Financial Intermediation System

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF STUDY

The banking sector is still the primary form of financial intermediation in the Asian and Pacific region. It is the largest conduit for the recruitment of domestic savings. Hence, it becomes the main source of external capital to firms and the key player in the payment system. Apart from their financial intermediation role, banks have been shown the contribution to the general economic stability. This was prevalent during the Asian financial crisis when economy was adversely affected by the then-weak banking sector.

Against the backdrop of the Asian financial crisis, many countries have undertaken the massive reform of their financial sectors. In the case of Malaysia, the governments have

Therefore, commercial banks, which are the main component of the banking system, have to be efficient otherwise they will create unbalanced mind and millstone in the process of development in any economy. In order to maintain the market share so as to survive and remain competitive, the technological advancements and globalization have given the pressure on the part of the banks. Competition from foreign banks as well from domestic banks themselves creates the greater pressure. Malaysia commercial banks also no exemption since banks are exposed to severe competition both locally and globally. Therefore, commercial banks not only need to be profitable, but also efficient. The reduction in spreading between lending and deposit rates is the basic benefit of enhancing the efficiency. Through the banking system, it will stimulate both greater loan demand for investment and greater recruitment of financial savings (Izah, 2009). The measurement of banking efficiency helps banks to remain competitive, profitable and viable, in an otherwise highly regulated in the banking industry. Das, Nag and Ray (2005) indicate that measurement of banking efficiency serves two important purposes. First, it helps to benchmark the relative efficiency of an individual bank against the best practice of banks. Second, it helps to evaluate the impact of various policy measures on the efficiency

In addition, global trend towards liberalization in banking has led to the blurring of demarcation lines in separating activities of the different groups of financial institutions. Similarly, deposit taking, credit granting, investment, insurance and financial advisory services are being bundled into one financial conglomerate of financial supermarkets. Since the Asian financial crisis, the number of players in the banking sector has changed significantly. Today, all the domestic banking groups have undertake full range of commercial banking, investment banking and Islamic banking activities. Due to the Asian financial crisis, the growth and innovation in Malaysia are constrained by banks, whose capital has been eroded by the accumulation of non-performing loans (NPLs). Although the non-performing loan ratios in Malaysia have fallen recently, the reduction in NPLs ratios were largely brought about by the transfer of NPLs from bank to public asset management companies. Thus, NPLs remained the main burden of the Malaysian banking and authorities were reluctant to disclose the true picture about the accumulated NPLs almost for a