Determining Oil-Macro-Financial Linkages and Feedback Loop Effects: Evidence from Malaysia

Abstract

The correlation between declined oil prices versus bank stability has widely drawn researchers’ attention and has set the stage for vicious feedback loops. This paper further explores the oil-macro-financial linkages and its intensity of the feedback loop between declined oil prices and macroeconomic-financial development in Malaysia. To gain further insights into this issue, we discuss the development of oil-macro-financial linkages that can propagate through the domestic financial system and reverberate to the real economy. The empirical results reveal that oil price shocks have a significant impact on banking performance, channelling through microeconomic banking-specific and macroeconomic country-specific variables which influence Malaysia’s banking stability and create a ripple effect onto its real economy. In addition, this paper applies Granger causality, impulse response, and variance decompositions evaluation to assess the existence of a feedback loop effect within the oil-macro-financial linkages by using the VAR setting. In conclusion, oil-macro-financial linkages were empirically evaluated and had a more adverse effect than macro-financial factors alone could have explained within the Malaysian economy. Hence, a comprehensive understanding and extensive knowledge of the potent form of oil price volatility are significantly crucial in guiding bank operators and government regulators to mitigate risks with increasing control measurement, particularly in terms of the heterogeneous impact across the banking system and real economy.
 Keywords: Oil-Macro-Financial Linkages, Feedback Loop Effects, Oil Price Shocks