1.

0 Introduction
In general, risk can be define as the possibility of suffering from harm or loss or
even in danger. Risk also a factor, thing, element, or course involving uncertain
danger or a hazard. While in the financial risk, risk is defined as risk that can give
bad effect, harm, and problems to the financial environment such as to the
financial market, financial institutions, business, economics and other institutions
that involved with financing activities. These risk should be look very series as it
is involving our country economics.
Financial risk can be divided by two categories that are, systematic risk and
unsystematic risk. Systematic risk is the risk inherent to the entire market or an
entire market segment, where it is also known as diversifiable risk, volatility
or market risk affects the overall market, and it is not just a particular stock or
industry. Systematic risk is both unpredictable and impossible to completely
avoid. It cannot be reduced through diversification, but only through hedging or
by using the right assets allocation strategy. While, Unsystematic risk is the risk
that company or industrys specific danger that is inherent in each investment. It
is also known as non-systematic risk, specific risk, diversifiable risk or residual
risk, which can be reduced through diversification.
There are many types of risk involving the financial environment such as, interest
rate risk, market risk, credit risk, liquidity risk, foreign exchange risk, sovereign
risk, technological risk & operation risk and insolvency risk. In this paper, we will
show how BNM will control or overcome this risk with suitable methods.

1.1 History of Financial Crisis in Malaysia

Financial Crisis in 1998
In the 1980s and 1990s, many developing countries fell into an external debt-led
financial crisis. In the first generation of these crises, the inability to service debt
was due to a combination of factors, including depression in commodity export
prices, increase in the price of oil imports, a rapid increase in foreign loans and
the inability to utilise these loans productively or appropriately.
In the 1990s, several more countries (including the more economically advanced
of the developing countries) experienced financial crises. A main cause of many
of

these

second-generation

crises

was

the

inappropriate

design

and

implementation of capital account liberalisation. Some countries that had

hitherto succeeded in attaining high economic growth rates and in using export
expansion for this growth, faced difficulties in managing rapid liberalisation in
financial flows.
In 1997 several East Asian countries began to experience serious financial
problems. Due to financial deregulation, they had received large inflows of
capital, including bank loans denominated in foreign currencies and portfolio
capital especially foreign purchase of equity in the local stock exchanges. A
significant part of the foreign loans was not channelled to activities that yielded
revenue in foreign exchange, and thus a mismatch occurred, at least in the short
term, so that pressures built up on foreign reserves.
In Malaysia, the ringgit came under speculative attack and also declined
significantly. However, the country had not liberalised its capital account to the
same extent as the other three countries, at least in one important respect the
local companies were allowed to obtain foreign loans only with Central Bank
permission, which would be given only if and to the extent that the borrower
could show that the loan would be used for activities that would yield revenue in
foreign exchange that could be used for loan servicing. Partly as a result of this
restriction, Malaysias debt situation remained manageable, although the
situation was also fragile, as there was also a possibility of debt-servicing
difficulty if the ringgit depreciated even more sharply, or if there was a rapid
enough outflow of capital.
2

The currency depreciation had several negative effects. Firstly, it increased the
burden of external debt servicing. At the start of the crisis, the countrys external
debt servicing position was rather comfortable. However, the depreciation
increased the debt burden in that the debtors had to pay more in local currency
amount; several large Malaysian companies that had taken foreign loans made
large losses.

Secondly, the continuous changes in the exchange rate were very destabilising
as traders and enterprises were unable to conduct business in a predictable way
as the prices of imports and exports (in local currency terms) kept changing.
Thirdly, the prospect of continuous decline in the ringgits rate contributed to a
sharp fall in the value of shares in the stock market and the inflow of foreign
portfolio funds in the stock market was reversed.
One positive effect was that those involved in exports (including producers of
commodities such as palm oil and petroleum) obtained higher incomes. Due to
the serious adverse effects of currency depreciation, stabilising the ringgit
became perhaps the over-riding concern of the policy makers during the crisis.
Another major effect on the economy was the very steep decline in the value of
shares in the stock market. The Kuala Lumpur Stock Exchange (KLSE) index fell
from a high of over 1,000 in July 1997 to a low point of 262 in September 1998.
This affected the credit-worthiness of many companies and individuals that had
used the value of their shares as collateral for loans and it thus also affected the
banks. The fall also had a negative effect on consumer sentiment and spending
as investors saw their wealth dwindling. The third major concern was the
prospect of large capital outflows as the confidence of foreigners and residents in
the economy fell.

Financial Crisis in 2008

As a highly open economy, Malaysia was, however, not insulated from the global
economic downturn. The deterioration in global economic conditions and the
major correction in commodity prices in the second half of 2008 saw Malaysias
GDP moderate to 0.1% in the final quarter of 2008. The domestic economy
experienced the full impact of the global recession in the first quarter of 2009,
declining by 6.2%. The concerted and pre-emptive measures taken by the Bank
Negara Malaysia (BNM), through the accelerated implementation of fiscal
stimulus measures, supported by the easing of monetary policy and the
introduction of comprehensive measures to sustain access to financing and
mitigate any impact of the heightened risk aversion among banks contributed
towards stabilising the domestic economy in the second quarter and its
subsequent recovery in the second half of the year. The economy resumed its
growth momentum in the fourth quarter, growing by 4.4%. This resulted in the
economy contracting by only 1.7% in 2009. Continued expansion in domestic
demand and increased external demand led to the strong growth of 10.1% in the
first quarter of 2010.
The global financial crisis of 2008-2009, with its epicentre in the United States,
has brought enormous ramifications for the world economy. What started as an
asset bubble caused by an array of financial derivatives that drove the sub-prime
mortgage boom, exploded into a housing and banking crisis with a cascading
effect on consumer and investment demand. From a housing crisis, it quickly
grew into a banking crisis with the investment and merchant banks first
absorbing the impact before it spread to the commercial banks. With the United
States economy contracting sharply, it sent ripples across export-dependent

Asian economies, which began to face a contraction as a consequence. Hence,

although the Malaysian economy was insulated from the direct effects of
financial exposure because the new derivatives were not allowed into the
country, the global financial crisis has cast doubt on the Governments plans to
achieve vision 2020 due to a collapse in exports and a slowdown in foreign direct
investment.

1.2 The Effects of Poor Management of Risk in Financial Environment to

the Malaysia
First of all risk can be harmful to our country where it can leads to many
problems to the economics. Poor management of risk in the national currency
can leads to unstable value of ringgit Malaysia currency. This is important where,
if the currency is not stable or the value is falling down such as the problems
faces by Indonesia, where their currency value is very low. This will affect the
price of imports between countries. Such as when our country still need to
import certain of goods from other country such as foods, because of the
problems of sarcasm or limited resources. Thus, the price of imports goods
increases. Then, when our currency becomes unstable, it will cause the investor
from another country to pull back their investment and decide not to invest in
our country.
Other than that, poor management in financial systems also can cause the
economics to become unstable or occurs problems in the economics. This can
effects the businesses in the country. When business in the country is not goods,
this will affects their rate of productions in goods and services. Thus affects our
country (GDP) or gross domestic productions. GDP will shows our country

performance in a year. This is important to shows that our country development

and rate of productions.
Then, when there is poor management, there will lead to the speculations or
predicting on the problems of deflations to our country in the future. From the
previous experiences that faced by our country and others country in 1997 to
1998. At that time, There occurs the currency value of many countries becomes
unstable which force our Prime Minister, Tun. Dr Mahathir Mohammad to peg the
currency value of ringgit Malaysia. Furthermore at the time, the inflations
problems happen and also the unemployment occurs.
In financial environments also, poor managements in banking institutions is a
bad effects where, when there is problems in banking services such as
technological and operational risk, this will effects the services of the banks.
Which, basically the society trust the banks institutions on safe keeping their
properties and moneys. If the services of the banks is not trusted then, people
will no longer keep their money at the banks. This will cause the economics
activities to slow down, where banks as the companies which activate the
economics is no longer in goods performances.
Investment also one of the main source of economic sources or which generating
our economics. However when other country looks at our economy as unstable,
then their trust on getting profits at our country is reduced. Then they will pull
out their investment in which this will leads to decreasing in monetary economics
thus the developments activities in our country.
2.0 Types of Risks
Interest Rate Risk
Interest rate risk can be defined as a risk that investments value will change
according to the level of interest rate, whether it spread between two rates that
are in the shape of investment curve or in any other interest rate relationship.
The changes can affect securities inversely but it can be reduced by diversifying
or hedging the investment.
This risk occurs because of the prices and reinvestment income characteristics of
long term assets react differently to changes in market than the prices and
interest expense characteristics of short term deposits.

Furthermore, in process of asset transformation that are buy primary securities

and issue secondary securities or liabilities part of the function is mismatching of
maturities of assets and liabilities exposing financial intermediaries to interest
rate risk. The primary securities purchased by the financing institutions often
have maturity and liquidity characteristics that are differently from the
secondary securities issued by financial institutions. As an example, bank buys
medium to long term bonds and makes medium term loans with funds raised by
issuing short term deposits.
In this risk, it divided into two that are refinancing risk and reinvestment risk.
Refinancing risk is an uncertainty of the earning rate on the deployment of
assets that have matured. It occurs when financial intermediary holds assets
with maturities that are less than the maturities of its liabilities. For example, if a
bank has a 10 year fixed rate loan funded by two year time deposit, the bank will
bears a risk of borrowing new deposits or refinancing at a higher rate in two
years. Hence, the interest rate increases would reduce net interest income. The
bank will get benefit if the rates fall as the cost of renewing the deposits would
decrease, while the earning rate on the assets would not change. In that case,
net interest income would increase.
For reinvestment risk, it is the uncertainty of the earning rate on the
redeployment of assets that have matured. This can happened when financial
institutions holds assets with maturities that are less than the maturities than the
maturities of its liabilities. For example, a bank has two year loan funded by 10
year fixed rate time deposit, the bank faces the risk that it might be forced to
lend at lower rates after two years. Besides, this reinvestment risk may cause
the realized yields on the assets to differ from the a priori expected yields.

Market risk
Definition of market risk is the possibility for an investor to experience losses due
to the factors that affect the total performance of the financial markets. In
addition, market risk also called systematic risk, it cannot be eliminated through
diversification even it can be hedged. This risk is a major natural disaster that
7

will cause a decline in income from deposit taking and lending matched by
increased reliance on income trading.
Market risk also can be defined as a risk that the value of an investment will
decrease due to the moves in market factors. It is also closely related to the
interest rate and foreign exchange risk.
The fluctuation frequently refers to the standard deviation of the change in value
of financial instrument with a specific time. It is also often been used to quantity
risk of the instrument over the period of time. The volatility is typically expressed
in annualized terms, it may either be an absolute number or a fraction of the
initial value.
Liquidity Risk
Liquidity risk is the uncertainty that financial intermediary may need to obtain
large amounts of cash to meet the withdrawals of depositors or other liability
claimants. In normal economic activity, depository financial intermediaries meet
cash withdrawals by accepting new deposits and borrowing funds in the short
term money markets. While in harsh liquidity crises, the financial intermediary
may need to sell assets at significant losses in order to generate cash quickly.
This risk occurs when depositors demand immediate cash or liability and holders
of off balance sheet exercises right to borrow. Interest rate changes can also lead
to liquidity problems where high interest rates may cause liquidity withdrawals
as depositors seek higher returns elsewhere.

Credit risk

Credit risk can be defined as a risk that loss of principal of a financial reward
stemming from a borrowers failure to repay a loan or otherwise meet a
contractual obligation. This risk arises whenever a borrower is expecting for
assuming this risk by the way of interest payments from the borrower or the
issuer of a debt obligation.
It is also can be defined as a risk of non-payment of borrowing provided to a
borrower on maturity date and arises due to promised cash flows on the financial
claims that are fixed coupon bonds and bank loans held by Financial
Intermediaries will not be paid in full. When no default, the financial
intermediaries earn coupon on the bonds and interest on the loans. On the other
hand, when it is default, the financial intermediaries earns zero interest and may
lost part or all of the principal lent. For example, life insurance companies and
depository institutions generally must wait a longer time for returns to be
realized than money market mutual funds and property casualty insurance
companies.
In this credit risk is divided into two that are firm-specific credit risk and
systematic credit risk. Firm-specific credit risk more to the likelihood that specific
individual assets may deteriorate in quality. Systematic credit risk involves
macroeconomic factors that may increase the default risk of all firms in the
economy. Besides, portfolio theory in finance has shown that firm specific credit
risk can be diversified away if a portfolio of well diversified stocks is held. If
financial intermediaries holds well diversified assets, the financial intermediaries
will face only systematic credit risk that will be affected by the general condition
of the economy. The risks specific to anyone customer will not be a significant
portion of the financial intermediaries overall credit risk.
Sovereign risk
This risk is also known as the Country risk. This risk refers to the risk of the
foreign Central Bank will change its foreign exchange regulations, where they
significantly reducing or completely nulling the value of foreign exchange
contract. Other than that, when a foreign country is not willing or not able to
repay a loan, then the financial intermediaries can be the alternatives. Other
than that, these risks also occur from the repayments from foreign borrowers
interrupted because of foreign government. Then, the leverage available to
ensures or increase repayment probabilities is control over the future supply of
loans or funds to the country concerned. Furthermore, there is a result of
9

exposure to foreign government in which may impose restrictions on repayments

to foreigner.

Foreign Exchange Risk

This risk refers to the risks of investments value changing an also import and
export activities due to the changes in currency exchange rates. Currency such
as United State s currency(US dollar), European s currency( Euro), UKs
currency(pound sterling), Thailands currency (baht) and also Malaysians
currency(ringgit Malaysia). Foreign exchange risks is also the risk that investor
will have to close out in a long or short position in a foreign currency at a loss
due to the worst movement in exchange rates. It is also known as currency risk
or exchange rate risk.
When dealings with foreign currency, we exposed to a certain risk, where this
risk usually affects businesses that doing export and/or import activities. Other
than that, it is also affect the investor who making an international investments.
For examples, if money must be converted to another currency to make certain
investment, then any changes in the currency exchange rates will cause the
investments value to either decreases or increases when the investment is sold
or converted back into the original currency. Furthermore, this risk can also
occurred when the businesses does not really aware on the other countries
background,

where

the

targeted

countrys

currency

is

unstable.

The

characteristic of exchange rates that it can go both up and down can tempting
the investor to gamble. This is extremely risky, where it could end with a
significant financial loss.
Insolvency risk
This risk is refer to the risk of insufficient capital to offset sudden decline in value
of assets. It is also known as bankruptcy risk. The original cause of these risk
may be excessive interest rate, market, credit, off-balance-sheet, technological,
sovereign, and liquidity risks. Insolvency can also be referred to the situations
when an individual or organization can no longer meet its financial obligations
with its lender or lenders as debts is higher than assets. Insolvency also can lead
to insolvency proceedings, where, legal action will be taken against the
10

insolvency entity. Thus, the assets can be liquidated to pay off the outstanding
debts. Further explanations, before a person or the company gets involved in the
insolvency proceedings, they should be involved in more informal arrangements
with creditors, such as in making an alternative payment arrangements.
Insolvency risk can occur from poor cash management, a reduction in the
forecasted cash inflow or from an increase in cash expenses.

Technological & Operational risk

Technology risk occurs when investment in new technologies does not generate
the cost savings expected in the expansion in financial services. In the terms of
economic of scale, it is occurred when the averages cost of the productions is
decreases with the expansion in the amount of financial services provided. While,
economics of scope occurs when the Financial Institutions is able to lower the
cost of the productions of the new product while the inputs is similar to those
used for other products. Furthermore, technology risk also refers to the
unpredicted environment of the implementation of new technology in the
operations of the financial institution. While, Operational risk refers to the failure
of the back room support operations that is needed to maintain the smooth
functioning of the operations of financial institutions, which include the
settlement, clearing and other transaction-related activity.

11

3.0 How Bank Negara Malaysia (BNM) control the risk using monetary
policies under Qualitative and Quantitative or other methods?
The primary objective of monetary policy is to regulate the nations supply of
money and credit. BNM will use this to control the level of banks reserves and it
can be used to reduce risk in financial environment.
BNM used interest rate regulation to reduce the interest rate risk in financial
environment. BNM has influence on bank liquidity and the availability and cost of
bank credit through the regulation of interest rates charged on bank loans as
well as the rates of interest offered for bank deposits.
BNM will setting up the minimum lending rates for banks and ceiling on interest
rates that may be offered by banks for deposits accounts. This will avoid the
banks from being bankrupt. In that case, interest rate risk can be control by
implemented this measures to the banks itself.
Foreign exchange risk can be minimized by using an appropriate hedging
technique. The most direct method of hedging this risk is a forward contract,
which enables the exporter to sell a set amount of foreign currency at a preagreed exchange rate with a delivery date from three days to one year into the
future. Accordingly, when using forward contracts to hedge this risk, exporters
are advised to pick forward delivery dates conservatively. If the foreign currency
is collected sooner, the exporter can hold on to it until the delivery date or can
12

swap the old foreign exchange contract for a new one with a new delivery date
at a minimal cost. Note that there are no fees or charges for forward contracts
since the lender hopes to make a spread by buying at one price and selling to
someone else at a higher price. Furthermore, The Central Bank issues licenses or
operating permit to deposit Money banks and also control the operation of the
banking system. From this advantage, The Bank Negara Malaysia(BNM) can
persuades banks in Malaysia to follow certain paths such as credit control or
expansion, increased savings mobilization and promotions of exports through
financial support, which otherwise they may not do on the basis of their risk and
return assessment.
In overcome or reduced the financial risks, BNM can use this instruments in order
to overcome the financial risks. Under these method or instrument, BNM have
the power in controlling the operations in the banking system within the country.

Foreign exchange risk is basically occurs when the exchange rates suddenly
changing either going up or down. This is due to some factors which are, the
foreign countrys background, such as the economic conditions on the particular
country. Such as China, where their economic conditions is not

really stable

where their fluctuations of currency is not predictable which can be extremely

risky especially for the investor or big company in our country which included the
banks institutions. Thus, to overcome or reduce these risks, BNM can controls the
operation of the banking system by persuade or advising the bank in Malaysia to
not dealing with the country which have very unstable economics Sovereign
Risk/ Country risk.

BNM can also advise the investor or import and/or export

company to do precautions on these risks.

BNM also used value at risk to monitor and control market risk. The board
provides a strategic, long term asset allocation study, usually based on meanvariance portfolio optimization, also taking into account liabilities. This study
determines the amounts to be invested in various asset classes that are
domestic stocks, domestic bonds, foreign stocks, foreign bonds, and perhaps
additional classes such as emerging markets, real estate, and venture capital.
The fund may delegate the actual management of funds to a stable of outside
13

managers, which is periodically reviewed for specific guidelines defining the

universe of assets they can invest in, with some additional restrictions such as
duration, maximum deviations from equity sector weights, or maximum amounts
of foreign currency to hedge or cross-hedge. Typically, risk is only measured expost, after the facts from historical data.
Liquidity risk can be control by assesses the liquidity crisis. It can be done by
assessing the adequacy of its short-term liquidity to meet crisis situations such
as significant deposit outflows. In assessing the impact on the licensed
institutions funding and cash flow projections, licensed institutions may adopt
behavioural assumptions for borrowers and depositors such as increase in
depositor withdrawal rate. Furthermore, credit tightening also can control this
risk. It also can be done by stressing the impact of credit and counterparty lines
tightening and estimate and anticipate alternative funding costs and sources in a
difficult market environment due to the downgraded of licensed institutions
rating. Then determine how it would affect the current business and the pricing
and competitiveness of future business. This also can be minimized with speed
and time period by estimate the speed and duration of the extreme market
moves and how well the portfolio can withstand it.

In credit risk, BNM will monitoring and reviewing banks. The process of
evaluating and reviewing credit exposures regularly is fundamental to measuring
and reporting exposures accurately. Banking institutions need to develop and
implement comprehensive procedures and information systems to monitor the
condition of individual credits and related single borrowers across the banking
institutions various portfolios. Reviews of individual credits must be performed
at least once a year. However, problem credits and credits where there are
indications of deterioration in credit quality should be reviewed at more frequent
intervals. This risk also can be control by using selective credit control. As credit
risk refers to the risk of loss of principle or loss of a financial resources that
comes from borrowers failure to repay the loan back, or otherwise the borrower
will meet a contractual obligations. Then, BNM can used the selected credit
control method or instrument to limits or to controls the limit of credits. Where,
14

BNM limit the amounts of available borrowing, so that the amount of borrowing is
lower and the interest rates is also lower, in which to prevent the problems of
unable or fail to repay the loan. In that case, BNM will know how to control this
risk by doing this method.
Statutory reserves requirements (SRR) can be used to control the insolvency risk.
As this risk refer to the risk that a company or a banks have more debts or
liabilities compared to the assets, where the problem is when the companys
equity or capital cannot cover the loss or debts in which this problem can leads
to bankruptcy. In order to overcome this risk, Bank Negara Malaysia (BNM) can
used statutory reserve requirements instruments, where before the situations
happen, BNM should increase the statutory reserve requirements for the banks
as when the SRR rates increased, it will avoid the problem as the company or
banks will have more equity to cover their debts.

4.0 Conclusion
This process is a long term cycle and its importance should not be missed at any
time. All steps need be followed, risk identification not being enough for saving
an organization from disappearing from the market.
Risk identification should be done with better care, and all risks must be
recognized

and

treated

carefully.

The

evaluation

of

potential

threats,

vulnerabilities and possible damage is very important. After this valuation is

15

done, necessary controls should be implemented in terms of cost effectiveness

and the level of risk reduced by the implementation. To identify the most
appropriate controls a cost analysis has to be done. Its results help managers
implement the most efficient controls that bring the greatest benefit to the
organization.
Risk management helps them to be better control the business practices and
improve the business process. If the results of risk analysis are well understood
and the right measures are implemented, the organization not only that will not
disappear from the market, but will grow and more easily obtain the targeted
results.

5.0 References
Joyce, J. (2013). The IMF and global financial crises: Phoenix rising? New York:
Cambridge University Press.

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Matz, L. (2007). Liquidity risk measurement and management: A practitioner's

guide to global best practices. Place of publication not identified: John Wiley
& Sons (Asia) Pte.
A.GHANI,

R.

(2011).

MONEY

AND

FOREIGN

EXCHANGE

MARKET.

In The

development of Malaysian financial institutions. Shah Alam: University

Publication Centre, Universiti Teknologi Mara.
C.Hull, J. (2007). Risk management and financial institutions. Upper Saddle River,
NJ: Pearson Prentice Hall.
Mishkin, F., & Eakins, S. (2009). Risk Management in Financial Institutions.
In Financial markets and institutions (6th ed.). Boston: Pearson Prentice
Hall.

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