“Escalating headwinds on both the domestic and global fronts pose greater downside risks to the performance of banks this year, even though we believe that Malaysian banks – with their strong fundamentals and prudent risk management – will be able to weather the storm,” observes Wong Yin Ching, RAM Ratings’ Co-Head of Financial Institution Ratings. While we have maintained a stable outlook on the Malaysian banking sector for 2020, we highlight that banks face heightened uncertainties and challenges in the still evolving economic landscape. Key expectations for the sector are outlined in RAM’s Banking Insight. These include:
- Loan expansion to moderate to 1.0%-2.0% (2019: +3.9%), with a downward bias
- Asset quality indicators to weaken with gross impaired loan (GIL) and credit cost ratios rising to 1.70%-1.90% (end-January 2020: 1.56%) and 50 bps (2019: 30 bps), respectively, even after considering banks’ relief measures
- Capital buffers to remain sturdy
- Funding and liquidity to stay healthy
- Softer profitability amid slower credit growth, compressed net interest margin (NIM) and heftier credit losses
The decade has gotten off to a rocky start with the outbreak of COVID-19 and political uncertainties. The far-reaching implications of the pandemic are anticipated to compound the effects of the US-China trade dispute, which had already slowed down the global economy in 2019. “We expect banks to closely monitor their credit exposures amid the present challenging scenario and envisage a pick-up in rescheduling and restructuring (R&R) activities,” highlights Sophia Lee, Co-Head of Financial Institution Ratings.
Although the immediate impact of COVID-19 will be felt in the airline and tourismrelated industries, retail trade, restaurants and hotel segments as well as in certain manufacturing sub-segments, spillover effects will be broad-based across economic sectors. Malaysian banks are extending temporary financial relief to affected borrowers, which include the R&R of credit facilities as well as a moratorium on loan repayments of up to six months. Although banks do not need to set aside provisions for loans that come under the relief measures now, impairment charges may be pushed out to 2021 if borrowers’ weaknesses stretch beyond short-term cashflow issues.
In light of current events that saw the collapse of oil prices, fresh risks may emanate from the oil and gas sector as the steep drop in oil prices threatens to derail recovery charted by the industry in the last two years. Although the situation is still fluid, persistently weak prices will constrict activity and again lead to repayment difficulties, as witnessed several years ago.
During this tumultuous period, RAM estimates that the banking system’s GIL ratio may worsen to 1.70%-1.90% in 2020 (end-January 2020: 1.56%) after taking banks’ forbearance measures into consideration – this is equivalent to a 15%-30% increase (or about RM3 bil-7 bil) in absolute GILs. “As events are still unfolding, our best estimate of credit cost ratio stands at 50 bps, which is still manageable in our view,” said Wong. Even in a hypothetical stress scenario that assumes a doubling of impaired loans to RM54 bil (resultant GIL ratio of around 3%), banks’ earnings would weaken significantly but pre-provision profits should sufficiently absorb credit losses without affecting capital buffers. The banking system’s common equity tier-1 capital ratio stood at a robust 14.3% at the end of 2019.
Apart from pressures on asset quality, RAM notes that Malaysian banks’ loan growth has been dwindling even before the onset of challenges brought on by COVID-19. Against the backdrop of weak business and consumer sentiments, the banking system’s loan growth clocked in at a multi-year low of 3.9% in 2019, as did aggregate credit expansion (+4.7%), which includes corporate bond issuances. Malaysia’s weaker loan growth in 2019 largely mirrored the performance of most of its regional peers amid a softer global economy.
“For now, we have pencilled in a loan growth of 1.0%-2.0% for 2020 (2019: +3.9%) but we highlight downside risks to our forecast given the evolving nature of the current environment,” highlights Lee. The rapid spread of COVID-19 domestically and globally in recent weeks is anticipated to significantly weaken domestic demand and result in a more pronounced contraction in trade activities. Domestic political uncertainties also add to the plethora of downside risks in this regard, although overshadowed by the global health crisis at this juncture. In the event economic conditions worsen drastically, we foresee that it could be challenging for the banking system to achieve even a 1.0% loan growth this year.
Liquidity is anticipated to stay healthy in 2020. Although the banking system’s liquidity coverage ratio came within a higher range of 140%-160% last year (2018: 130%-150%), Bank Negara Malaysia (BNM) had lowered the statutory reserve requirement (SRR) in November 2019 and more recently, in March 2020 (-150 bps cumulatively). The SRR currently stands at 2.0% – if the need to shore up the financial system’s liquidity arises, the regulator would still have room to reduce the SRR (1.0% was the historical low between March 2009 and March 2011). We point out that Malaysian banks have limited dependence on offshore wholesale funding (less than 10% of the total banking system’s funding liabilities), which lowers their susceptibility to any tightening in global liquidity conditions.
Looking ahead, topline pressure and potentially heavier impairment charges amid the current environment could dent banks’ earnings this year (the eight banking groups’ pre-tax ROA came in at 1.4% in 2019). BNM has slashed the overnight policy rate twice in 1Q 2020 to mitigate downside risks to Malaysia’s economic growth, which will undoubtedly crimp NIMs further. RAM’s Banking Insight: Weathering the Storm is available for download at www.ram.com.my.
Copyright Press Releases 2020