Profitability is an important component here - if the banks’ profitability is poor, it may drive them to invest in more risky projects in an attempt to regain profitability. What loan losses might the banks suffer in the future? By looking at the quality of the banks’ assets, we link the analysis of the banks to the analysis of the borrowers. Might the banks suffer liquidity problems? We study the banks’ financing capacity to obtain an impression of this. The final chapter contains an analysis of the financial infrastructure. This must function so efficiently that any problems arising within an individual financial institution or sub-market will not spread to other participants or markets. Nor should there be any problems in the infrastructure resulting from shocks to the systems themselves. Analysis of the infrastructure is made difficult by the fact that it also requires fairly detailed insight into how different computer systems are constructed - technological issues thus become more important here than in other areas. Each report concludes with one or more articles. These articles give us an opportunity for more in-depth analysis of various fields or for presenting the results of various studies. This is all done with the aim of increasing our knowledge and making us even better at analysing and overseeing the financial system. Although the standard layout of the report provides some form of framework for our analysis work, we are constantly developing our analyses. Conditions change, with new operators, risks and technological developments.
Since the start of the crisis in 2008, Malaysia has experienced three episodes of large foreign capital outflows. Thankfully, our policy framework, a healthy level of foreign exchange reserves, and the robustness of our financial system, have enabled us to withstand such flows without significant disruption of domestic economic and financial activity. The third form of risk is through interest differentials. Very low interest rate in the AEs do not just attract yield-searching foreign funds to the higher yields in the emerging markets (EMs), they also create a very strong temptation for residents in EMs to borrow from abroad. We saw this type of vulnerability in this region in the period before the Asian financial crisis and more recently, in the Eastern European economies. The build-up of unhedged foreign currency debt by residents can be a significant source of vulnerability during times of economic and financial upheaval. Then there are global liquidity spillovers into domestic liquidity that put downward pressure on domestic interest rates. We see this most evidently with the negative interest rates of the ECB, which has resulted in capital flows to the neighbouring countries and pressure on their exchange rates. As a consequence, interest rates in neighbouring Denmark, Sweden and Switzerland have all also become negative. Such contagious fall in interest rates can lead to excessive borrowing, a decline in savings, increases in asset prices, and increases in leverage, which in turn increase the risks of financial imbalances developing and undermining financial stability.