We retain our NEUTRAL sector call. Yesterday, BNM kept the OPR unchanged at 3.25% but lowered the SRR to 3.5% from 4%, effective 1 Feb 2016. We estimate the lower SRR would help release c.MYR5bn-5.5bn of liquidity into the system and would reduce the cost of intermediation for banks. By our estimates, the impact from the lower SRR would not be too significant on banks’ bottomlines.

OPR unchanged but SRR lowered. Bank Negara Malaysia's (BNM) Monetary Policy Committee (MPC) decided to keep the overnight policy rate (OPR) unchanged at 3.25%. However, BNM announced a reduction in the statutory reserve requirement (SRR) to 3.5% from 4.0% effective 1 Feb 2016 to ensure sufficient liquidity in the domestic financial system, among others. Net external outflows over the past year have reduced the amount of liquidity in the system by c.MYR40bn as of 21 Jan 2016. We note that during the Global Financial Crisis, BNM had cut the SRR to 1% from 4%.

Releasing liquidity and reducing cost of funds. By our estimates, the reduction in the SRR would help release c.MYR5bn-5.5bn of liquidity into the system. Assuming the SRR is set at 1% (from 4%), this would release an estimated MYR36bn of liquidity back into the system. The lower SRR would also help reduce the cost of intermediation for banks. Assuming that the additional amount released from the SRR cut earns interest income at Kuala Lumpur interbank offer rate (KLIBOR), we estimate the incremental interest income could add up to 1.5% to banks’ bottomlines, ie not too significant.

No impact on LDR but potentially positive for LCR. We do not expect the reduction in SRR to impact system loan-to-deposit ratio, which is currently at a multi-year high of 91%. The impact on banks’ liquidity coverage ratio (LCR), however, could potentially be positive if the SRR stays at the current level or is lowered ahead. This is because banks are currently allowed to recognise SRR balances in the LCR computation although this is just a temporary measure that will be phased out ahead.

SRR reduction to help keep a lid on lending rates? Possibly. By releasing liquidity into the system, this may help head off banks’ having to pay excessively for deposits. Recall that with the base rate (BR) regime, pricing for retail loans is now linked to funding costs. As such, higher funding cost should result in higher BR and base lending rate (BLR), which may not be ideal when the macroeconomic environment is softening.

Investment case. While we expect BNM to keep the OPR at 3.25%, external outflows are likely to continue and this may prompt BNM to reduce the SRR further. No change to our NEUTRAL stance with Public Bank (PBK MK, NEUTRAL, TP: MYR19.00) as our preferred sector pick.