Determinants of Ex Post and Ex Ante Credit Risk: A Novel Panel Analysis and Comparative Evidence of Foreign and Local Malaysian Banks

Abstract

Amid the credit expansion in Malaysia and for 19 commercial banks (11 foreign and 8 local) over 2002-2013, we utilize a novel panel-data model to investigate the role of charter value, moral hazard, managerial performance, income diversification, and macroeconomic environment as determinants of non-performing loans (NPLs) (ex post credit risk) and loan loss provisioning (LLP) (ex ante credit risk). We find a strong evidence that bank’s charter value as an endogenous variable is disciplining both types of credit risk, especially for foreign banks. Increasing capital ratio increases credit risk. Better performance (higher return on equity) reduces credit risk. Higher inefficiency and operating leverage increase credit risk. Income diversification increases NPLs and LLP of local banks, and it reduces NPLs of foreign banks. Higher levels in GDP growth and money supply M1 growth (monetary growth), raise credit risk in banks. We provide a strong evidence that foreign direct investment reduces credit risk, especially for foreign banks. Policy implications are suggested in order to attain financial stability.