Banking risk pdf

USA is a pioneer in such regulation when they tabled a proposal in that required US banks to maintain capital that reflects the riskiness of bank assets. The aim is to prevent banks from excessive risk-taking, with regulators tring to relate this to the risk of the loan portfolio.

By , the time of the first international initiative Basel Accord , most countries had already introduced one or the other form of risk-sensitive capital regulation. The Basel Accord was signed by the G10 countries and was intended to apply only to internationally active banks. The accord assigns assets to different risk buckets. Thus, banks are forced to manage the risk efficiency to prevent them from putting more capital.

The so called risk management process is aimed at allocation capital efficiently in order to obtain optimal benefits and reduce the cost of capital. The method used was: the bank earning assets as well choosing the activities that banks may be effectively measured in terms of risk and risk adjusted return of company culture; the ability of capital, organization and infrastructure.

It is important for banks to understand business issues and investments in which the bank to invest so that the bank may benefit the optimum amount of capital, risk and return. The objective of this study is to examine the relationship between inefficiency, risk and capital in ASEAN banking. Ahmad et. Jeitschko and Shin on the other hand, study the relationship between portfolio risk and capitalization in Korean banking.

In addition, Konishi and Yasuda analyze the factors determining the risk taking behaviour among Japanese commercial banks. The remainder of the paper is organized as follows. Section 2 briefly reviews the literature and Section 3 describes the data and variables used in the study. Section 4 describes the methodology, followed by empirical results in Section 5.

The conclusion is given in Section 6. Literature Review Every study on capital in the banking industry departed from the same point with the theory of capital structure in the financial theory.

The most referred paper is the theory of the frictionless world of Modigliani and Miller. They argue that capital structure is irrelevant andr does not affect the value of the company. However if we look at the bank capital structure, the MM is not valid because of two things; first, the presence of the regulatory safety net that protects the safety and soundness of the banking system and is likely to lower capital, second, regulatory capital requirement that raise the capital of some banks, may give a negative impact to the value of the banking firm.

Many studies focused on the relationship between risk and capital especially after the introduction of minimum capital regulation. Capital regulation is one of the important tools that are used to prevent banks from failure. It means the theoretical issue of how higher capital ratios reduce overall banking risk is not yet entirely solved.

On the other hand, capital regulation should be set up as a part of other prudential regulations Altunbas et. Capital regulation is one of the key instruments of modern banking regulations. The regulation aims to increase a cushion during economic crisis and a mechanism to restrain banks from taking excessive risk.

During an economic downturn, the quality of bank assets decreases and the impact is to reduce capital. As we know, theoretical foundation on the relationship between capital and risk is mainly based on the theory of moral hazard that existed because of agency problem. They tested whether increased capital regulation forces bank to increase their risks or vice versa Jokipii and Milne, Shrieves and Dahl argue that positive relationship between key variables in line with several hypotheses which include the unintended effect of minimum capital regulation, regulatory cost; bankruptcy cost avoidance as well as managerial risk aversion.

Jacques and Nigro on other hand, find a negative relationship between change in capital regulation and risk level. Empirical evidence on the relationship between capital requirement and risk taking is mixed. In USA study by Sheldon find that asset volatility rose rise and decreased for both bank that increased capital and that did not.

Calem and Rob quantified the effect of capital based regulation and find the U-shaped relationship between capital and risk taking. When capital increases again, they will take higher risk again. They found that undercapitalized bank took higher risk because the cost of bankruptcy is shifted to deposit insurance. For well capitalized banks, they took higher risk because it is more profitable and there is low probability of bankruptcy. In Japan, higher capital requirement is responded by lowering asset volatility.

Konishi and Yasuda analyzed the factors determining the risk taking behaviour among Japanese commercial banks and found that risk taking activities are reduced when capital regulation is introduced see Ford and Weston, Iannota et. After controlling for size, output mix, asset quality, country and years effects, they found that ownership type and ownership concentration play an important role on risk and performance.

Private banks were more profitable than mutual and public banks. However, private banks were more profitable due to their earning asset structure rather than from superior cost efficiency. Public sector banks have poorer loan quality and higher insolvency risk. This means public banks are is relatively less profitable and riskier than other types of ownership. Public banks rely their funding on wholesale interbank and capital market but they have higher liquidity and lower loan level.

It is different from private banks that rely their funding from customer deposit and provide more loans. In terms of cost, private and mutual banks have lower operating cost. In term of ownership concentration, there is not much significant impact on profitability. However when the ownership concentration is linked to other variables such as loan quality, asset risk and insolvency risk, higher concentration is attributable to better loan quality, better asset risk and lower insolvency risk.

Dispersed ownership banks are incurring higher cost per dollar income than concentrated one. It is in accordance with agency theory framework. Altunbas, et. They did not find any strong relationship between inefficiency and bank risk-taking.

Evidence from the full sample suggests that inefficient European banks do not seem to have an incentive to take on more risk. They also find evidence that the financial strength of the corporate sector has a positive influence in reducing bank risk-taking and capital levels.

There are no major differences in the relationships between capital, risk and efficiency for commercial and savings banks although there are for co-operative banks. In the case of co-operative banks we do find that capital levels are inversely related to risks and we find that inefficient banks hold lower levels of capital.

Brewer et. They model bank capital ratio as function of public policy, regulatory, bank specific, macroeconomic and country level financial condition. The model estimated using annual data from to for unbalanced panel of the 78 largest private banks. The study found that banks maintain their higher capital ratio when the banking sector is relatively smaller and when regulator practices prompt corrective actions more actively.

Higher capital ratio is also related to the existence of stringent capital regulations and better good corporate governance mechanism. In general, capital ratio difference among counties under investigation is in part explained by the public policy and regulatory regime applied in the countries.

Using dynamic model, banks can adjust its deposit to a desired level in continuous —time model. Banks adjust the volume of its deposit voluntary, because of two purposes: reduce leverage; or increase deposit volume.

As the banks must comply with the leverage regulation, any increase in deposit will end capital binding. If restructuring asset cost apples, when banks increase deposit, banks must incur the cost and reduce the deposit to prevent from a violation of the regulation in the future.

The findings are in line with empirical studies that banks do not hold the minimum capital but have voluntary capital buffer. When banks do not have attractive investment possibility, banks prefer to reduce the deposit and increase it later in the future. Surprisingly, when the higher volatility of asset value and a lower deposit growth exist, they tend to lower cost of default cost.

Lindquist studied the excess capital both for commercial and saving bank in Norway using panel data approach. In general, saving banks are holding more capital than commercial banks.

In relation to the risk, a saving bank excess capital has negative relationship. The effect of credit risk to excess capital is not significant but previous profit is.

In general, high risk banks are not poorly capitalized but in reality low risk banks are having too much capital. In connection to price of subordinated debt, there is negative relationship which supports the assumption that excess capital is insured against the cost related to market discipline and supervisory action due to lower capital condition.

Small banks hold higher capital buffer than big banks. Gross domestic product GDP growth is not significant to influence the capital buffer. Data and Variables Data In this study we use a panel set of individual commercial bank from economically important countries in ASEAN region from to The sample comprises a large set of panel data of banks over the six years under consideration.

Samples are selected merely based on the availability of the data in the Fitch Bankscope database. Table 1 presents the distribution of samples for the study. This is followed by Malaysia and Cambodia 16 percent each, Thailand 14 percent, Singapore and Brunei 4 percent and Vietnam 1 percent. All variables in this study are measured in thousand US dollar.

Variables Variables to be used in this study are variables that are theoretically and empirically plausible. The variables and definitions are presented in Table 2. We use accounting measures total banking cost to total income to measure bank cost inefficiency Tahir, , used both accounting and stochastic approaches to measure efficiency. To capture banking risk, we use loans to total assets RISK. The bank specific variables consist of net loans to total assets NLTA ; growth in loans may increase risk and therefore have an unfavourable impact on capital and bank efficiency.

Goldberg and Rai used this to account for cost differences related to bank size and for the greater ability of larger banks to diversify. Finally, the ratio of off-balance sheet items to total assets OBSTA is also included to account for off-balance sheet activities.

While OBS activities help banks in increasing their sources of revenue, they also increase risks. RISK Loans to total assets. CAP Total equity to total assets. Make dynamic utilization of framework based security administration and observing devices. Ensure that crisis management processes are able to cope with Internet related incidents.

The sugesstions that offered by the research, seems great. However, the research not clearly explained the approach and research methodology that the researchers used. It leads to a question, whether the findings and the sugesstions are valid and reliable, or not. The research about risks of internet banking, should come with recommendations, how to avoid or prevent the risks.

However, sometimes risks cannot be avoid or prevent. The only way to reduce the damages from the risks, is finding and understanding the way to manage risks. Running the risks and putting into practice controls for online banking schemes tags along very similar standards with likewise procedures of managing risks James, Research Design and Methods This research will be conducted using case study method.

This method is being used due to several reasons, such as take us to a better understanding of a complex issue or object. Moreover, it can increased the experience and knowledge for findings that already found through previous research. The research about internet banking risks has been conducted many times, with different method, area, and researchers, that is why, case study is taken as a choice, to enrich the informations of internet banking risks to consumer that have been found by previous research.

As a research method, case studies seems to be appropriate for investigating phenomena when 1 a large variety of factors and relationship are included, 2 no basic laws exist to determine which factors and relationships are important, and 3 when the factors and relationships can be directly observed Fidel, This research will follow the chronological order.

The approach that will be used in this research is qualitative approach, by collecting data from various literature. For instance, journals, articles from newspaper and online news sites. Unlike, any other research methods, case study cannot fullfill the two criteria for assesing quality of research, which are reliability and validity.

Case studies cannot be repeated under constant conditions: the observer records events as they occur. So, case studies cannot claim its method reliability. Regarding the validity, case study is very depend on subjective understanding. Validity can be an issue of concern. The investigator should institute controls to test whether a theme or interpretation is valid Fidel, Sometimes, bias cannot be avoided in case study method.

However, there is a methods recommended by Diesing to compenstates for bias in an interpretation by requiring each interpretation to be based on several kinds of evidence. Interpretations are recheked and validated through comparisons of the different kinds of evidence.

This method was systematically applied in this study. To addressed the issue of validity, this research will enact triangulation method.

Patton cautions that it is a common misconception that the goal of triangulation is to arrive at consistency across data sources or approaches; in fact, such inconsistencies may be likely given the relative strengths of different approaches.

Findings and Discussion Internet Banking Risks The internet and technological advancements with the beginning of vend and commercial financial transactional options have differentiated the precedent years. The degree of peril financial institutions are opened has been intensified due to factors such as an ever present and universal character of electronic systems, exceptional pace through which innovative equipments are recognized, incorporation of online financial transaction policies and heritage networks with the growing reliance of financial institutions on outsourcing Natasha, Numerous financial institutions understand that online transaction principally enhance data protection perils with little or no attention being paid towards the consequence involving further financial transaction precise perils.

Controls involving the supervision of perils are developing at a slow pace when compared to the momentum at which loads of organizations are growing without the integration of risk management principles in their business arrangements Ganesh, Internet banking risks can be categorized in several categories. Online financial transactions do not create fresh peril groups, but to a certain extent draws attention to the risks that several monetary establishment faces Michael and Herbert, The consumers of internet banking must face the risks of internet banking.

However, the risks of internet banking mostly come from technology perspectives, such as malicious software issue, online fraud, phising, unautorhized person accesed their account, keylogger, and many more.

These kind of risks usually considered as operational risk. Operational risk emerges from the potential for misfortune because of the eficience cannot be fulfilled in system unwavering quality or integrity. Operational risk can likewise emerge from client misuse, and from deficiently composed or implemented electronic banking and electronic money systems.

A large portion of the particular conceivable signs of these risks apply to both electronic banking and electronic money. Concerns about security system of internet banking are included in operational risks. Controlling access to bank frameworks has ended up progressively unpredictable because of extended machine capacities, geological dispersal of access focuses, and the utilization of different correspondences ways, including open systems, for example, the Internet.

It is vital to note that with electronic cash, a break of security could bring about falsely made liabilities of the bank. For different types of electronic banking, unapproved access could prompt immediate misfortunes, added liabilities to clients or different issues.

A mixture of particular access and verification issues could happen. Case in point, deficient controls could bring about a fruitful attacks by programmers working by means of the Internet, who could get to, recover, and use classified client data. Without sufficient controls, an outside outsider could get to a bank's machine framework and infuse an infection into it.

Notwithstanding outer assaults on electronic money and electronic banking system, banks are presented to operational risk regarding representative extortion: workers could surreptitiously secure validation information so as to get to client records, or steal stored value cards Incidental slips by workers might likewise trade off a bank's system. Of immediate concern to supervisory powers is the danger of lawbreakers counterfeiting electronic money, which is elevated if banks neglect to consolidate satisfactory measures to recognize and dissuade forging.

A bank confronts operational risk from duplicating, as it might be subject for the measure of the of the falsified electronic money balance. Technology is evolving every day and in almost in every aspect but not everything that is coming in the way is being accepted.

Likewise with conventional keeping money administrations, client abuse, both deliberate and coincidental, is an alternate wellspring of operational danger. Danger may be increased where a bank does not enough teach its clients about security insurances. Moreover, without satisfactory measures to confirm exchanges, clients may have the capacity to renounce exchanges they formerly approved, exacting budgetary misfortunes on the bank. Clients utilizing individual data e.

Other risks that raise are systems or products do not work as expected. Table 1 presents the distribution of samples for the study.

This is followed by Malaysia and Cambodia 16 percent each, Thailand 14 percent, Singapore and Brunei 4 percent and Vietnam 1 percent. All variables in this study are measured in thousand US dollar. Variables Variables to be used in this study are variables that are theoretically and empirically plausible. The variables and definitions are presented in Table 2. We use accounting measures total banking cost to total income to measure bank cost inefficiency Tahir, , used both accounting and stochastic approaches to measure efficiency.

To capture banking risk, we use loans to total assets RISK. The bank specific variables consist of net loans to total assets NLTA ; growth in loans may increase risk and therefore have an unfavourable impact on capital and bank efficiency. Goldberg and Rai used this to account for cost differences related to bank size and for the greater ability of larger banks to diversify. Finally, the ratio of off-balance sheet items to total assets OBSTA is also included to account for off-balance sheet activities.

While OBS activities help banks in increasing their sources of revenue, they also increase risks. RISK Loans to total assets. CAP Total equity to total assets. NLTA Net loans to total assets. SIZE Logarithm of total assets as indicator of bank size.

ROA Profit before tax to total assets as indicator of profitability. IRC Total interest revenue to total assets. On the inefficiency side, we expect positive sign with CAP meaning that well capitalized banks operate less efficiently. RISK will have negative signs as riskier banks increase inefficiency. Table 3 presents the descriptive statistics of the variables used in this estimation. From observations, we can see that variable INEFF as a measure of cost to income ratio indicates the inefficiency level; the higher the value, the higher the inefficiency level.

The most inefficient is 3 percent and the most inefficient is percent. The mean value is 52 percent with standard deviation of RISK has a mean value of 6.

In terms of SIZE, the mean is It can be seen from NLTA where the mean is The minimum value is 0. For ROA, the mean value is 1. The lowest is The highest value of ROA is 8.

The mean value is Methodology From the literatures above, researchers underline that the relationship between capital and risk are regressed simultaneously and are interrelated. This situation is known as endogeneity.

Implication in the modelling requires the use of a simultaneous equation specification and estimation methodology. To simplify, we follow the approach adopted by Altunbas et. This approach solves the availability of the data. To estimate equation 1 , equation 2 is used as instrumental variables. The use of 3SLS is necessary as it will avoid simultaneous bias for estimated coefficients.

Several studies have focused on understanding the relationship between risk and capital. They tested whether an increase in capital regulation forces bank to increase their risk or vice versa Jokipii and Milne, According to Deelchand and Padgett , their study confirmed that risk, capital and efficiency are determined simultaneously.

Using Japanese cooperative banks, empirical model shows a negative relationship between risk and level of capital. Inefficient cooperative banks operate higher risk but also hold more capital. The situation may reflect the existence of moral hazards problem. In this study, we adopt an approach taken by Deelchand and Padget and Heid et.

These researchers treat efficiency, risk, and capital simultaneously. However, their approach is not fully adopted as their efficiency measure is specified using stochastic frontier approach SFA.

We use accounting ratio to measure inefficiency i. Empirical Results Capability of the Model Before we conducted the estimation, we did unit root tests to see if the data is stationary or not. As the data is a mixture of time series and cross sectional, and the sample period is only six years, the risk that the data tend to be non-stationary is viable.

In addition, some observations have been deleted due to the unavailability of data. This makes the time frame becomes less evident. To solve the problem, we conduct a simple Augmented Dickey Fuller ADF test and found that all variables are stationary at 1 percent level.

We also conducted the Hausman specification test to investigate for the endogeneity of inefficiency, risk, and capital variables. We compared the residuals and predicted value to see the correlation and found that there is no significant correlation.

Table 4 presents the capabilities of the model to link inefficiency, risk, and capital. In general, the model is capable to explain the relationship between inefficiency, capital, and risk. From the table, we can see that the coefficient for bank capital CAP is negative and significant, meaning that banks with higher capital operate more efficiently. This finding is consistent with previous research which concludes that more capitalized bank operates efficiently than banks with less capital Shrieves and Dahl, ; Berger and Young, ; Altunbas et.

According to Berger and Young , well capitalized banks are better run. RISK also provides very provocative results. Banks with higher risk profile, tend to operate more efficient than less risky banks. Higher risk means lower inefficiency.

It is rational because higher risk banks tend to get higher revenue and so reduce the operating inefficiency score. However RISK is not significant. SIZE, measured by logarithm of asset has negative coefficient with inefficiency. In other words, larger banks are more efficient. The relationship is theoretically strong and can be explained by both economies of scale as well as economic of scope. Banks can enjoy higher efficiency when they can manage a larger amount of loan. Bank with higher portion of loan in its portfolio tend to operate more efficiently.

This situation can be explained by the revenue side of OBS activities that generates more revenue. In this model, an accounting measure of bank risk loan to total assets, RISK is used as the dependent variable.

We use this term to link with the relationship between risk and return with the portfolio theory. The bigger the loan portion,, the bigger the profitability of the bank in the future. The use of non-performing loan breaches this relationship.

In the table, CAP is negative and significant with risk. It means a stronger capital is associated with less risk taking behaviour. This relationship provides further evidence that the banking sector in ASEAN behaves similarly toother studies that provide negative coefficient. It means that the possibility of moral hazard by increasing risk to get higher return on the cost of depositors is valid.

When the deposit insurance exists, the evidence points to similar evidence from the US setting that lower capital tends to increase risk. The moral hazard problem may exist due to various reasons, for example, binding capital regulation in the area is less effective. The coefficient of INEFF is negative, meaning that inefficient banks tend to be prudential by reducing risk. This situation is supported by unsophisticated market where basically small banks are very difficult to find investment opportunities other than loans.

Inefficient banks are more sensitive to risk because they understand when they make loss their banks will be easily operating under less capital that may causebank regulators to act.

Their action may lead to the closure of the bank or bank being taken over by other investors. This finding also supports the view that inefficient banks aremore sensitive to risk taking than efficient banks because the implication of risk taking behaviour can be substantial to their capital.

Bank size SIZE is also risk sensitive. The coefficient for SIZE is negative and significant, meaning that large banks are relatively more capable to reduce risk by introducing more diversified portfolio and risk management especially credit risk management. Furthermore, if we look at the SIZE, the result provides evidence that large banks take lower credit risk as the coefficient is negative and significant.

Higher net loan to total asset is prone to higher credit risk. When the portion of loan to asset is bigger, it means bank asset is dominated by loan. In ASEAN countries, where the most important role of the banking industry is to perform intermediation, the higher portion of NLTA leads to a positive contribution to the credit risk.

In this equation we found that higher risk has negative and not significant coefficient. The negative sign means higher risk taking has negative association with lower capital.

This finding confirms that the capital regulation is not binding strictly in ASEAN countries and that there is enough room for banks to escape from this situation.