During the last decennary, many fiscal crises have been experienced in the development states due to the absence of a stable macroeconomic environment, an efficient legislative-administrative model, and a sound surveillance-supervision system ( Duvan & A ; Yurtoglu, 2004 ) . At the same clip, bank failures happened from clip to clip and the rate of bank failures around the universe has been increased significantly over the last several old ages. The illustrations of the biggest Bankss failure are Washington Mutual, IndyMac Bank, Colonial Bank, BankUnited and others.
Banks are in the concern of utilizing the financess provided by the depositors to do loan to borrowers and loans comprise a big portion of the banking concern. The loan can be short term, average term or long term. Short term loan normally has adulthood of one twelvemonth or less ; average term loan has adulthood of one to three old ages and long term loan normally has adulthood of three to ten old ages. Loans can be repaid in the signifier of episodes spread over a period of clip or in a ball amount sum and there is an involvement charged on the sum that lent out to the clients. Loans are usually secured against touchable assets of the company.
However, imparting entails presuming the hazard that some loans wo n’t be collected back which are known as default debts. Asiatic fiscal, US sub-prime and Euro debt crisis and effects have increased the defaults loans among the commercial Bankss. Hence, Bankss are required to make shock absorber against the possibility of the hereafter unexpected and expected loan losingss in order to safeguard against fiscal hazards that the Bankss face and to protect the Bankss and state from bankruptcy. In rule, loan loss commissariats are widely used by the commercial bank directors to pull off the hazard exposure that may happen in their loaning and funding activities. Commercial bank directors need to gauge the losingss that will inherent in a bank ‘s loan portfolio at a given minute of clip and put aside as a loan loss proviso for this likeliness in order to vouch a bank ‘s solvency and capitalisation if and when the loan defaults occur. The loan loss proviso will be charged to the Bankss ‘ net income and loss statements that creates a modesty on their balance sheets. Ideally, the sum of the loan loss proviso should be relative to the peril of the loans that offered by the Bankss and the overall strength of the economic system. However, federal bank and securities regulators recognize that the commissariats can non accurately fit the existent losingss ( Montgomery, 1998 ) .
In the aftermath of the Asiatic fiscal crisis, many Asiatic cardinal Bankss and supervisory governments have strengthened their attacks to loan loss provisioning, every bit good as discretional steps. This has contributed to stronger banking systems in the part. Harmonizing to Betty and Liao ( 2009 ) , loan loss provisioning policy is great importance for the Bankss as it is critical in measuring the soundness of the banking sector ‘s fiscal system and it is a cardinal determiner of bank ‘s net incomes and capital places, which has a bearing on Bankss ‘ supply of recognition to the economic system. There are no internationally-adopted criterions for loan loss commissariats. Each state tends to be differing sing the quality and measure bounds of provisioning demands ( Pinho & A ; Martins, 2009 ) . Therefore, each state must follow the regulations of loan loss commissariats set by bank regulators. In Malaysia, all the commercial Bankss are obligatory to unwrap the sum of the loan loss commissariats in their net income and loss histories, which will diminish the pre-tax net incomes.
Prior surveies indicated that loan loss commissariats were used for the intent of gaining direction ( Ahmed, Takeda & A ; Thomas, 1999 ; Beatty, Chamberlain & A ; Magliolo, 1995 ; Greenawalt and Sinkey, 1988 ) , capital direction ( Collins, Shackelford & A ; Wahlen, 1995 ; Kim & A ; Kross, 1998 ) , signaling future purposes to the stock market ( Liu & A ; Ryan, 1995 ) , supplying signals about future losingss and net incomes and following with the legal demands ( Zoubi & A ; Al-Khazali, 2007 ) .
1.1.2 Capital Adequacy Framework in Malaysia
In Malaysia, commercial Bankss are required to follow with the risk-weighted capital adequateness model in utilizing loan loss commissariats to pull off the hazards that may happen in their loaning and funding activities. The risk-weighted capital adequateness model has been introduced by the Basel Committee on Banking Supervision ( BCBS ) in twelvemonth 1988 and it is developed based on the international criterions on capital adequateness. However, it is besides named as Basel 1. All the banking establishments are required to keep a minimal sum of 8 % of entire capital based on a per centum of risk-weighted assets ( RWA ) . The entire capital is consists of Tier 1 and Tier 2 capital. Tier 1 capital is considered as nucleus capital and it must transcend at least 4 % of the hazard weighted assets and 3 % of entire assets. The Tier 1 capital is includes of common stock, undivided net incomes, paid-in-surplus, non-cumulative ageless preferable stock, and minority involvements in amalgamate subordinates less goodwill and other intangible assets. On the other manus, Tier 2 capital is known as auxiliary capital which the sum must non transcend the sum of Tier 1. Tier 2 is includes of reappraisal militias, ageless preferable stock, intercrossed capital instruments, ageless debt, compulsory exchangeable debt securities, subordinated term debt and intermediated preferable stock. In June 2004, the BCBS has revised the Basel I and it is farther known as Basel II. The Basel II did non alter the sum required for capital adequateness and it is implemented in two phases which are 2008 for the Standardized Approaches and 2010 for the Internal Ratings-Based ( IRB ) Approach.
2.1 Review of the literature
The banking system in Malaysia is comprises of commercial Bankss, Islamic Bankss and investing bank. In Malaysia, the commercial banking system is operated independently under Banking and Financial Institutions Act ( 1989 ) which is governed by Malaysia Central Bank, Bank Negara Malaysia ( BNM ) . Harmonizing to the Aisyah ( 2010 ) , there were 22 local Bankss and 16 foreign Bankss wholly since 1990. In the late ninetiess, Bank Negara Malaysia has launched a consolidation plan in order to promote sustainability in the face of fiscal liberalization. From the latest information that extracted from Bank Negara Malaysia web site, Malaysia presently has 8 local Bankss and 19 foreign Bankss.
Commercial banking has ever played a critical function in the banking system as they are the largest and most important suppliers of financess in the banking system and they have contributed vastly financing to back up the state ‘s economic development. However, many fiscal crises such as Asiatic fiscal, US sub-prime, Euro debt crisis and effects have been experienced in the underdeveloped states during last two decennaries and this has caused many commercial Bankss failure. Loans comprise a big portion of the commercial banking concern and the fiscal crises have increased the defaults loans among the commercial Bankss in Malaysia. This has raised the concern of the commercial bank directors to aware about the loan loss proviso in order to safeguard the Bankss against fiscal hazards and to protect the Bankss and state from bankruptcy.
Many surveies have been done to find the factors that impacting the loan loss proviso of commercial Bankss. However in this research, the factors that determine the bank loan loss proviso have been divided into internal factors and external factors. Internal factors include bank size, capital ratio, gaining before revenue enhancements and proviso, non-performing loan and entire loan. All these factors are mentioning to the factors that can be managed by the direction of a bank. For the external factors which besides are macroeconomic factors, it includes of gross domestic merchandise ( GDP ) and market loaning rate. All these factors are beyond the control of a bank ‘s direction.