OF ABBREVIATIONS
Asset Quality
Financial Reporting for Licensed Institutions
Capital Adequacy
Cash to Deposit
Earnings
Foreign Direct Investment
Federal Deposit Insurance Corporation
Financial Institutions
Malaysian Gross Domestic Product
Liquidity
Lonpac Insurance
Loan to Deposit
Malaysian Rating Corporation Berhad
Malaysia Building society Berhad
Management
Malaysian Reinsurance Berhad
Not Performing Loan
Ordinary Least Squares
Rashid Hussein Bank
Return on Assets
Return on Equity
vi
1
-==
I
RWCR Risk Weighted Capital Ratio
VIF Variance Inflation Factor
vii
CHAPTER 1
INTRODUCTION
11 Background
The global financial crisis from 2008 t02009 had brought huge impact for the world
economy due to the price of the assets which has been over inflated and caused the
sub-prime mortgage booming and exploding into housing and banking crisis with a
cascading effect on consumer and investment demand In addition the financial market
becomes panic due to the subprime mortgages and the failures of Lehman Brothers
and Washington Mutual in United States The government of United States had
implemented some solutions and actions to reduce the panics during the first half of
October by promoting the liquidity and the solvency of the financial sector reducing
the prices for the asset classes and the commodities the cost of the corporate and the
bank borrowing rose significantly and high volatility in financial market which
increasing infrequently In the case of Malaysian economy the countrys economy was
sheltered from the direct effects of financial exposure because the new derivatives were
not allowed into the country The global financial crisis may result the Governments
plans to achieve vision 2020 being interrupted because of decreasing in the exports and a
slowdown in foreign direct investment (FDI)
The financial services sector is the bedrock of any economy It is the key to the overall
economy by providing various fonns of capital to enable the growth of other
industries in the economy All large and successful economies require strong banks
system vibrant capital markets and well-functioning financial infrastructures
Moreover the sector is also a core component in a services-based economy and a key
growth engine in its own right As demonstrated by the emergence of international
1
___--==========-=-----------=---=------- ---_
II
shy
financial services centres worldwide the financial sector growth comes from serving
domestic businesses and consumers as well as tapping external markets and sources of
funds
Mansor (2007) states that financial liberalization and development has been the major
financial feature in many developing countries Malaysia is a highly open economic
country and it also witnesses a respectable economic growth and rapid financial
development since the introducing of Financial Sector Masterplan in 2001 the
Malaysian financial sector has undergone significant transformation and progress The
banking sector especially has undergone restructuring consolidation and
rationalization Moreover the flexibility and the performance of the financial
landscaping had been improved due to the transformation and deregulation and
liberalization Moreover a stable and effective financial sector will affect the
performance of the financial sector and it will become an important pillar of strength
in our economy
Schumpeter (1911) contends that the services provided by the financial intermediaries
are essential drivers for innovation and growth Well developed financial systems
channel financial resources to the most productive use Malaysias Prime Minister
Dato Sri Mohd Najib bin Tun Hj Abdul Razak states that financial sector in Malaysia
is expected to have a greater role in assisting the economic growth as Malaysia transit
towards achieving a developed economy status by year 2020 The financial sector is
able to assist the economy growth and encourage the economy transformation into the
next phase of development and provide the world class high value added financial
products and services at the competitive prices and speed up the new economic
sectors In order to enhance the economys expansion Government has taken the
2
initiatives to promote structural change within the economy and diversify the sources
of the financial sectors growth by offering liberalisation package from 2009 to 2012
The foreign equity limits of investment banks Islamic banks insurance companies
and Takaful operators had increased from 40 percent to 70 percent The alliances will
strengthen business potential and enhance the growth of the financial institutions
through international expertise and global network foreign shareholders The rapid
growth and the strong financial sector of the country will enable the consumers to get
more infonnation between the financial service providers the regulators and the
authorities will need to provide the conducive environment that raises the consumer
empowennent The more consumers can afford and able to buy the products or
services provided by of the financial institution such as commercial bank investment
company or insurances company will positively affect the perfonnance of the
financial sector
As a result the financial sector plays crucial role for the economic growth and the
countrys development From Table 1 it shows that then financial sector comprises of
26 institution consisting 4 commercial bank 6 insurance company 14 investment
holding companies stock broking companies finance companies and the exchange
holding companies The lists of the financial institutions in Table 1 are public listed
on the Bursa Saham Malaysia
3
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
ASST
BNMlGP8
CAP
CTD
EARN
FDI
FDIC
FIs
GDP
LIQ
LPI
LTD
MARC
MBSB
MNGT
MNRB
NPL
OLS
RHB
ROA
ROE
LIST OF ABBREVIATIONS
Asset Quality
Financial Reporting for Licensed Institutions
Capital Adequacy
Cash to Deposit
Earnings
Foreign Direct Investment
Federal Deposit Insurance Corporation
Financial Institutions
Malaysian Gross Domestic Product
Liquidity
Lonpac Insurance
Loan to Deposit
Malaysian Rating Corporation Berhad
Malaysia Building society Berhad
Management
Malaysian Reinsurance Berhad
Not Performing Loan
Ordinary Least Squares
Rashid Hussein Bank
Return on Assets
Return on Equity
vi
1
-==
I
RWCR Risk Weighted Capital Ratio
VIF Variance Inflation Factor
vii
CHAPTER 1
INTRODUCTION
11 Background
The global financial crisis from 2008 t02009 had brought huge impact for the world
economy due to the price of the assets which has been over inflated and caused the
sub-prime mortgage booming and exploding into housing and banking crisis with a
cascading effect on consumer and investment demand In addition the financial market
becomes panic due to the subprime mortgages and the failures of Lehman Brothers
and Washington Mutual in United States The government of United States had
implemented some solutions and actions to reduce the panics during the first half of
October by promoting the liquidity and the solvency of the financial sector reducing
the prices for the asset classes and the commodities the cost of the corporate and the
bank borrowing rose significantly and high volatility in financial market which
increasing infrequently In the case of Malaysian economy the countrys economy was
sheltered from the direct effects of financial exposure because the new derivatives were
not allowed into the country The global financial crisis may result the Governments
plans to achieve vision 2020 being interrupted because of decreasing in the exports and a
slowdown in foreign direct investment (FDI)
The financial services sector is the bedrock of any economy It is the key to the overall
economy by providing various fonns of capital to enable the growth of other
industries in the economy All large and successful economies require strong banks
system vibrant capital markets and well-functioning financial infrastructures
Moreover the sector is also a core component in a services-based economy and a key
growth engine in its own right As demonstrated by the emergence of international
1
___--==========-=-----------=---=------- ---_
II
shy
financial services centres worldwide the financial sector growth comes from serving
domestic businesses and consumers as well as tapping external markets and sources of
funds
Mansor (2007) states that financial liberalization and development has been the major
financial feature in many developing countries Malaysia is a highly open economic
country and it also witnesses a respectable economic growth and rapid financial
development since the introducing of Financial Sector Masterplan in 2001 the
Malaysian financial sector has undergone significant transformation and progress The
banking sector especially has undergone restructuring consolidation and
rationalization Moreover the flexibility and the performance of the financial
landscaping had been improved due to the transformation and deregulation and
liberalization Moreover a stable and effective financial sector will affect the
performance of the financial sector and it will become an important pillar of strength
in our economy
Schumpeter (1911) contends that the services provided by the financial intermediaries
are essential drivers for innovation and growth Well developed financial systems
channel financial resources to the most productive use Malaysias Prime Minister
Dato Sri Mohd Najib bin Tun Hj Abdul Razak states that financial sector in Malaysia
is expected to have a greater role in assisting the economic growth as Malaysia transit
towards achieving a developed economy status by year 2020 The financial sector is
able to assist the economy growth and encourage the economy transformation into the
next phase of development and provide the world class high value added financial
products and services at the competitive prices and speed up the new economic
sectors In order to enhance the economys expansion Government has taken the
2
initiatives to promote structural change within the economy and diversify the sources
of the financial sectors growth by offering liberalisation package from 2009 to 2012
The foreign equity limits of investment banks Islamic banks insurance companies
and Takaful operators had increased from 40 percent to 70 percent The alliances will
strengthen business potential and enhance the growth of the financial institutions
through international expertise and global network foreign shareholders The rapid
growth and the strong financial sector of the country will enable the consumers to get
more infonnation between the financial service providers the regulators and the
authorities will need to provide the conducive environment that raises the consumer
empowennent The more consumers can afford and able to buy the products or
services provided by of the financial institution such as commercial bank investment
company or insurances company will positively affect the perfonnance of the
financial sector
As a result the financial sector plays crucial role for the economic growth and the
countrys development From Table 1 it shows that then financial sector comprises of
26 institution consisting 4 commercial bank 6 insurance company 14 investment
holding companies stock broking companies finance companies and the exchange
holding companies The lists of the financial institutions in Table 1 are public listed
on the Bursa Saham Malaysia
3
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
I
RWCR Risk Weighted Capital Ratio
VIF Variance Inflation Factor
vii
CHAPTER 1
INTRODUCTION
11 Background
The global financial crisis from 2008 t02009 had brought huge impact for the world
economy due to the price of the assets which has been over inflated and caused the
sub-prime mortgage booming and exploding into housing and banking crisis with a
cascading effect on consumer and investment demand In addition the financial market
becomes panic due to the subprime mortgages and the failures of Lehman Brothers
and Washington Mutual in United States The government of United States had
implemented some solutions and actions to reduce the panics during the first half of
October by promoting the liquidity and the solvency of the financial sector reducing
the prices for the asset classes and the commodities the cost of the corporate and the
bank borrowing rose significantly and high volatility in financial market which
increasing infrequently In the case of Malaysian economy the countrys economy was
sheltered from the direct effects of financial exposure because the new derivatives were
not allowed into the country The global financial crisis may result the Governments
plans to achieve vision 2020 being interrupted because of decreasing in the exports and a
slowdown in foreign direct investment (FDI)
The financial services sector is the bedrock of any economy It is the key to the overall
economy by providing various fonns of capital to enable the growth of other
industries in the economy All large and successful economies require strong banks
system vibrant capital markets and well-functioning financial infrastructures
Moreover the sector is also a core component in a services-based economy and a key
growth engine in its own right As demonstrated by the emergence of international
1
___--==========-=-----------=---=------- ---_
II
shy
financial services centres worldwide the financial sector growth comes from serving
domestic businesses and consumers as well as tapping external markets and sources of
funds
Mansor (2007) states that financial liberalization and development has been the major
financial feature in many developing countries Malaysia is a highly open economic
country and it also witnesses a respectable economic growth and rapid financial
development since the introducing of Financial Sector Masterplan in 2001 the
Malaysian financial sector has undergone significant transformation and progress The
banking sector especially has undergone restructuring consolidation and
rationalization Moreover the flexibility and the performance of the financial
landscaping had been improved due to the transformation and deregulation and
liberalization Moreover a stable and effective financial sector will affect the
performance of the financial sector and it will become an important pillar of strength
in our economy
Schumpeter (1911) contends that the services provided by the financial intermediaries
are essential drivers for innovation and growth Well developed financial systems
channel financial resources to the most productive use Malaysias Prime Minister
Dato Sri Mohd Najib bin Tun Hj Abdul Razak states that financial sector in Malaysia
is expected to have a greater role in assisting the economic growth as Malaysia transit
towards achieving a developed economy status by year 2020 The financial sector is
able to assist the economy growth and encourage the economy transformation into the
next phase of development and provide the world class high value added financial
products and services at the competitive prices and speed up the new economic
sectors In order to enhance the economys expansion Government has taken the
2
initiatives to promote structural change within the economy and diversify the sources
of the financial sectors growth by offering liberalisation package from 2009 to 2012
The foreign equity limits of investment banks Islamic banks insurance companies
and Takaful operators had increased from 40 percent to 70 percent The alliances will
strengthen business potential and enhance the growth of the financial institutions
through international expertise and global network foreign shareholders The rapid
growth and the strong financial sector of the country will enable the consumers to get
more infonnation between the financial service providers the regulators and the
authorities will need to provide the conducive environment that raises the consumer
empowennent The more consumers can afford and able to buy the products or
services provided by of the financial institution such as commercial bank investment
company or insurances company will positively affect the perfonnance of the
financial sector
As a result the financial sector plays crucial role for the economic growth and the
countrys development From Table 1 it shows that then financial sector comprises of
26 institution consisting 4 commercial bank 6 insurance company 14 investment
holding companies stock broking companies finance companies and the exchange
holding companies The lists of the financial institutions in Table 1 are public listed
on the Bursa Saham Malaysia
3
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
CHAPTER 1
INTRODUCTION
11 Background
The global financial crisis from 2008 t02009 had brought huge impact for the world
economy due to the price of the assets which has been over inflated and caused the
sub-prime mortgage booming and exploding into housing and banking crisis with a
cascading effect on consumer and investment demand In addition the financial market
becomes panic due to the subprime mortgages and the failures of Lehman Brothers
and Washington Mutual in United States The government of United States had
implemented some solutions and actions to reduce the panics during the first half of
October by promoting the liquidity and the solvency of the financial sector reducing
the prices for the asset classes and the commodities the cost of the corporate and the
bank borrowing rose significantly and high volatility in financial market which
increasing infrequently In the case of Malaysian economy the countrys economy was
sheltered from the direct effects of financial exposure because the new derivatives were
not allowed into the country The global financial crisis may result the Governments
plans to achieve vision 2020 being interrupted because of decreasing in the exports and a
slowdown in foreign direct investment (FDI)
The financial services sector is the bedrock of any economy It is the key to the overall
economy by providing various fonns of capital to enable the growth of other
industries in the economy All large and successful economies require strong banks
system vibrant capital markets and well-functioning financial infrastructures
Moreover the sector is also a core component in a services-based economy and a key
growth engine in its own right As demonstrated by the emergence of international
1
___--==========-=-----------=---=------- ---_
II
shy
financial services centres worldwide the financial sector growth comes from serving
domestic businesses and consumers as well as tapping external markets and sources of
funds
Mansor (2007) states that financial liberalization and development has been the major
financial feature in many developing countries Malaysia is a highly open economic
country and it also witnesses a respectable economic growth and rapid financial
development since the introducing of Financial Sector Masterplan in 2001 the
Malaysian financial sector has undergone significant transformation and progress The
banking sector especially has undergone restructuring consolidation and
rationalization Moreover the flexibility and the performance of the financial
landscaping had been improved due to the transformation and deregulation and
liberalization Moreover a stable and effective financial sector will affect the
performance of the financial sector and it will become an important pillar of strength
in our economy
Schumpeter (1911) contends that the services provided by the financial intermediaries
are essential drivers for innovation and growth Well developed financial systems
channel financial resources to the most productive use Malaysias Prime Minister
Dato Sri Mohd Najib bin Tun Hj Abdul Razak states that financial sector in Malaysia
is expected to have a greater role in assisting the economic growth as Malaysia transit
towards achieving a developed economy status by year 2020 The financial sector is
able to assist the economy growth and encourage the economy transformation into the
next phase of development and provide the world class high value added financial
products and services at the competitive prices and speed up the new economic
sectors In order to enhance the economys expansion Government has taken the
2
initiatives to promote structural change within the economy and diversify the sources
of the financial sectors growth by offering liberalisation package from 2009 to 2012
The foreign equity limits of investment banks Islamic banks insurance companies
and Takaful operators had increased from 40 percent to 70 percent The alliances will
strengthen business potential and enhance the growth of the financial institutions
through international expertise and global network foreign shareholders The rapid
growth and the strong financial sector of the country will enable the consumers to get
more infonnation between the financial service providers the regulators and the
authorities will need to provide the conducive environment that raises the consumer
empowennent The more consumers can afford and able to buy the products or
services provided by of the financial institution such as commercial bank investment
company or insurances company will positively affect the perfonnance of the
financial sector
As a result the financial sector plays crucial role for the economic growth and the
countrys development From Table 1 it shows that then financial sector comprises of
26 institution consisting 4 commercial bank 6 insurance company 14 investment
holding companies stock broking companies finance companies and the exchange
holding companies The lists of the financial institutions in Table 1 are public listed
on the Bursa Saham Malaysia
3
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
II
shy
financial services centres worldwide the financial sector growth comes from serving
domestic businesses and consumers as well as tapping external markets and sources of
funds
Mansor (2007) states that financial liberalization and development has been the major
financial feature in many developing countries Malaysia is a highly open economic
country and it also witnesses a respectable economic growth and rapid financial
development since the introducing of Financial Sector Masterplan in 2001 the
Malaysian financial sector has undergone significant transformation and progress The
banking sector especially has undergone restructuring consolidation and
rationalization Moreover the flexibility and the performance of the financial
landscaping had been improved due to the transformation and deregulation and
liberalization Moreover a stable and effective financial sector will affect the
performance of the financial sector and it will become an important pillar of strength
in our economy
Schumpeter (1911) contends that the services provided by the financial intermediaries
are essential drivers for innovation and growth Well developed financial systems
channel financial resources to the most productive use Malaysias Prime Minister
Dato Sri Mohd Najib bin Tun Hj Abdul Razak states that financial sector in Malaysia
is expected to have a greater role in assisting the economic growth as Malaysia transit
towards achieving a developed economy status by year 2020 The financial sector is
able to assist the economy growth and encourage the economy transformation into the
next phase of development and provide the world class high value added financial
products and services at the competitive prices and speed up the new economic
sectors In order to enhance the economys expansion Government has taken the
2
initiatives to promote structural change within the economy and diversify the sources
of the financial sectors growth by offering liberalisation package from 2009 to 2012
The foreign equity limits of investment banks Islamic banks insurance companies
and Takaful operators had increased from 40 percent to 70 percent The alliances will
strengthen business potential and enhance the growth of the financial institutions
through international expertise and global network foreign shareholders The rapid
growth and the strong financial sector of the country will enable the consumers to get
more infonnation between the financial service providers the regulators and the
authorities will need to provide the conducive environment that raises the consumer
empowennent The more consumers can afford and able to buy the products or
services provided by of the financial institution such as commercial bank investment
company or insurances company will positively affect the perfonnance of the
financial sector
As a result the financial sector plays crucial role for the economic growth and the
countrys development From Table 1 it shows that then financial sector comprises of
26 institution consisting 4 commercial bank 6 insurance company 14 investment
holding companies stock broking companies finance companies and the exchange
holding companies The lists of the financial institutions in Table 1 are public listed
on the Bursa Saham Malaysia
3
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
initiatives to promote structural change within the economy and diversify the sources
of the financial sectors growth by offering liberalisation package from 2009 to 2012
The foreign equity limits of investment banks Islamic banks insurance companies
and Takaful operators had increased from 40 percent to 70 percent The alliances will
strengthen business potential and enhance the growth of the financial institutions
through international expertise and global network foreign shareholders The rapid
growth and the strong financial sector of the country will enable the consumers to get
more infonnation between the financial service providers the regulators and the
authorities will need to provide the conducive environment that raises the consumer
empowennent The more consumers can afford and able to buy the products or
services provided by of the financial institution such as commercial bank investment
company or insurances company will positively affect the perfonnance of the
financial sector
As a result the financial sector plays crucial role for the economic growth and the
countrys development From Table 1 it shows that then financial sector comprises of
26 institution consisting 4 commercial bank 6 insurance company 14 investment
holding companies stock broking companies finance companies and the exchange
holding companies The lists of the financial institutions in Table 1 are public listed
on the Bursa Saham Malaysia
3
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
_ _ _ ____ _
Table 1 List of Financial Institutions as Public Listed in Bursa Saham Malaysia
Code in Bursa
5185
1015
1155
1295
5258
2143
6688
3379
6483
8621
6459
1236
5053
6009
4782
1066
9296
4898
1163
5097
1198
1058
6139
5088
1818 1171
Financial Insituitions
Affin Bank Bhd
Ambank(M) Bhd (AMMB)
Malayan Banking Bhd
Public bank Berhad
BIMB Holding Bhd
ECM Libra Financial Group
Hwang-DBS Malaysia Bhd
Insas Berhad
KampN Kenanga Holding Bhd
LPI Capital Bhd (Lonpac Insurance)
MNRB Holding Bhd
MBF Holding Group (MBFHLDG)
OSK Investment bank Bhd
PacificampOrient Berhad
PacificMas Bhd (PACMAS)
RHB CAPITAL
RCE Capital
T A Enterprise Bhd
Allianz Malaysia Bhd
KURASIA (Kumia Asia Bhd)
MAA
MANULIFE
TAKAFUL
APEX Equity Holding Bhd
Bursa
MBSB
Sources Share Info Bursa Malaysia
111 Malaysian Gross Domestic Product (GDP)
Type of Firms
Commercial bank
Commercial bank
Commercial bank
Commercial Bank
Investment holding company
Investment banking group
Investment company
Investment holding company
Investment company
Investment holding company
Investment holding company
Investment holding company
Investment holding company
Insurance company
Investment holding company
Investment company
Investment company
Investment holding company
Insurance company
Insurance company
Insurance company
Insurance company
Insurance company
Stock broking company
Exchange holding company
Exempt Finance Company
Malaysia is a rapidly developing economy in Asia and the financial services sector is
an integral component of the economy The total population of Malaysia was 283
million (Census 2010) Besides that Malaysias GDP has a strong growth in year
2010 as shown in the Figure 1 the Malaysia real GDP growth rate was -72 percent
--==-o---===--=-----shy
4
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
$15000
$14000
$13000
S12OOO
Pu ot Khidmat Maklumat Akademik UNlVERSm MALAYSIA SARAWAK
largely driven by the Services sector and Manufacturing sectors of 68 percent and
114 percent respectively (Department of Statistic Malaysia 201 O)This is the positive
sign for the country since 2008 and 2009 which real GDP growth rate was -16
percent and 47 percent (CIA World Factbook)
Figure 1 Malaysia Real Growth Rate
GDP Growth Rate
800 1 700
6 00
5 00
j2006 2007 2008 2011
520~ 400
300 ~GDP Growth Rate
200
1 00
000
-100
-2 00
Figure 2 shows that the Malaysias GDP per capita was US$14744 and estimate that
in the Year 2011 the GDP Per Capita will increase to US$15579 As a result
Malaysia is a middle income country with the openness of economy to encourage the
foreign investor to invest in the country
Figure 2 Malaysia GDP Per Capita (US$)
Malaysia GOP Per Capita (US$)
$16000 $15579
-+-GDP Per Capita (USS)
$11000
$10000
2006 2007 2008 2009 2010 2011
5
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
112 Malaysian Financial System
The Malaysian Financial System consists of Bank Negara Malaysia (Central Bank of
Malaysia) banking institutions (commercial banks finance companies merchant
banks and Islamic banks) and a miscellaneous group (discount houses and
representative offices of foreign banks)As shown in Table 2 shown that the Malaysia
fmancial system is structures into two major categories Financial institutions and
Financial Market The Financial Institutions comprise Banking System and Non-bank
Financial Intermediaries The Financial Market in Malaysia comprises four major
markets which is Money and Foreign Exchange Market Capital Market Derivatives
Market and Offshore Market Besides that the banking system is the largest
component of the financial system accounting for about 67 of the total assets of the
fmancial system
On the other hand the Asian financial crisis of 1997 and 1998 had give a valuable
lessons for Malaysia by focusing on enhancing the institutional capacity through
consolidation and strengthening the regulatory and supervisory framework The
consolidation of 22 banks into 9 anchor banking groups has created sizeable and
profitable institutions that have stayed strong throughout the recent global financial
crisis The strong capital positions of banks coupled with ample liquidity in the
financial system provided a buffer against the global downturn The levels of nonshy
perfonning loans held by commercial banks declined in 2009
Besides that the debt market activities have remained strong and Malaysia continues
to be the third largest domestic currency bond market in Asia excluding Japan In
2009 total corporate debt issuance increased 22 percent year-on-year to reach RM61
billion In 2009 Malaysia had a dominant share in the global sukuk issuance market
6
~~~-~------------- ---shy
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
accounting for 47 percent of the global market Malaysia also has the largest Islamic
fund management industry in the world in terms of number of funds and is
recognised as a centre for product innovation in the realm of Islamic finance The
growth of Islamic finance owes much to the strong legal and regulatory framework
that has been established here In addition Malaysia has been recognised
internationally for its regulatory environment
Overall Malaysias financial services sector has enhanced its domestic
competitiveness and broadened its activities However some segments like banking
are maturing With a population of 28 million people the domestic market lacks the
necessary critical mass to further develop these segments Going forward there is a
need to look externally for growth and to develop new engines of growth
7
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
Table 2 The Malaysian Financial System
Financial Institutions
Banking System
bull Bank Negara Malaysia
bull Banking Institutions - Commercial banks
(Including Islamic Banks) - Finance Companies - Merchant BankInvestment Bank
bull Others - Discount houses bull Representative office of Foreign
banks - Offshore banks in Labuan
Non-Bank Financial Intermediaries (NBFI)
I
bull Provident and pension funds
bull Insurances companies (Including Takaful)
bull Reinsurance cos bull Development finance Institutions
bull Saving Institutions bull National savings bank - Co-operatives
bull OtherNBFI - Unit trusts - Universal brokers - Cagamas Bhd - Credit guarantee corp bull Leasing companies - Housing Credit Institutions - Factoring - Venture capital
Financial Markets
Money amp Foreign Exchange Markets
bull Money market bull Foreign exchange market
Capital market
bull Equity market
bull Bond market Public debt securities Private debt securities
Derivative markets
bull Commodity Futures
bull KUBOR Futures
Offshore market
bull Labuan International Offshore Financial Centre
Source Bank Negara Malaysia the Central Bank and the Financial System in Malaysia
8
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
113 Challenges in Malaysian Financial Sector
There are some challenges that being faced by the Malaysia financial sectors First
the industry has gone through a phase of consolidation the segment such as
investment banking and brokerage remain fragmented Besides that many of the
Malaysian banks are still significantly smal1er than regional powerhouses Apart from
this there is lack critical mass to attract significant levels of investment in Malaysian
capital market
Second Malaysias financial markets are lack of liquidity and diversity in capital
markets Before the Asian financial crises in 1997 and 1998 the capital markets have
lost some of their vitalities Moreover Malaysias liquidity ranking in Asia has
dropped from 3rd in 1996 to 14th in 2010 (The World Factbook) Between there is
also limited diversity in the market in tenns of investors products or currency
Third the level of personal financial literacy is low thus the growing consumerism as
well as changing in customer expectations There is a need to reinforce better
management towards their personal finances in order to achieve high income
economy Lastly the competition from other regional financial centres will affect the
performance of the local financial services sector Malaysia continues to face negative
perception issues due to the capital control measurement implemented during the
Asian financial crisis In addition the foreign financial centres have developed their
reputations as being open and pro-business As a result the foreign investor interest is
currently directed towards North Asia
Hence this study is to investigate and analyze the factors that affecting the financial
sector performance for the period 2006 to 2011 A question appeal from the study is
how the financial sectors services performs during the 2008 to 2009 and then after the
9
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
financial crisis A large number of studies on the banking sectors examme the
profitability cost efficiency and market performances of banks
The study investigates the performance of Malaysian financial services sector during
2006 to 2011 period The study focuses largely in the context of CAMEL which are
related to the capital assets management earnings and liquidity considerations
This chapter will proceed with the description of the problem statement and research
objective The significance of research will end with the research scope assumption
and limitation Chapter 2 will be focusing on the literature that related to performance
of financial sectors in Malaysia and South East Asia by various authors the definition
of CAMEL components and the relationship between the CAMEL and the
performance of the financial sectors Chapter 3 describes data and methodology
where it begins with the description of data sources and follows with the explanation
on the analysis of data As well as the components of the CAMEL and the financial
ratios used to evaluate the performances of the financial services sectors Chapter 4
represents and discusses the findings It includes analysis of data for the financial ratio
variables derived from CAMEL assumptions such as capital asset quality
management earnings and liquidity Chapter 5 concludes the research findings and
some suggestions to further refine future research on the international financial
sectors and performances of Malaysian financial sectors
12 Problem Statement
The Malaysian financial sector plays a crucial role in the economy Therefore the
instability of the financial sector will affect the economy development and overall
countrys development Mansor (2007) states that financial liberalization has been a
financial feature in many nations to develop and liberalize financial markets This
10
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
follows the argument that the development of the financial sector can promote growth
The economic growth will encourage more financial institutions financial products
and services emerge in the markets in response to the higher demand of financial
services
However the presence financial institutions in the Malaysia financial sector raised
some challenges which are lack of scale lack of liquidity and diversity in capital
market low levels of financial literacy and competitions from other regional financial
centre Lensik R amp Hennes N (2004) claims that the entrance of foreign investors
had increased the market competitions and improves the quality and the availability of
foreign financial institution and motivate the local financial institutions to enhance
their efficiency and increase the diversity and quality of financial services The
restructuring of the financial system policy by the Malaysian government after the
economic recession during had brought the important of the growth for local financial
development
As a result it is important to analyze the important of financial services sector in
Malaysia because of the stability of the financial services sector will encourage
economic growth and fast growing for a country development Apart from that
different structure and characteristics of financial institutions and the different
influence of external factors on these financial institutions will lead to differences
perfonnances between the financial services for instance the differences of
performances among commercial bank investment companies insurance companies
and stock broker In order to evaluate the financial sectors perfonnances the CAMEL
method was applied and as supervision tool and measure the banks current overall
financial managerial operational and compliance perfonnance The empirical
11
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
analysis will assists the financial institutions expand their financial services to the
international market to gain greater profit
The study is to identify what kind of factors will affect the performance of the
financial sector Besides that the relationship between the performance of the
fmancial sectors and the factors will be examined and analyzed in this study
Although there are many study had been done to analyze the financial sector around
the world based on the economic development and the financial indicators However
the study will use the financial ratios to analyze the performance of financial
institution as shown in the Table 1 based on the CAMEL approach on 26 financial
institutions comprising 4 commercial bank 6 insurance companies 13 investment
holding companies stock broking company finance company and the exchange
holding company
13 Theoretical Framework
131 Agency Theory
Agency theory or agency relationship is the theory which concern to the relationships
between the owners of the company in the form of shareholders (equity investors) and
those appointed to in charge for the company management which is a director of the
company The agency theory plays a crucial role for every aspects of the business
activity especially for the decision-making by directors which included executive and
non-executive directors) In addition the agency concepts had became more important
due to the global financial crisis especially the corporate collapses of the major
multinational companies for instance Enron 2001 WorldCom 2001 and Lehman
brothers 2008 and nationalization of many financial institutions
12
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
The theory stated that the owner of the company assigns the day to day decision
making to the directors who are shareholders agent Besides that the agents are no
necessary to make decisions according to best interest of the principal The personal
interests of companys senior managers can differ from the company shareholders
The manager and the owner of the company are differing to each other As a result
the board of director of the company plays a crucial role in balancing and control the
action of the senior management who control day to day operation of the company
and on the shareholders behalf
Apart from that the agency relationship occurred because of the different goals and
interests among the agents and the principals Bohren (1998) assumed that the
individual agents and principal that involved in the agency relationship are
opportunistic due to they are aiming to maximize their own interest Thus there is no
guarantee that agents will always act in the best interest for their principals Therefore
if the company unable to manage their agency problem in their company so it will
affect the company performance due to agents will only aim to maximize their own
interest from the company
132 Characteristics ofAgency Problems in Financial Institutions
According to the theory of the firm which views a firm as a nexus of contract
between parties and with conflicting interests (Jensen and Mekling 1976) the agency
problem may occurred among all stacks holders within the company However the
agency problem generally refers to conflicts of interest between firms management
(agent) and its owner (principal) Also the corporate governance is widely accepted
as a mechanism that makes the management (agent) operate the firms not for him own
sake but for the interest of the owner (principal) According to the work Fama and
13
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
Jensen (1983) which views an owner as a residual risk bearer and residual
claimholder a shareholder generally refers to the owner as who bears the residual
risk There is a substantial research studying the agency problem focusing on the
problems between companys shareholders and management
However the agency problem is not limited to the shareholders and management but
extends to the companys stakeholders One of the most critical is the conflicts of
interest between shareholders and debtholders In a company only after interest and
other payments are paid to its debtholders then shareholders hold unlimited claims
for the remainder On the other hand debtholders have fixed size senior claims to the
companys cash flows This arrangement creates incentives for shareholders to pursue
high-risk-high-return businesses to raise the expected value of residual claims This
may transfer wealth from debtholders to shareholders which goes against the
debtholders interest
The agency problem between the shareholders and debtholders is more important in
financial institutions because they hold their customers funds as debt and therefore
customers are debtholders This distinguishes the agency problem in financial
institutions form other types of firms for instances ordinary manufacturing
companies In a commercial bank fixed claims are widely dispersed among many
small deposit holders In this situation due to the well-known free rider problem
each deposit holder has little incentive to monitor and control business decisions made
by shareholders or managements In addition the protection for deposited principal
exacerbates this type of moral hazard Therefore potential agency costs incurred
between shareholders and debtholders can be significantly large
14
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15
Therefore for the sake of corporate governance of a financial institution it is not
sufficient to align only the interests of shareholders or management It is also
important to align the interest of shareholders or management and customers by
preventing from institutions the venturing excess high-risk-high-retum businesses
with customer deposit A possible solution is found in market discipline from
competition where customers pay enough attention when choosing a financial
institution or product However the complexity and information asymmetry which lie
in financial products can hamper the effective operation of market discipline The
other possible option is to strengthen the monitoring and discipline of managements
decision making by customers However this is not realistic considering the
customers lack of expertise and the aforementioned free rider problem In the end
the government may have to step in and represent the interest of customers and
taxpayers by monitoring and disciplining the decision making at financial firms In
todays market this takes the form of regulations and supervision over financial firms
lIDs provides partial explanation why regulations and supervision over the financial
industry are generally stronger than those over the general manufacturing industry
14 Conceptual Framework
Figure 3 shows that the diagram of the determinants for the performance of the
financial sector in Malaysia The independent variables comprise the financial
institutions capital adequacy asset quality management earning and liquidity
Furthermore the dependent variables are Return on Asset (ROA) and Return on
Equity (ROE) The performance of the financial sector will evaluate by using the
financial ratio The capital adequacy is related to the overall financial leverage of the
firms The high financial leverage will experience more volatile earni~g behavior As
15