KUALA LUMPUR: Bank Negara Malaysia’s stress test has affirmed the resilience of banks in the face of an expected increase in credit losses under more adverse economic conditions despite higher impairments forecast.

Under the assumed scenario of economic and financial shocks arising from the pandemic, it said overall impairments are projected to rise above 4% of loans by end-2021, mainly driven by higher business impairments.

In its “Financial Stability Review - First Half 2020” report issued on Wednesday, it said this takes into account the effects of the blanket moratorium implemented in April and subsequent targeted repayment assistance for individuals that was announced by banks in August.

Business impairments are expected to be driven by defaults of maturing bullet repayments of firms operating in vulnerable sectors, mostly in the services industry which is expected to experience a slower recovery, as well as exposures to several large borrower groups with weaker financials.

Meanwhile, household loan impairments are projected to double, albeit from historically low levels.

Higher household impairments are expected to emerge in the second half of 2021 given the extended repayment assistance programmes that will remain in place through 1Q 2021 for individuals who have experienced a loss in income.

“Overall, credit costs to banks could rise to RM29bil (1.4% of total loans) over 2020 and 2021. These projections assume conservative estimates of the share of loans under bespoke targeted repayment assistance (mainly for businesses) based on restructuring and rescheduling (R&R) trends observed at the onset of the pandemic.

“With uncertain conditions persisting, banks have been much more proactive in extending repayment assistance, as seen in recent months. This was not taken into account in the simulations, ” it said.

Bank Negara said since July, the number of businesses receiving repayment assistance from banks has increased seven-fold. This would improve debt serviceability and mitigate credit losses.

It also pointed out that in anticipation of higher credit losses, banks have been shoring up their buffers, adding RM2.7bil to provisions in 1H 2020.

“At an individual bank level, additional provisions by banks have already risen to an average of 16% of banks’ projected stressed credit losses over a 12-month horizon based on their internal stress tests.

“Provisions could increase further as banks obtain greater visibility on credit developments based on more informed assessments of borrowers after the end of the blanket moratorium.

“The gradual build-up of provisions will also ensure that banks maintain healthy buffers to absorb losses and support continued lending to the economy, ” it said.

The impact of stressed credit losses on banks’ solvency would result in the aggregate total capital ratio (TCR) and CET1 capital ratio declining by two percentage points (ppts) and 1.4 ppts, respectively, over the next 12-18 months.

Under the bottom-up scenario analysis, the aggregate TCR and CET1 capital ratio as reported by commercial and Islamic banks are projected to decline by a larger extent of 3.4 ppts and 3.1 ppts, respectively, from initial positions.

Bank Negara said by applying a sensitivity analysis to these results, individual banks are projected to have adequate buffers above the regulatory minimum capital requirement to withstand further losses associated with default rates that are eight times higher than the banks’ historical default rates.

These multiples are significantly more severe than Malaysia’s historical worst experience in the Asian Financial Crisis, during which overall impairments rose by three to five times from initial levels.

The drivers of credit losses were observed to be broadly similar under both the macro simulation and the bottom-up analysis, further affirming that the financial system has adequate buffers to withstand extreme stresses that are more severe than the historical worst experienced to date.

Bank Negara said while the stress tests capture plausibly adverse scenarios with some degree of conservatism, the actual impact of the pandemic on banks’ solvency over the next 12-18 months will depend on multiple factors.

They include the pace and strength of the domestic economic recovery, which in turn is contingent upon how the pandemic continues to evolve, labour market conditions and business and consumer behaviour in the new normal.

The other factors include the pace of economic recovery within the region, which could affect the asset quality and profitability of overseas operations of domestic banking groups;

Initiatives taken by financial institutions to support viable borrowers, which could improve debt servicing capacity and reduce potential impairments;

Bank management actions to shore up buffers such as new capital issuances or capital injections from parent bank(s); and

Additional policy intervention by Bank Negara, government and/or other authorities to support economic recovery.

Bank Negara said while banks can be expected to be more cautious given continued uncertainties and prospects of a more protracted recovery, it is in the collective interest of the banking industry to continue supporting viable businesses and households throughout this period.

“Capital buffers built up over the years are intended to support lending during times of stress and therefore can be used. Further, such buffers are vital for banks to remain resilient and reduce risk aversion.

“This will be critical to avert larger repercussions on economic growth and recovery prospects, which in turn will inflict much higher losses on banks, ” it said.

https://www.thestar.com.my/business/business-news/2020/10/14/bank-negara-stress-test-impairments-to-rise-above-4-of-loans