Bank Negara Malaysia yesterday announced that the Net Stability Funding Ratio (NSFR) has been deferred to not later than 1 Jan 2019 so as to allow banks to understand further the implementation. We are positive on the news as the extra grace period will most likely minimise the risk of sharp upward surge in cost of fund thereby compressing NIM. However, we still do not rule out banks chasing for cheaper and easier source of funding, i.e. deposits (vs. capital funding), which could be at the expense of marketing cost, as credit demand accelerates ahead. All in, we maintain our NEUTRAL stance on the sector as the prevailing challenges in the economy still remain. We maintain our MARKET PERFORM call for most of the banking stocks in our coverage with the exception of AFFIN (TP: RM3.00), AMBANK (TP: RM5.00), ABMB (TP: RM4.15), CIMB (TP: RM6.90) and RHBBANK (TP: RM5.60) which are at OUTPERFORM due to their undemanding valuations.

Deferment of NSFR. Bank Negara Malaysia (BNM) announced yesterday the deferment of the implementation of the Net Stability Funding Ratio (NSFR) to not later than 1 Jan 2019 and not 1 Jan 2018 as required under the BASEL III framework. The Central Bank said this is to allow the domestic banks to understand further the NSFR in terms of operational requirements to meet the NSFR standard. The NSFR requires banking institutions to maintain a stable funding profile in relation to the composition of their assets and off-balance sheet activities. This standard complements the Liquidity Coverage Ratio (LCR) which had been phased in since 2015. BNM also stated Liquidity Coverage Ratio on the domestic front of 141% which is well above the minimum regulatory requirements of 100% with the NSFR industry average of 107%, also well above the minimum regulatory requirements of 100%. BNM also added that in the global arena, there is uncertainty in the implementation schedule of 1 Jan 2018 with some advanced countries also opted to defer the implementation of NSFR from the scheduled date.

Liquidity is still robust. BNM also reiterated that liquidity in the domestic banking system remains resilient with diversified funding sources to support growth. Reliance on deposits for funding fell from 80% to 76% of total funding with capital funding growing from 9% to 12% of total funding in the period from 2008 to 2016. For the same period, long-term borrowings and capital for funding seen a CAGR of 12.5% with debt securities growing at 9.1% CAGR indicating that banks are earnestly diversifying their funding sourcing on top of deposits. Ample liquidity is still evident with Loan-to-Fund (LTF) ratio and Loanto-Fund & Equity (LTFE) ratio at 83% and 74%, respectively, vs Loan-to-Deposit (LDR) ratio at 89%.

Positive on the deferment. The deferment is welcomed as some banks have been struggling to achieve the minimum regulatory requirements before 1 Jan 2018. BNM added that only about 75% of the banks have achieved above 100% requirements and the deferment gives ample time for those still below the requirements, minimising the risk of sharp upward surge in cost of funds (as banks chase for long tenure deposits) thereby compressing NIMs. With most of the banks achieving NSFR of >100%, there will be less pressure for banks to intensify their deposit-taking activities with higher deposit rates. The banks will be able to pay its funding costs with low costs debt instruments. Furthermore, take note that the loan-todeposit ratio is used to calculate a lending institution's ability to cover withdrawals made by its customers. So long as the LCR is sufficient, banks can actually able to manage a slightly higher LDR.

Will NIM improve? Decelerating pricing cost will lower cost of fund and ease downward pressure on NIM. However, it is still up to the banks to decide on their funding costs. If the banks have no urgency in expanding deposits or they are still able to attract deposits at a lower rate (especially for the big banks) or improved CASA, then there will be less upward pressure on funding costs. Applying the LTF/LTFE gives the banks more options in terms of liquidity management; hence, they are less likely to react by raising deposit rates.

All down to pricing? Nonetheless, from banks’ perspective, apart from tenure to maturity, decision on the source of funding could be price-driven. Meaning, so long as cost of deposits is relatively lower as opposed to other sources of funding, bankers would still prefer to opt for deposits as major source of funding. Hence, we do not rule out that competition in deposit taking will continue. We also do not rule out the banks reducing their exposure to long-term loans as higher long-term loans will put pressure on NSFR and the banks will have to compensate by having higher long-term funding thereby adding pressure on their funding costs.

Maintain NEUTRAL. We reiterate our NEUTRAL call as we see no change in the prevailing conditions ahead (and market cap weighted total return for the sector is still <10%). There is no concrete catalyst and game changer on the horizon and structural and cyclical headwinds are still prevailing such as; (i) moderating economy, (ii) subdued loans growth, with (iii) mild downward pressure on NIM. We maintain our MARKET PERFORM call for most of the banking stocks in our coverage with the exception of AFFIN, ABMB, AMBANK, RHBBANK and CIMB which are at OUTPERFORM as at current share prices, as we see attractive proposition with potential total return of more than 10% each.

Source: Kenanga Research - 29 Sept 2017