Analysis: Impact of Low Interest Rates on Malaysian Banks (2015-2020)

This report delves into the impact of low interest rates on the Malaysian banking sector from 2015 to 2020. It begins with an introduction to the changing global financial markets and the risks faced by financial institutions, including credit, market, and operational risks. The literature review explores various studies on the effects of low interest rates on banks, covering topics such as profitability, risk-taking behavior, and customer saving behavior. The report analyzes the risks associated with banks in Malaysia, followed by data collection and calculation, critical analysis, and an executive summary. The findings highlight the negative impacts of low interest rates on banks' profitability and risk-taking behavior, emphasizing the importance of effective risk management and the need for banks to adapt to changing economic conditions. The report also discusses the relationship between monetary policy and bank profitability, as well as the impact of globalization and collective savings on interest rates and profitability.

Table of Contents
1. Introduction …………………………………………………………….. 2
2. Literature review ………………………………………………………… 4
3. Risks associated with banks in Malaysia ………………………………… 8
4. Data Collection and Calculation. ………………………………………… 9
5. Critical Analysis. ………………………………………………………… 10
6. Executive Summary. …………………………………………………….. 13
7. References …………………………………………………………………14
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Impact of low interest rates on Banking Sectors of Malaysia (2015-2020)
1. Introduction.
Current digital world is rapidly changing due to which global financial markets are also rapidly
changing. Financial institutions like conventional and Islamic banks are facing difficulties in
their operations because risks are associated with them. These risks are credit risk, market risk
and operation risks etc. These all risks are sometime collectively hit an institution and totally
destroy its structure. Risks are associated with every organization and in order to control or
reduce these risks every organization must have information about each risk and the process
through which they can be measure. They must know that which type of risk is very harmful for
them and need to be control. Some experts are considering that Islamic banks are risk free but as
Islamic banks are also engage in operations thus they are also facing risks like other financial
organizations are facing.
This study focuses on which types of risks are associated with financial institutions like Islamic
and conventional banks in Malaysia. How these risks are harmful for them and through which
procedures these risks can be control. How global financial crises affect financial institutions
and what are the effects of low interest rates on financial institutions.
Many studies regarding global financial crises and low interest rates are published through
which we can understand the concept and get some insight for further study.
Bikker and Vervliet (2018) investigated the impact of low interest rates on profitability and risk
taking in banking sector for the period of 2015 to 2018. They explain that low interest rate
environment negatively impact banks profitability and risk taking. Banking sector did not
compensate for their lower interest rate as they expand their operations due to which they focus
on trading activities with higher risk. In addition they express that low interest rate not only
effect profitability negatively but also effect other operations of the business credit risk etc.
Finally they conclude that low interest rates environment is the key factor for any failure in
banking sector because banks are totally depends on interest rates.
Chang Shu et al (2003) they study the impact of low interest rates on banks for the period of
1992-2002. For this purpose they consider banks assets quality because it affect positioning
charges and second net interest margin because it affect profitability yield. The results reveal
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that decline in interest rates impact negatively Banks’s profitability. Because interest rates of
deposits are more related with volatility of interest premium than lending interest rates. In
addition they explain that change in local interest rate combine with US interest rate has little
impact on the margin during the period of the study. Finally they conclude that low interest
rates are very dangerous for the financial health of banks and banks with low financial health
can be default. Deborah O et al (2013) they study the association between
interest rates and customer saving behavior in Nigerian banking sector. For this purpose the
researchers study the association between commercial lending, average income, legal rights
strengths, annual losses of commercial banks and central bank’s monetary policy. The results
show that all factors are positively related with customers saving behavior because during the
study period Banks’s deposits increased. In addition they explain that all factors highly related
with banks profitability in long run, in short rum some factors were positively related while
others have no association with banks profitability. Finally they conclude that customer saving
behavior and interest rates are positively associated with banks deposits.
Delis and Kouretas (2013) this study show the relationship between interest rates and risk taking
behavior of the banks. The researchers have studied approximately 18000 annual observations
of EURO area banks for the period of 2001-2008. The empirical results show that low interest
rates increase banks risk taking behavior. Furthermore they explain that low interest rates
negatively affect banks deposits due to which their profitability decrease. In addition they
explain that banks are very strongly associated with volatility in interest rates. Finally they
conclude that with decrease in interest rates banks risk taking behavior is increased.
Peydro et al (2018) this study shows the relationship between standard and non-standard
monetary policy and bank profitability. For this purpose the researcher gather data for the
period of 2013-2018. The results reveal that monetary policy decrease short term interest rates
of banks and thus affect banks profitability negatively. Furthermore they explain that
accommodative monetary policy affects the main components of the profitability. In addition
they explain that monetary policy during low interest rates period surprises us by showing
improvement in stock prices and CDS. Finally they conclude that monetary policy negatively
affects banks profitability in long run while positively affect profitability main components in
short run.
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2. Literature review.
Various studies are conducted regarding the impact of low interest rates on banks or financial
institutions some of them are given bellow.
Awdeh et al (2012) they study the association between low interest rate environment and banks
profit margin. For this purpose the researchers analyze data for the period of 2011-2015. The
researchers gather data of 50 US banks. The results reveal that return on investments and return
on equity are decreased during low interest rate period while stock prices increase. In addition
they explain that stock prices have no association with low interest rates in short run while in
long run stock prices also affect negatively. Furthermore they express that low interest rates
decrease banks deposits due to which main stream profitability component decreases thus as a
result banks profitability also decreases. Finally they conclude that all factors of profitability are
highly associated with low interest rates that negatively affect profitability.
Hofmann et al (2015) they study the effect of monetary policy on banks profitability. They
analyzed the data of 109 international banks of 14 advanced economies for the duration of 1995
to 2012. The results reveal that monetary policy and bank profitability has positive relationship.
This means that return on assets have no affect due to low interest rate policy by the central
bank. This submits that positive affect on low interest rate structure dominates the negative one
on loan loss provisions with non-interest income. Furthermore they explain that the affect is
even stronger when the interest rate is lower and the curve was less steep. Finally they conclude
that low interest rates and banks profitability are highly correlated.
Kozak (2016) this study show the association between low interest rates and banks profitability
for the period of 2008 to 2014 of 488 listed banks of Poland. The show the effect of low interest
rates on return on assets, return on equity and sales. The results show that low interest rates
affect all variables of concern and have positively correlated. Furthermore the study explains that
interest rates in a country are decreases due to globalization and collective savings. In addition
the study explains that globalization and collective saving have direct impact on banks
profitability. Finally the study concludes that low interest rates and profitability are highly
correlated.
Borio (2015) this study show the causes and consequences of low interest rates in the banking
sector of different countries. The study considers return on equity and gross profit margin as
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proxy for profitability. The results indicate that High profile banks in A+ category show positive
profitability while low category banks X show negative profitability. Furthermore the study
explain that high profile banks always hedge their funds against risk that’s why low interest rate
cannot affect them while low profile banks always risk taking and did not take care of risk thus
due to poor risk management they affect.
Schnabl et al (2017) they tested the association between low interest rates and banks financial
health for the period of 2011 to 2018. The analyzed the data of 40 international banks of
advanced countries. The results reveal that low interest rate environment affect financial
conditions of any bank because it affect deposits other main components of the profitability of
the banks. Furthermore they explain that low interest rates not only affect profitability but also
damage reputation of the banks due to which customers lose confidence and affect the bank
reputation in long run... Finally they conclude that low interest rates are highly harmful for banks
in long run. In short run it only affect profitability and no other components of the profit.
Kozarik and Dzelihodzic (2020) they study the relationship of low interest rates environment and
banks profitability. For this purpose the researchers analyzed the data of Bank of Bosnia and
Herzegovina for the period of 2008 to 2018. They consider return on equity as proxy for
profitability of bank. The results reveal that low interest rate environment positively affect banks
profitability while negatively affect in short run. In addition the results explain that low interest
rates also affect banks other products like CDS and repurchase agreements. Finally they
conclude that low interest rates are highly beneficial in long run while in short run banks must
hedge their funds.
Zeman and Jurca (2008) they study the relationship among low interest rate environment and
banks return margin. For this purpose the researchers analyze data for the period of 2005-2015.
The researchers gather data of 110 Slovakia banks. “The results reveal that return on investments
and return on equity are reduced during low interest rate period though stock values increase. In
addition they clarify that stock values have no link with low interest rates in short run while in
long run stock rates also affect negatively. Furthermore they express those little interest rates
decreases banks guarantees due to which key stream profitability component decreases thus as a
result banks productivity also decreases”. Lastly they conclude that all factors of profitability are
highly related with low interest rates that negatively affect productivity.
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Said and Tumin (2011) they test the relationship of financial ratios and financial performance of
banks in china and Malaysia. For this purpose they analyzed data of four banks of china and
eleven banks of Malaysia for the period of 2001 to 2007. The collect data from financial
statements and evaluated. They considered liquidity, capital, credit and operating expenses as
bank specific factors while return on average assets and return on average equity for financial
performance. The results show that except credit and capital ratios all factors are differently
related and impact on financial performance of banks in china and Malaysia. Furthermore they
explain that operating ratios are positively affecting financial performance in China but this
influence is not true for Banks in Malaysia.
Spiegel et al (2018) they study the impact of negative nominal interest rates and banks
profitability. For this purpose they analyzed the data of 5100 banks of 27 countries for the period
of 2010 and 2016. The results show that low nominal interest rates negatively affect banks with
low securities and loans. While those banks that has more cash and assets are not associated with
nominal interest rates and have no impact on banks profitability. Furthermore they explain that
low deposit banks enjoyed high income during low interest rates environment while high deposit
banks enjoyed low income during low interest rates environment. Finally they conclude that low
interest rates environment is highly negatively correlated with banks profitability in short run.
Cheng et al (2020) they study the effect of low interest rates on small economies profitability.
They analyzed the data of 100 international banks of 40 advanced economies for the duration of
2011 to 2020. “The results reveal that monetary policy and bank profitability has positive
relationship. This means that return on assets have no affect due to low interest rate policy by the
central bank. This submits that positive affect on low interest rate structure dominates the
negative one on loan loss provisions with non-interest income. Furthermore they explain that the
affect is even stronger when the interest rate is lower and the curve was less steep”. Finally they
conclude that low interest rates and banks profitability are highly correlated.
Holten et al (2020) they test the relationship of financial ratios and financial performance of
banks in Malaysia. For this purpose they analyzed data of four banks of china and eleven banks
of Malaysia for the period of 19902 to 2010. “They collected data from financial statements and
assessed. They considered liquidity, capital, credit and operating expenses as bank specific
elements while return on average assets and return on average equity for financial performance.
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The results display that except credit and capital ratios all elements are differently related and
impact on financial performance of banks in Malaysia”. Furthermore they explain that operating
ratios are positively affecting financial performance Malaysia.
Miteva (2020) this study aims to test the association between negative interest rate policies of
central banks on interest rates of bank. For this purpose the researcher analyzed 158 months
observations. The results reveal that there is strong correlation between short term deposits
interest rates and short term loans for non-financial institutions in Bulgaria Germany. The study
also explains that in general the volume of deposits is not correlated with interest rates.
Furthermore the study express that low interest rate environment has huge impact on
consumption loan of households. In addition the study explain that it is found that weak or no
correlation found between deposit rates and credit cards rates in Germany. Finally the study
conclude that low interest rates environment is harmful for banks and central banks should
regulate such policy through which financial as well as non-financial corporation get high
income and gain their customer confidence.
Shean (2020) this study explains the impact of Covid-19 pandemic on Malaysian banks.
Financial crises of 1997 and financial crises 2007 have thought great lesson to Malaysian banks
therefore government has implemented Movement control program in order to deal with covid-
19 pandemic. But despite of implementing control program banks are facing some problems.
Bank Negara Malaysia cut down the interest rates that affected their interest income negatively.
Low interest rate is attractive for borrowers but it is very dangerous for banks because with low
interest rates banks will lose deposits, because due to low interest rates customers will not
deposit money in bank’s savings account. Moreover bank Negara close most of their branches in
all parts of the country due to Covid-19 due to which their regular or daily earning of bank
charges through different transections are reduced. Thus Covid-19 effected Malaysian banks
negatively. Finally this study concluded that low interest rates affect the profitability of the banks
negatively.
Xeng and Waha (2019) they explain different types of risks and their impact on banks in the
context of Malaysia. For this purpose they analyzed ten banks of Malaysia for the period of 2001
to 2010. They explain that there are different risks are associated with the banks of Malaysia but
the most dangerous and considerable risk for them is market risk. Central bank of Malaysia
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regulate banking industry by providing financial support and training in the area of banking
sector to the human resource of these banks. Thus the banks of Malaysia have experts that
manage and control all types of risk efficiently.
3. Risk associated with Banks in Malaysia.
Risk is the possibilities of loss in term of financial resources or it can be in term of image or
reputation. The following risks are associated with banks.
I. Credit risk :
According to the Basel committee of supervision of banking, it is the risk that the
borrower of the loan will not be able to meet the agreement requirements with bank.
Credit risk usually comes from loans acceptance, interbank transactions, trade
financing, foreign exchange transactions, Swaps, equities, options and bonds etc.
II. Market risk:
The Basel committee of supervision of banks defines market risk as: the risk which
occurs due to fluctuation or volatility of market prices of interest rates, instruments,
equities, commodities and currencies prices. Some of the examples of market risks are
interest rate risks, equity risk, currency risk and commodity risk.
III. Operational risk:
According to the bank of international settlement it is the risk that occurs due to
inadequate or inappropriate processes, people and system or from external situations. It
includes legal risk but exclude reputational and strategic risk. This risk can be possibly
occur due to human, information technology and processes but operational risk in banks
usually occurs due to mistake or human errors.
IV. Liquidity risk:
Possibility of loss occur due to a situation where there will not be enough cash or cash
equivalent to meet the needs of depositors and borrowers or liquid assets will not be
sold at the desired time due to lack of purchasers.
V. Business risk:
This is risk is the possibility that a company or bank will have lower profit than the
expected profit or the company or bank will have loss rather than profit. In banks
business risk is the risk associated with the failure of bank’s long term strategy,
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estimation of forecasted revenue and number of other things related to probability. Thus
business risk can be come from external sources or internal sources. The entire banking
industry is very unpredictable thus all banks must have back up in order to hedge
business risk.
VI. Reputational risk:
The Federal Reserve board in the US defines reputational risk as the potential loss in
reputational risk as the potential loss in reputational capital based on either real or
perceived losses in reputational capital.
VII. Systematic risk:
Systematic risk is the risk is the risk that not only affects one financial institution or
bank but also affect the whole industry. The risk that occurs due to failure of one big
member of the industry and thus affect the whole industry.
VIII. Moral hazard:
This is a risk in which one big financial institution take risk knowing that someone
other will face the burden of this risk.
4. Data Collection and Calculation.
There are total twenty seven (27) commercial banks in Malaysia and sixteen (16) Islamic banks
in Malaysia. From twenty seven commercial banks three commercial and from sixteen Islamic
banks three Islamic banks are selected. These banks are:
Affin Bank Berhad, Alliance Bank Malaysia Berhad, AmBank (M) Berhad and Bank Islam,
Alliance Islamic Bank, Alkhair Islamic International Bank. The variables selected are return on
assets, which is the ratio between net income and total assets, return on equity, which is the ratio
between net income divided by total shareholders’ equity and total Credit. Data collected for
these banks from the official websites of these banks from 2015 to 2020 for the period of six
years. Data regarding these variables is extracted from annual reports of the concern banks.
Yearly data of each bank is taken for further analysis. Below given table summarizes the
required data from 2015 to 2020 for the required variables such as ROA, ROE and CR.
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Variables Conventional Banks Islamic Banks
Affin
Bank
Berhad
AllianceBank
Malaysia
Berhad
AmBank
(M)
Berhad
Bank Islam Alliance
Islamic
Bank
AlkhairIslamic
International
Bank
ROA (2020) 0.70 0.7 0.9 0.44 0.7 -4.0
ROA (2019) 0.68 1.0 1.1 0.10 1.0 -4.6
ROA (2018) 0.69 0.9 0.9 0.78 0.9 -1.8
ROA (2017) 0.60 0.9 1.1 0.25 0.9 -2.0
ROA (2016) 0.83 1.0 1.1 -0.14 1.0 -6.2
ROA (2015) 0.55 1.0 1.1 0.33 1.0 -0.4
Standard Deviation 0.096 0.11 0.1 0.31 0.116 2.13
Coefficient of Variance
ROE (2020) 5.65 7.3 7.4 8.61 7.3 -13.0
ROE (2019) 5.42 9.9 8.8 7.84 9.9 -12.8
ROE (2018) 5.94 9.5 7.8 1.70 9.5 -4.5
ROE (2017) 4.93 10.5 8.5 13.46 10.5 -5.1
ROE (2016) 6.65 11.2 8.8 4.27 11.2 -15.7
ROE (2015) 4.55 10.4 8.5 -2.37 11.0 -1.1
Standard Deviation 0.74 1.35 0.57 5.59 1.42 5.87
Coefficient of Variance
. (RM in Million) . . . . .
CR(2020) 56796 54986 149643 49759911 54986 661258
CR(2019) 58945 50788 140103 49472522 50788 655648
CR(2018) 67235 48479 120221.2 45680680 48479 287181
CR(2017) 61680 48975 117614.7 42113420 48975 292284
CR(2016) 60155 50785 117644.7 39189274 50785 291617
CR(2015) 59087 50342 115947.9 34294690 50342 360229
Standard Deviation 3601.98 2298.58 14338.66 6079730.74 2298.58 183089.99
Coefficient of Variance
5. Critical Analysis.
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The financial crises of 1997 and 2007 were very severe that it had affected almost all
financial institutions in the world. Like financial crises 1997 and 2007 the pandemic of
covid-19 badly affected financial institutions in Malaysia. We can infer from the table that
most of the financial institutions are badly affected during and after Covid-19 pandemic.
From table we can see that return on assets during 2019 and 2020 are decreased which shows
that banks operations are badly affected by covid-19 pandemic. While during 2015 to 2019
return on assets were gradually increased. In case of conventional banks the results are mix
some banks managed their profitability and hence we can see in the table that Alliance bank
and Am bank return on assets from 2015 to 2020 are decreased very less and in the next year
recovered. While in case of Islamic banks the results show that their operations are badly
affected by the pandemic. We can observe in the table that in 2019 and 2020 the return on
assets of Alkhair Islamic international bank reaches -4.6 and 4.0 respectively, which shows
that bank operations were poor during this 2019 and 2020. Thus it is clear from the analysis
that conventional banking performance is better than Islamic banking system.
Results of the return on equity ratio explains that after covid-19 in 2020 the ratio decreased
of all banks which means that before and during covid-19 the banks management easily
manage their operations but in 2020 they affected and they were not able to use their wealth
of shareholders. We can see in the table that every bank ROE decreased while in case of
Alkhair Islamic international bank the ratio reaches -13.0 which indicate that the bank
performance was very poor after covid-19. Thus the results of the return on equity ratio are
the same as of return on assets, which means that the performance of conventional banks is
better than the Islamic banks during and after covid-19. Thus it can be inferred from the table
that the performance of conventional banks is better than the performance of the Islamic
banks during the period of 2015 to 2020. Both low ratio of return on assets and return on
equity also explain that this decrease occur only due to poor or operations suspension during
covid-19 pandemic.
From total Credit or Liabilities portion we can also explain that banks liabilities increased
during and after covid-19 pandemic due to lack of back up or less cash in account to support
the bank operations. We can see in the table that each bank total Credit increased during the
years 2019 and 2020 which shows that during covid-19 pandemic banks were in trouble to
fulfill their operational needs and after covid-19 pandemic the same results can be seen in the
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table. Moreover during the years 2015 to 2018 the total liabilities were less than the years
2019 and 2020. This show that banks were normally operating during the years of 2015 to
2018 but during the pandemic in 2019 and after the pandemic year in 2020 the total
Liabilities increased which indicates that banks were in need for more funds during and after
the covid-19 pandemic. Here we can also describe from the results that the performance of
the conventional banks are better than the performance of the Islamic banks during and after
the covid-19 pandemic.
Low interest rates also affect banking industry. As low interest rates are very beneficial for
borrowers or customers because they can take required amount of loan at low interest rate but
in case of deposits customers will not agree to deposit their funds for low interest rates in
savings accounts thus they will search for another best option like investment in the equity
market or investment in bonds. Therefore low interest rates effect banking industry
negatively and it is very dangerous for the sustainable growth of the banks in current
situation and in current digital world, where information is available to everyone in a single
click. Thus form low interest rates we can also infer that during and after covid-19 pandemic
conventional banks performance and Islamic banks performance were bad because low
interest rates reduced their income.
Moreover international transactions like foreign exchange is also a good source of direct
profitability of banks but due to covid-19 pandemic most of the expatriates were jobless in
the foreign countries and most of the bank’s branches were closed therefor this source of
direct profitability also did not perform well and as a result the bank financial health
decreased during and after the covid-19 pandemic. In addition local transactions were also
very less in number because almost all businesses operations during lock down were
suspended. Due to which most of the people were restricted in their home specially women
and youth. As a result fewer transactions were done during and after the covid-19 pandemic,
which leads to low profitability or financial performance of the banks in Malaysia in the year
2019 and 2020. Thus finally we can conclude that the impact of low interest rates during
covid-19 pandemic on banks was very bad because all banks conventional as well as Islamic
banks performance was very low during the years of 2019 and 2020.
6. Executive Summary.
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