While global financial markets remained volatile in the second half of the year, stresses are assessed to have eased, primarily on the back of growing expectations that the US monetary policy stance would be eased sooner than later. Fresh geopolitical tensions and China’s sluggish economic performance weighed on prospects, though not significant enough to derail optimism that has followed-through into early 2024. Domestic financial market conditions in 2H 2023 remained orderly with continuous intermediation of two-way flows in the bond and equity markets.

To no great surprise, yield differentials between Malaysian Government Securities and US Treasuries weighed on the Ringgit in 2H 2023, though more pronounced in recent weeks which prompted Bank Negara Malaysia’s (BNM) Financial Markets Committee (FMC) to issue a second statement on the Ringgit in the space of nine months. All said, the impact of recent currency movements on financial stability remains manageable. Only a small number of corporates with unhedged external borrowings (1.8% of total business debt) may be susceptible to exchange rate volatility.

Resilience in the business sector is underpinned by steady domestic demand, though financial performance in certain sectors have been impacted by cost pressures. While a small proportion of SMEs are showing signs of financial vulnerabilities, most have been able to sustain debt repayments.

Resilience in the household sector is underpinned by continued improvements in income and labor market conditions meanwhile. While household borrowings that may be at higher risk of default increased to 4.8% of total household loans (June 2023: 4.3%), this remains within banks’ expectations and is about 40% lower in value terms than at the peak of the pandemic.

Bursa Malaysia’s Finance Services Index has performed well year-to-date with a +5.0% gain, a result of recent encouraging financial results which reflected effects of cumulative rate hikes in 2023/33, less pronounced funding pressures and steadier asset quality, pockets of weakness notwithstanding. While we still see no threats to near-term prospects of the sector, we retain our NEUTRAL view given limited share price upsides for stocks under coverage. For sector exposure, we still like CIMB Group.

Household sector. While mortgage and hire purchase loans continue to make up the bulk (73.7%) of total household loans, it has been observed that more (unsecured) personal and credit card debt is also being piled on, though the composition as a % of total household debt remains broadly unchanged. Risks remain manageable. Ongoing measures to encourage ownership sustained demand for house purchases while promotional campaigns and new model launches underpinned car financing growth. Household loan growth was a healthy +5.7% in 2H 2023 (1H 2023: +5.2%), partly contributing to the household debt-to-GDP rising to 84.2% (1H 2023: 82.0%).

In 2H 2023, median debt service ratios (DSR) of newly-approved and outstanding household loans stood unchanged at 41% and 35% respectively, preserving healthy buffers for households to support loan servicing. Most households appear to be able to sustain consumption patterns and savings. About 70.9% of household banking system debt is held by middle- and higherincome borrowers with monthly incomes of more than RM5,000. Overall median debt-to-income ratio is stable at 1.4x (1H 2023: 1.4x).

Household financial assets recorded a healthy growth rate of +5.8% (1H 2023: +4.7%) in 2H 2023, helped by higher bank savings and contribution to the Employees Provident Fund (EPF). Households continue to hold financial assets well in excess of debt however, at 2.1x (1H 2023: 2.1x).

New signs of asset quality stress in the household sector appear to be muted, reflected by the overall impairment ratio edging slightly lower to 1.2% (1H 2023: 1.3%). Overall share of household borrowings under repayment assistance remained largely stable at 1.6% (1H 2023: 1.8% of total banking system and Development Financial Institutions’ loans).

Business sector. The recovery and performances of businesses were uneven in 2H 2023 though most remained resilient. The services sector benefitted from improvements in consumer spending and tourism. The non-electronic manufacturing sector fared better than its electronic-related counterparts as external regional demand for the former improved slightly towards the end of the year.

Aggregate business operating margins improved in 2H 2023 despite ongoing cost pressures, as revenue growth of companies continued to be supported by domestic demand. Business leverage trended lower while cash buffers remained significantly above pre-pandemic levels.

Overall debt servicing abilities of businesses are healthy, with median interest coverage ratio (ICR) of 5.7x (1H 2023: 5.6x) well above the prudent threshold of 2.0x, while the aggregate share of firms at risk has also trended lower in the recent quarter.

Businesses appear to be more confident in 2H 2023, reflected by the relativelyrobust +3.6% expansion in corporate loans (1H 2023: +0.6%). This is driven by small and medium enterprise (SME) loans, primarily for working capital purposes. Smaller contractions (-0.5%, 1H 2023: -4.6%) were also observed in loans growth among larger firms, in line with improved business outlooks.

Asset quality challenges are most evident in the SME space, with level of impairments inching marginally higher to 3.1% (1H 2023: 3.0%) amid further signs of financial vulnerabilities. The share of SMEs missing repayments increased to 2.1% (1H 2023: 1.6%) of total SME loans, though the bulk of this increase was driven by SMEs with a history of missing repayments.

Capitalization. The banking system’s total capital ratio remains strong at 18.5% (1H 2023: 18.8). Excess buffers above the minimum regulatory capital requirements currently stand at RM142.6bn meanwhile, continuing to provide important safeguards against potential unexpected losses. These large capital buffers have also allowed banks to sustain healthy dividend payouts which have largely returned to pre-pandemic levels.

Stress test. BNM’s latest top-down macro solvency stress test covers a 3- year horizon up to end-2026. Adverse scenario 1 (AS1) tests the resilience of financial institutions against a temporary but deep shock in economic conditions. Adverse scenario 2 (AS2) assesses financial institutions’ ability to withstand a persistently challenging operating environment over an extended period.

Overall impairments are expected to rise to 7.8% and 8.6% of total banking system loans under AS1 and AS2 respectively by end-2026. Under both scenarios, household borrowers earning less than RM5,000 per month will account for the bulk (64%) of those at-risk of defaulting due to limited financial buffers. In value terms however, these borrowers form a smaller part (41%) of new impairments lower amounts borrowed relative to higher-income groups.

Meanwhile, 61% of the projected increase in business impaired loans under AS2 are attributable to non-SMEs, the bulk of which are those with pre-existing weak financials.

Cumulative credit costs over the 3-year horizon are estimated at RM63.1bn and RM70.8bn (or 53% and 57% of total losses) under AS1 and AS2 respectively, with about 20% originating from banks’ overseas operations (bulk of which are defaults of large non-SMEs). Projected increase in yields will also cause sizeable revaluation losses on bonds held in the fair value through other comprehensive income portfolio (FVOCI), amounting to RM54.7bn and RM51.7bn (or 45% and 41% of total losses) respectively.

All said and done however, results of the current stress test continues to affirm banks’ abilities to withstand significant macroeconomic and financial shocks, and are well-positioned to sustain lending to businesses and households.

Source: PublicInvest Research - 21 Mar 2024