The Effect Of Liquidity On The Profitability And Insolvency Risks Of Commercial Banks In Malaysia

Abstract

Studies in Malaysia and other countries indicated that banks suffered from liquidity risk issues which affect their performances and triggered the 2008 financial crisis. This study used secondary data from 2000 to 2016. The objectives of the study is to; (i) analyze the effect of bank specific factors and macroeconomic factors on profitability and insolvency risks (measured through Z score) of Islamic banks (IB) and conventional banks (CB) in Malaysia, (ii) analyze the effect of bank specific factors and macroeconomic factors on the liquidity of Islamic and conventional banks in Malaysia, (iii) examine the effect of liquidity on profitability and insolvency risks of Islamic and conventional banks in Malaysia, and (iv) compare the profitability, insolvency risks and liquidity of Islamic and conventional banks before and after the 2008 financial crisis. Drawing upon the concepts of risk absorption, balance portfolio, efficient structure, signalling, uncertainty, life circle consumption, structure conduct performance, and risk-return tradeoff, this study identifies the similarities and differences across these factors for pooled, Islamic and conventional banks samples. For pooled study, (i.e. X on Y), the findings show an insignificant relationship for all the bank specific factors and macroeconomic factors on profitability. Capital adequacy ratio (-ve), earnings quality (-ve), concentration risk (-ve), gross domestics products (GDP) and inflation (-ve) are found to have a significant effect on insolvency risks. As for the effect of these factors on liquidity (i.e. X on M), only capital adequacy ratio (CAR) is found to have a significant positive impact on liquidity. Splitting the data between Islamic and conventional banks; for Islamic banks samples, the research found that only efficiency (-ve) has significant effect on profitability. In addition, only concentration and GDP have a significant positive effect on insolvency risks. For conventional banks, only CAR (-ve) and assets quality (-ve) have a significant impact on profitability. However, concentration, GDP and inflation are the factors that have a significant impact on insolvency risks. With regards to the effect of X on M, CAR, concentration (-ve) and GDP (-ve) are found to have significant impact on liquidity for both Islamic and conventional banks. As for impact of M on Y, liquidity significantly affect the insolvency risks (-ve) in pooled and Islamic banks study only. For all the studies, though the banks were found to have adequate liquidity, it insignificantly effect their profitability. This might be due to the absence of instruments to manage the excess liquidity and thus, negatively effect the banks solvency. Accordingly, the Malaysian government through Bank Negara Malaysia (BNM) needs to constitute policies for all banks after the crisis that will enable them to have a better and sustainable liquidity structure, these includes a mechanism that will attract a more long term funding and more secured investments. Further study should explore other possible mediators and use more items for each latent variable (i.e. efficiency ratio, concentration risk, assets quality etc.). Notwithstanding, a comparison between developed and developing countries study will also be feasible.