Problem Statement
Discuss about the Determinants of local commercial bank’s profitability in Malaysia.
The financial crisis that took place in the year 2008 was the initiation towards the financial distress in many companies throughout the world. The banks had struggled during this period and therefore most of their financial tools had an impact as it is seen that loans were even defaulted (Noman et al., 2015). The commercial banks have an essential role in order to maintain sustainability of the economy of a nation as it is seen that the performance of the banks can not only have an impact on the financial sector but may even have an impact on the other sectors as well. The key economic role of a banks has been to facilitate the fund flow from the additional funds to the deficit funds and this explains that the commercial banks performs as a representative to control the funds in the economy and also provide credit within the economy.
Petria et al., (2015) explained that the commercial banks in Malaysia is the powerful financial organizations and they play a vital role in stabilizing the economy and the hence the commercial banks need to perform in an effective manner in order to create financial benefits and profits to the individuals, companies, government and even to the household. The banks who are able to attain consistent profits become more competent in order to withstand the negative shocks and therefore are able to live through the time of financial crisis within the economy.
The businesses and organizations that are in nature risky like investment and the lending is the main business activities of the banks. This suggests that the banks are vulnerable to uncertainties and risks. Sufian, & Kamarudin (2016) explained that there exists a positive trade-off among the return and risk and this suggests that increased amount of risk leads to increased returns. Hence, the assessment of the determinants of the profitability of the banks becomes an essential issue for any bank. In order to control and manage these determinants of the profitability of the banks in an efficient manner, the banks need to know and gain understanding about the effect of the determinants on the profitability of the banks. Furthermore, the banks with sound and effective banking process will have the ability to enhance the financial stability and would be able to manage and take care of the negative shocks of the economy in an effective manner. This topic therefore creates greater amount of risk and challenge and therefore are able to attract the interest of the researchers and the management of the banks for more discovery and exploration.
Importance of Banks’ Performance
The risks that are known to be default or credit is one of the key issues for the banks where it is seen that decline in the quality of the asset will lead to the failure of the banks which can have an influence on the entire economy badly. However, the study that was undertaken by Kiganda, (2014), it has been stated that there exists negative relationship among the profitability of the banks and credit risk. It is even seen that the banks that have lower level of liquidity is due to the fact they are unable to gain adequate funds, which has an impact on the performance of the banks and thereby efficiency of the banks gets hampered. Hence, the liquidity risk is even known to be one of the financial risks that have an influence on the profitability of the banks. Onuonga, (2014) discovered that the liquidity variable does not have an impact on the profitability of the banks. Hence, in this specific paper, the discrepancy outcomes of these variables with the previous researches will be examined and investigated. Furthermore, interest rate, inflation and several other variables that are associated to the bank and the macroeconomic factors would be taken into consideration in order to discover the aspects that have an impact on the profitability of banks in Malaysia. It is known that the overall trend of profitability of the Malaysian banking system has been looked upon to be stable and it is even seen that Malaysia is not impacted by the financial crisis. Therefore, it becomes important to understand the potential external and the internal factors that leads to the significant amount of changes to the profitability of the banks in Malaysia and therefore captures the idea and the attractiveness towards the precise assessment. This research would therefore look to assess the probable determinants of the profitability of the banks and address the relationship among the profit of the banks and the associated determinants.
The theoretical framework refers to the theories that look to explain the philosophy associated to the research and it assists on the creation of the link among the theoretical elements and the practical applications. This section would therefore address the theorized relationship among the variables and assists to create a logical aspect of relationship among the variables so that it would act as a base to construct the proposed conceptual model (Frederick, 2014). There have been several theoretical frameworks that have been used in the past studies and these models would be helpful in creating a relationship among the dependent and the independent variables like return on asset, credit risk and liquidity risk and even create an understanding of the other variables like the size of the banks, GDP, inflation and competition.
Assessing Determinants of Bank Profitability
This theory even reveals a negative relationship among credit risk and the profitability of the banks. Ho, & Heang (2016) addressed the fact that if the extent of loss of loan provisions is increasingly high this would mitigate the ability of the banks to supply loans to the consumers and this would lead to credit shortage and thereby would mitigate the lending operations of the banks and thereby reduce their extent of profits. It is similar to the credit rationing theory which regarded to be a scenario where the lenders are unable to supply credit to the borrowers who are in need of funds and this even addresses that the demand for credit overcomes the credit supply. In this scenario, the borrowers are willing to pay increased rate of credit but the banks are unable to provide the credit to the shortage of credit that takes place to the increased loan loss reserve.
This theory addresses the fact that the bigger companies are able to attain cost benefit when they manufacture outputs. This addresses the fact that when the output scale is enhanced, the aggregate cost per unit would diminish. It is seen that the economies of scale addresses the positive relationship among the profitability and the size of the banks. Ir-library.ku.ac.ke, (2018) explained that bigger banks are able to take the benefit out of the economies of scale as it is seen that the bigger banks are able to diminish the collection cost and evaluation of the data which is leads to the rise in the profitability of the banks.
This theory has addresses the capability of the banks and other financial institutions to have an impact on the price and the quantity in the market. The market power theory is implied in the banking industry which addresses the profitability of the banks would be impacted by their market share and the theory explains the fact that there is a positive relationship among market share and profitability of the banks (Al-Jafari, & Al Samman 2015). The extent of market share has a positive relationship with the size of the banks due to the fact that the larger banks have the ability to exercise market power in order to have an influence on the price in order to lower the rate of deposits and thereby charge increased amount of loan rate in order to earn profits that are non-competitive in nature.
Gyamerah, & Amoah (2015) explained that Gross Domestic Product (GDP) is utilised as a measurement of the impacts of the cyclical input. It is seen that GDP has a positive relationship among the profitability of the banks and GDP. It is seen that when the GDP of a nation increased the demand for the financial services like loans would be increased as the customers are in need of funds in order to take care of their business activities and thereby leading an increased income for the banks. The rise in the activities of the business would increase the growth of the GDP which would again increase the profitability of the banks. Therefore, it is seen that each one of them is inter-related to each other and therefore discloses a positive relationship.
Review of Relevant Theoretical Model
This method is applied in order to have an understanding of the relationship of the profitability of the banks and the liquidity risk. The degree of liquidity risk is associated to the ability of the banks to maintain liquid asset and cash. The extent of liquidity discloses the banks to ability to pay off the short term demands of the customers (Ali et al., 2015). It is seen that there exists a negative relationship among the profitability of the banks and liquidity risk as it is seen that liquidity risk reduces the extent of profitability of the banks as the risk reduces the liquid asset that is available to the banks which in turn can have an impact on the extent of profit and accordingly reduce the performance of the banks as well.
Parametric model is a limited model and non-parametric model is an unrestricted model. The two models are utilised in order to understand the relationship among the credit risk, inflation and interest rate risk along with the profitability of the banks. This model undertakes extensive analysis and by evaluating the relationship among profitability of the banks along with inflation, which is done with the help of R-Squared Model, it is seen that there exists a negative relationship (Jimf-bi.org, 2018). It is seen that the rise in the level of inflation reduces the deposits in the banks and therefore the banks increases their rate of interest in order to reduce reduce the customer from taking more loans and hence, it is seen that the profitability of the banks gets hampered.
The monetary policies that are constructed by the government of the country have an impact on the extent of the profitability of the banks. It is seen that monetary policies are helpful in the rise in the supply of money and this in a way would increase the extent of funds that are available to the commercial banks. The extent of fund that is available to the banks even increases their interest income. It is even seen that the rise in the demand for bonds from the banks increases their price as well. Onuonga, (2014) explained that there exists a negative relationship between the rate of interest and the price of bonds and therefore higher price of bonds would lower the rate of interest and this would have an impact on the rate of consumption among the customers and thereby increase the investment rate as well. This would lead to the rise in the extent of scale of commercial bank credit, which would be helpful in the rise in the profitability of the banks.
Credit Rationing Theory (1969)
Reference List
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