Risks in banking and financial services Essay

The banking industry, which provides banking and financial services to consumers, is one of the main components of the financial system. The core functions of these banks are to accept deposits, offer loans and make investments. The financial system plays an important role in a country's economy by contributing to its economic growth (Jokipii & Monnin, 2013 Levine et al., 2000 Demirg-Kunt & Maksimovic, 1998). Levine (1997, 1999) found a positive relationship between the sophistication of the financial system and economic growth. Schumpter (1911), who studied the role of the financial sector, argued that the provision of services by financial intermediaries plays an important role in contributing to the health and efficiency of an economy. Nonetheless, there are a few conflicting views on whether economic growth contributes to the financial system or vice versa (Favara, 2007) but the economists still believe in the strong links between financial system and economic growth.
Banking sector involves risk both globally and domestically. For instance, systematic banking crisis, financial risk , and currency crises, (Herring 2000). Like other developing countries, Malaysia had no exception from being experience of Financial Crisis namely Asian Financial Crisis and Global Financial Crisis which left a bigger impact to Malaysian banking industry. The crisis has effected the entire economy and the financial intermediaries as well. The crisis led to a reduction of economic growth, increase unemployment, a deterioration of financial stability indicator and increase of non-performing loans (Apatachioae, 2014). Despite that, financial disturbance is costly and for all these reasons banking soundness has been the important agenda in each countries.
One of the banking risk that attract the world attention is fast growing in household debt to Gross Domestic Product (GDP). Over the past 5 years, Malaysia has experienced sharp growth in household debt to GDP, 87.9% (BNM report 2014). The figure 1.1 below shows the trends of household debt are incresing from year 2002 until 2013. This figure indicate that Malaysia household debt to GDP among the highest in South East Asia (World Bank, 2014). Analyses carried by World Bank argue on its sustainability and the consequences to the financial system and the economic as a whole.
Figure 1.1 Household debt to GDP
Risk to banking stability arising from household indebtedness may effect depends on 2 consideration. First is the ability of household to service their debt. If the borrower is unable to pay back their debt it will lead to increasing in nonperforming loan (NPL)(Meniago et al. 2013). Households' debt represents a large items in banks' balance sheets, any changes will imply higher risk to the bank's asset. In addition, liquidity of the individual bank will be effected when the bank has to make some unexpected payments (Aptchioae 2014). Second, the exposure of financial system to the household sector in the events of financial stress. Household sector are vulnerable to any changes in income, unemployment status, interest rate and inflation (Benito.et 2007). This factors will increase the fragility of the banking systems (Charpe, & Flaschel 2013) (Borio and Lowe, 2002).