1.2

Purpose of the Study

The purpose of this study is two-fold as follows:

1. To identify the optimum approach and metrics for measuring the efficiency of Malaysian banks;

2. To analyze archival financial performance data using the optimum approach for measuring the efficiency of Malaysian banks to determine historic efficiency levels in an effort to identify opportunities for improvement in the future.

1.3

Importance of the Study

The importance of the study directly relates to the need to identify effective ways to measure the efficiency of Malaysian banks. The evaluation of bank efficiency, though, introduces a number of constraints that are related to the nature and function of financial intermediaries, particularly in view of the fact that banks provide products and services that are dissimilar to those found elsewhere. As a result, one of the most important issues involving the investigation the efficiency of the banking sector concerning the specification of discrete bank inputs and outputs, but there remains an ongoing controversy concerning precisely what banks produce (Tahir et al., 2009). In this regard, Kaparakis, Miller and Noulas report that, "Little agreement exists as to what a bank produces or how to measure output" (1994:875). Generally speaking, there have been two conventional approaches used to analyze the banking industry: the production and intermediation approaches. According to Kaparakis and his associates, "The production approach measures outputs by the number of accounts and considers only operating costs. The intermediation approach asserts that banks collect deposits and purchased funds, with the assistance, of course, of labor and capital, and intermediate these funds into loans and other assets" (1994:876). On balance, these authorities suggest that the intermediation approach represents a superior alternative: "It measures outputs by the dollar value of accounts and considers both operating and interest costs. Conceptually, the latter approach seems more appropriate when the sample contains large banks, which fund a larger share of their assets from nondeposit sources" (1994:876). In their study of the efficiency of Islamic banks, Mohamad, Hassan and Bader also weigh in on the production approach. In this regard, Mohamad and his colleagues advise, "In the production approach, banking activities are described as the production of services to depositors and borrowers. Traditional production factors, land, labour and capital, are used as inputs to produce desired outputs. The production approach views banks as producers of loan and deposit services using capital and labour. However, majority of the recent empirical research of banking efficiency are based on the intermediation approach" (2006:107).

Whichever approach is used to identify a bank's products, there remains a need to determine how efficiently it is producing them. Therefore, the importance of the study also relates to the need for an informed approach to banking regulation to maintain the economic recovery that is taking place in Malaysia. In this regard, Karim emphasizes that, "How the increased competitive pressures will affect banks depends in part on their ability to adapt and operate efficiently in the new environment. Banks that fail to do so will be driven off the market by the more efficient ones. That is, the most efficient banks will have a competitive advantage" (2001:289).

1.4

Rationale of the Study

Today, Malaysia stands at an important juncture in its economic development. For example, a study by Desa (2003) points out that, "The message is clear, which is even louder after the recent financial crisis of the banking sector in 1997. Commercial banks in Malaysia will have to review the way they have been doing business in the past and . . . understand the internal and external factors which influence their profitability performance" (p. iv). On the one hand, the World Bank's most recent analysis of the Malaysian economy found that it has been experiencing a solid recovery with economic growth projected to reach a respectable 5.7 per cent in 2010 as a result of increased domestic private consumption and investment (Schellekens, 2010). On the other hand, though, the ability of the country to continue this pattern of growth during a period of global economic downturn represents one of the primary near-term risks (Schellekens, 2010).

Other issues are also at work that make the study of banking efficiency an important issue today. For instance, Katib and Matthews emphasize that, "In this changing environment, the measurement of efficiency in the banking sector becomes pivotal and more complex. For the banking institutions themselves, efficiency analysis helps to appraise their performance" (2003:89). Likewise, Schellekens emphasizes that for Malaysian banks, another issue "is whether private sources of growth can lead the recovery once fiscal and monetary policy support unwinds. The medium-term growth outlook is favorable, with growth at 5.3 per cent in 2011 and 5.6 per cent in 2012. These forecasts price in gradual structural reform implementation as well as fierce external competition for trade, talent, and foreign direct investment" (2010:3). Taken together, the foregoing issues create an environment in which the investigation and analysis of the efficiency of Malaysian banks represents a timely and valuable enterprise and the organization of the study that will...

Chapter one was used to introduce the topic under consideration, including a statement of the problem, the purpose and importance of the study, as well as its supporting rationale. Chapter two was used to provide a critical review of the relevant and peer-reviewed literature concerning banking efficiency in general and the efficiency of Malaysian banks in particular, and chapter three presents the study's methodology, a description of the study approach, the data-gathering method and the database of study consulted. Chapter four consists of an analysis of the data developed during the research process and chapter five was used to present the study's conclusions, as well as a summary of the research.
2.0 Literature Review

2.1.

Introduction

This chapter delivers a review of the related literature to provide an overview of the Malaysian banking industry, and a discussion concerning the stochastic frontier approach that has been used to evaluate the efficiency of banks in Malaysia and other countries. The foregoing is followed by a similar analysis concerning the distribution-free approach and data envelopment approach for banks in Malaysia and other countries. A discussion concerning the non-bank financial institution research that has been conducted in Malaysia in recent years is followed by a summary of other research that has been conducted in this area. Finally, a summary of the literature review is provided in the chapter conclusion.

2.2

Overview of the modern Malaysian banking industry

Unlike the so-called "Asian Tigers" that suffered greatly during the Asian monetary crisis during the 1990s, the commercial banking industry in Malaysia managed to avoid many of the problems its neighbors in the region experienced and has enjoyed significant growth in recent years. In this regard, Stewart reports that, "Malaysia was markedly less afflicted by the regional economic crisis than Thailand and Indonesia. However, the paper wealth of the country had been halved, some companies, mainly in the service industries, were shedding staff, civil servants faced restrictions on overseas travel and bonus payments to workers were on hold" (2003:44). After the completion of the consolidation program by Bank Negara Malaysia following the Asian monetary crisis and the elimination of merchant banks from the Malaysian banking sector, the commercial banking industry in Malaysia currently consists of 22 financial institutions; nine of these institutions (or about 41 per cent) are domestically-owned and 13 (or about 59 per cent) are foreign-owned as shown in Table 1 below.

Table 1

List of commercial banks currently competing in Malaysia

Bank Name

Ownership

Affin Bank Berhad

Domestic

Alliance Bank Malaysia Berhad

Domestic

AmBank (M) Berhad

Domestic

Bangkok Bank Berhad

Foreign

Bank of America Malaysia Berhad

Foreign

Bank of China (Malaysia) Berhad

Foreign

Bank of Tokyo-Mitsubishi UFJ (Malaysia) Berhad

Foreign

CIMB Bank Berhad

Domestic

Citibank Berhad

Foreign

Deutsche Bank (Malaysia) Berhad

Foreign

EON Bank Berhad

Domestic

Hong Leong Bank Berhad

Domestic

HSBC Bank Malaysia Berhad

Foreign

J.P. Morgan Chase Bank Berhad

Foreign

Malayan Banking Berhad

Domestic

OCBC Bank (Malaysia) Berhad

Foreign

Public Bank Berhad

Domestic

RHB Bank Berhad

Domestic

Standard Chartered Bank Malaysia Berhad

Foreign

The Bank of Nova Scotia Berhad

Foreign

The Royal Bank of Scotland Berhad

Foreign

United Overseas Bank (Malaysia) Berhad

Foreign

Source: Monthly Statistical Bulletin, Bank Negara Malaysia, July 2009

According to Elyor (2009), the fact that a majority of the commercial banks that are competing in Malaysia today has some important positive as well as negative consequences for the industry in general. In this regard, Elyor notes that, "The presence of foreign banks in a domestic financial landscape has positive as well as negative implications, particularly for a developing economy. [F]oreign banks' presence contributes positively in the development of a strong and stable domestic banking industry" (2009:15). In addition, the foreign banks that are operating in the Malaysian banking sector today provide the impetus for domestic banks to improve their efficiency in order to remain competitive. As Elyor concludes, "The comparatively more efficient foreign banks which adopt cutting-edge technology in their banking services create competitive pressure on the domestic banks, resulting in positive spill-over effects on the banking industry in general" (Elyor 2009:16). Consequently, the banking industry in Malaysia was in a relatively solid position when the Asian monetary crisis struck the region, but it is also worthwhile emphasizing at the outset as…