Page 318 - Contributed Paper Session (CPS) - Volume 4

CPS2245 Azrie Tamjis
1. Introduction
Malaysia was hit by the Asian financial crisis in 1997–98. The Malaysian
Ringgit fell by 40% against the US Dollar; the stock market plunged by over
70%, resulting in extreme volatility in financial markets and the country’s
sovereign rating being downgraded (Jomo and Chin, 2001). The scenario
worsened as economic activity declined: GDP contracted by 7.5% with weak
regional export demand; companies were in distress and unable to service
debt and over leveraging. In the banking system, the number of non-
performing loans (NPLs) increased sharply, which caused capital erosion due
to over-concentration of risk (mainly in the large corporate sector). At the
same time, the intermediation process was also inefficient due to tight liquidity
and loan growth moderated sharply.
The FSMP initiatives changed the financial landscape of the banking
industry. As of 2011, the banking industry was consolidated and rationalised,
from 33 domestic financial institutions into eight banking groups (Abdul Majid
et al., 2011). Banks were also found to be diversifying and improved their
efficiency in delivery channels for financial products and services by enhancing
access to financing, particularly for SMEs and consumers. These changes
diversified the financial sector, with a deep and liquid debt securities market
and a better focus on investment banks assisting corporations to get
alternative finance in the bond market. Banks are now more focused on
corporate governance and risk management, particularly with the
implementation of principles-based regulations, coupled with an adequate
supervisory and surveillance framework. Moreover, the market structure has
improved, with an increased emphasis on market orientation, supported by
greater regional cooperation, increased competitive pressure from new and
current foreign banks, and freedom in the pricing of lending and deposits.
Similar to initiatives in other developing countries, the objectives of these
reforms and liberalisations, via the FSMP, are to promote diversity, efficiency
and productivity, and to facilitate a competitive banking system by improving
resource allocation and building a stronger economy (Fry, 1995). As a
consequence, banking efficiency received even more attention in the
aftermath of the financial crisis, with structural reforms and liberalisations,
rendering the examination of this banking efficiency an important issue for
1
both the public and policymakers alike (Berger and Mester, 1997).

1 Improved banking efficiency could result in better resource allocation, which benefits society by
intermediating greater amounts of funds, providing more products with better prices and service quality
for customers, improving bank profitability and achieving greater safety and soundness in banking sector
(Berger and Mester, 1997). Therefore, the study of efficiency could assist banking regulators to design
policies by evaluating the impacts of financial liberalisation, consolidation and market structure on
efficiency.
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