Impaired Financing Determinants of Islamic Banks in Malaysia

Abstract

Despite commendable growth of Islamic banking on a macro level, impaired financing is an issue among Islamic banks at the micro level. The 2008 Global Financial Crisis shows large credit risk was largely attributable to staff inefficiency. This study investigates the moderating effect of staff efficiency on determinants of credit risk or impaired financing of sixteen Islamic banks in Malaysia over the 2005-2013 periods. The determinants include new variables such as political stability index and corruption index besides GDP, inflation, finance to deposit, loan loss provisions, liquidity, capital, net interest margin, profitability, loan growth and net charge offs. The study highlights new findings where impaired financing reduced with higher political stability index and corruption index. Loan loss provision has significant positive whilst loan growth has negative impact on impaired financing. Staff efficiency significantly moderates the impaired financing relationship with capital ratio, profitability and loan growth. This relationship yields model fit of 0.889. The results support Resourced - based Theory and provide statistical evidence of the importance of staff efficiency in managing banks’ credit risk. None of the external factors had significant influence on impaired financing, which statistically proved that the profit and loss sharing concept of Islamic banking provides effective tool to mitigate external risks.

Moderating Role of Intellectual Capital between Relationship of Bank Specific Factors and Credit Risk of Islamic Banks

“…It shows that the relationship between credit risk and commercial bank performance is negative and significant. Nor and Ahmad (2015) revealed that impaired NPL financing reduces bank profitability and growth that ultimately impacts the country's economic growth. Berger and DeYoung (1997) illustrate the connections between bank-specific factors and focus on indicators of efficiency and problem loans.…”

“…On the other hand, the global financial sector has undergone more than 100 crises over the past three decades (Stiglitz & Stiglitz, 2003). Many researchers such as Hassan and Kayed (2009); Nor and Ahmad (2015) argued that the unethical and moral hazard issues such as risk mismanagement, debt default, imprudent mortgage loan, inadequate transparency, human frailty, and complex financial instrument are the major reason behind the crisis. These crises have enforced that ethics issues are linked to the survival of the financial system.…”

The Moderating Role of Staff Efficiency in the Relationship between Bank’s Specific Variables and Liquidity Risk in Islamic Banks of Gulf Cooperation Council (GCC) Countries

“…In addition, the theory of financial intermediation from the Islamic banking perspective stressed that the Islamic banking is not just intermediaries but also a business entity to run the provided capital by the depositor or capital provider (Nor et al, 2015). In a similar token, Bariah, Hubeis, and Hafidhuddin (2015) quoted Danuwirana (2012) stressing that Islamic human resources are required to have core competence in various areas including functional (expert in Islamic economics, banking operations, finance administrations, financial analysis) and managerial skills.…”

“…There is handful number of research on the moderating role of staff efficiency in financial risk literature. Nor et al (2015) reported high significant level (0.01) of the impact of staff efficiency on reducing impaired financing (credit risk). The authors stressed that banks' management should give identical importance on increasing the role of staff efficiency in managing credit risk.…”

“…With respect to liquidity risk, earlier research has ignored staff efficiency which creates a gap in the existing literature. Nor et al (2015) focused only on credit risk and this variable has not been yet tested on liquidity risk. in conjunction with this, since other risks like credit, market and operational risks directly or indirectly have impact on liquidity risk, AbdulGaniyy et al 2017, it can be suggested that staff efficiency should be used as a moderator variable between bank's specific variables and liquidity risk.…”