Bank Negara Malaysia (BNM) held an engagement session yesterday in conjunction with the release of the Financial Stability Review 1H 2023.

Domestic financial markets remain orderly despite the global rout

Despite a global financial crisis in the latter half of 2022, Malaysia's domestic financial markets have remained stable. To recap, concerns arose due to the collapse of several financial institutions in the US and Europe, raising risks to financial stability. However, as anticipated, the contagion effect was well contained, and any impact on the Malaysian banks was negligible. Although concerns about the failures from these FIs have abated, BNM noted that the global financial markets continue to be volatile, with investors remaining cautious about the underlying vulnerabilities in the non-bank financial sector due to the elevated interest rate environment and a slower-than-expected recovery in China.

Domestically, BNM has observed reduced market stress levels during the 1H of 2023. Market conditions have remained orderly. There was sustained demand for corporate bonds and healthy interest in new government bond issuances. The bonds and foreign exchange markets have also shown stability. Additionally, domestic business activities have improved significantly, while the household sector benefits from better income and employment conditions.

Households Remain Resilient

Among measures tracked by BNM, the central bank noted that the share of risky loans to total household loans has declined to 4.6% from 6.7% as of December 2022 - below the pre-pandemic level of 5.8%. Loans under the repayment assistance had also fallen to 1.7% of total loans compared to 1.9% in December 2022. Encouragingly, the repayment capacity improved with steady readings of the median debt-to-income (DTI) ratio for overall households at 1.4x. BNM also noted that other measures, such as the median debt service ratios (DSRs) for newly approved and outstanding household loans, remained prudent at 42% and 36%, respectively. BNM attributes this soundness in household asset quality and the limited emergence of new risks to the responsible lending standards maintained by banks.

Domestic business activities improved despite broad challenges

Domestic business activities have shown improvement, even in the face of significant challenges. BNM has observed that the overall business sector remains resilient despite ongoing domestic and global difficulties. This resilience is supported by healthier financial indicators, including the debt-to-equity ratio, which improved to 20.6% in the 2Q of 2023, compared to 22.5% in the 4Q of 2022.

The percentage of firms facing significant risks has decreased to 26% in the recent quarter reviewed, down from 30.3% in the 4Q of 2022. BNM noted that larger businesses have been more adept at navigating challenges like elevated input costs (e.g., electricity and labour) and weak external demand due to economies of scale, efficient inventory management, and larger cash reserves. Consequently, the overall business loan impairment ratio remained stable at 2.8% of business loans, in line with the 2.6% average between 2015 and 2019.

In contrast, smaller businesses, particularly those in the SME segment, have been more affected by the challenging operating environment. Despite these widespread concerns and difficulties, banks have continued to support the SME segment's business needs and expansion. Loans disbursed to SMEs have increased at a faster pace, growing by 6.4% YoY in the 1H of 2023, compared to a 0.7% YoY expansion in business loans. The financing to SMEs is further bolstered by facilities provided under BNM's Fund for SMEs, with RM23.2bn disbursed out of a total allocation of RM32.4bn.

FIs remain watchful over underlying credit quality concerns

BNM reports a slight uptick of 10 bps in impaired SME loans, reaching 3% of total SME loans or 0.5% of the total banking system loans. This increase is attributed to emerging signs of financial vulnerabilities in certain segments of SME borrowers. In the 1H of 2023, there has been a higher frequency of missed repayments, and banks anticipate a potential deterioration in asset quality among borrowers with higher risk profiles. Increased borrowing costs and the rising cost of living drive this deterioration. Specifically, in the household segment, this includes borrowers with lower incomes and those employed in business sectors still grappling with challenges from the external economic environment.

In the business segment, banks exercise caution, particularly in sectors such as Wholesale and Retail Trade, Construction, Manufacturing, Real Estate, and Hotels and Restaurants. Additionally, Agriculture and sub-segments like Retail, Food and Beverages are exhibiting significant increases in loans-in-arrears during the 1H of 2023.

Businesses and banks remain resilient against FX risk

Corporate external debt rose to RM485.3bn from RM461.1bn in December 2022, driven by exchange rate revaluation due to a strengthening USD. Despite that, BNM noted that both businesses and banks in Malaysia have showcased remarkable resilience in handling FX risk. Even though nearly 85% of corporate external borrowings are denominated in foreign currency, the regulator has reassured that these exposures remain well-managed. BNM attributes this resilience to prudent FX risk management practices among large resident corporations, significant hedging of external debt through financial instruments or natural business operations, and the fact that most of these exposures have medium- to long-term maturities, thereby reducing rollover risks.

Going Forward….

Overall, while FIs anticipate ongoing challenges in asset quality, it is not expected to lead to a widespread deterioration in credit quality. According to BNM, banks foresee any deterioration to remain within their existing provisioning and capital reserves. The banking system remains robust, with CET1 and total capital ratios at 14.5% and 18.2%, respectively, along with Liquidity Coverage and Net Stable Funding Ratios of 149% and 117%, providing a solid cushion.

Simultaneously, BNM emphasised its commitment to combat financial fraud. The National Scam Response Centre (NSRC), launched in October 2022, has successfully disrupted 40,000 mule accounts, owing to its enhanced ability to detect and act on such accounts used in financial scams. Furthermore, FIs are expected to maintain vigilance in monitoring evolving threats and ensuring the resilience of their digital services against new forms of cyberattacks on their IT infrastructure and customer devices.

In addition, efforts to bolster climate risk resilience will persist, with a focus on advancing FIs' climate readiness through the implementation of Climate Change and Principle-Based Taxonomy (CPPT), adoption of the Climate Risk Management and Scenario Analysis Policy, preparation for an industry-wide climate stress testing exercise in 2024, and mandatory disclosures in alignment with the Task Force on Climate-Related Financial Disclosures (TCFD).

Neutral Maintained

We reiterate our NEUTRAL call on the sector for now, as we foresee earnings in 2023 to be dampened by more moderate loan growth, NIM compression, lacklustre fee income and rising overhead expenses. Nevertheless, on a positive note, we foresee sector earnings to be supported by healthier investment income, a benign asset quality outlook, and ample capital and liquidity reserves in the banking system. Other potential downside risks in 2023 include uncertainties surrounding the ongoing geopolitical tensions, competition, rising interest rate and FX risks, increasing inflationary pressures and rising interest rates leading to larger-than-expected credit losses, all of which could pose challenges for the sector.

Source: TA Research - 10 Oct 2023