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Malaysia’s banking system is at its strongest, thanks to the lessons learned and the foundations laid after previous crises, but is it enough to overcome an unprecedented calamity that has affected economies around the world?
Deputy Governor of Negara Malaysia Bank Jessica Chew does not rule out that the risks are great and acknowledges that “the future challenges will be significant” for the banking system, but points out that banks are entering this crisis from a position of strength.
“There is certainly no doubt that the current banking system is much more resilient than at any other time in its history. Much of this is due to the reforms we have implemented after the Asian financial crisis. [AFC] “It was a bitter pill for us and we took important steps to reform the banking system, but we didn’t stop there,” Chew tells The Edge in an exclusive interview last Tuesday.
“We believe that the reforms were good for the banking system and will help us in a situation exactly like the one we are in now. It puts us in a position to endure enough pain … probably a substantial amount of pain. “
2019 data shows that the banking sector had a total capital ratio of 18.4%. It has a surplus capital of RM121 billion versus RM39 billion in 2008 and is able to withstand potential credit and market losses.
The sector had a common Tier 1 capital ratio of 14.4% and a gross impaired loan ratio of 1.6% in February this year. Liquidity continued to be broad with a liquidity coverage ratio of 148.0%. The credit loss coverage ratio was 125% at the end of February compared to an average of 120% from 2015 to 2019.
In particular, economists tend to agree with Chew. They also believe that the capital and liquidity buffers of the financial system at current levels are strong enough to cope with the Covid-19 pandemic, which has caused shocks to both the economic and health systems in the country.
Lee Heng Guie, Executive Director of the Associated Chinese Chambers of Commerce and Industry of the Malaysian Center for Socioeconomic Research, notes: “During the AFC of 1997/98, Malaysian banks had to be recapitalized due to a deep economic recession and overexposure. to overheated property and equity markets, which had fallen due to the severe regional currency crisis.
“Since then, the Malaysian financial system has built a solid capital base to withstand major economic shocks and absorb potential losses, thanks to better risk management, liquidity management, asset and liability management, as well as asset quality management “.
When the time came for testing in the form of the 2008/09 global financial crisis (GFC), the country’s banking system was “intact,” recalls Lee.
While the effects of Covid-19 are expected to be more severe than previous crises, Lee believes that banks’ significant capital and liquidity buffers will help them survive this economic downturn.
In perspective, the excess capital of RM121 billion is 3.1 times greater than during the GFC. As such, the banking system is in a stronger position to absorb losses in the current crisis, says Dr. Yeah Kim Leng, professor of economics at Sunway University School of Business.
In simulations of the central bank’s financial stability review (FSR), in severe stress scenarios, the potential losses of the debts of households at risk are estimated at 42.6% to 67.5% of the excess capital buffers of banks .
It does say that this means that to shake up the banking system, the downside will have to double in intensity.
Without a doubt, the banking system is a vital part of the economy, since it holds the country’s financial system together.
Currently, the credit granted by the banking system to companies and households amounts to RM 1.77 trillion, or 117% of the country’s gross domestic product (GDP) in 2019.
Commenting on the importance of the country’s banking system, Yeah says: “A problematic banking system will cause a deeper recession like the one experienced by the country during the 1998 AFC, where the economy contracted by 7.5%. In contrast, the recession was -1.5% lower in 2009 during the GFC. A weak banking system certainly impedes economic recovery, as is evident in advanced GFC-affected countries. Due to a robust banking system, Malaysia recorded a strong rebound in growth of 7.4% in 2010. “
Bank Negara had previously introduced measures such as the automatic moratorium on business and private loans to ease the cash flow pains that could arise during this crisis. It has also undertaken two rate cuts this year, reducing the overnight policy rate to 2.5%.
UOB economist Julia Goh notes that these measures have been among the key stabilizers for the economy as stress increased with the extension of the Movement Control Order (MCO) amid continued global supply shocks and demand.
“Interest rates are much lower and more stable today, with greater flexibility in exchange rates than during the AFC, when interest rates saw a sharp rise that worsened the NPLs [non-performing loans] and intensified economic stress, “says Goh (see” Expecting NPLs to Rise. “)” The main concern today is the extent of economic weakness and the form of recovery after MCO. “
Untested waters
In fact, the banking system is in a stable position, but the banks’ playbook for all these years may not be as helpful in an unproven environment clouded by a pandemic.
A key challenge for banks now will be to monitor the evolution of credit in their portfolio, says Chew, reasoning that, for a period of at least six months, banks will not be able to observe the behavior of payments due to the moratorium.
“Banks will have to be much more agile in the way they approach credit monitoring and evaluations. For example, they will have to go beyond their usual sources of information to assess development risk within their portfolios … and we see that the banks we supervise do this, “she says.
Citing examples, Chew says banks are looking at utilization rates for their clients’ facilities and how operating account balances are developing, in addition to reaching out to small and medium-sized business (SME) clients and engaging them in plans. of recovery.
Recognizing that the country is in unknown territory, he points out that this is where the Negara Bank stress tests come in.
“Ultimately, it is very difficult to predict where a bump or shock will come from and you don’t have much control over how they will transmit and evolve. We do stress tests precisely to give us the ability to see where these pressure points might be and regardless from the source of the crisis, we want to know that banks will be able to respond. ”He adds that banks are much more agile than before to respond to the current crisis.
While the severity of Covid-19’s impact on the economy and the banking system has yet to be determined, considering past crises, Malaysia fell into a recession in 1985, with GDP contracting 1% that year.
The unemployment rate increased to 5.6% in 1985 and 7.4% in 1986. Delinquency rates for commercial banks peaked at 30% in 1987 and 1988.
The government then embarked on a contractive fiscal policy and devalued the local currency. Emphasis was also placed on promoting foreign direct investment in the economy. New prudential regulations were introduced in the financial sector in 1989.
For 2020, Bank Negara has forecast that GDP growth will be between -2% and 0.5%. Meanwhile, unemployment is expected to rise to 4% this year.
In the most recent central bank macro stress test, two recession scenarios are assumed: one V-shaped, where negative growth is followed by recovery; or an L-shaped one, where there are four years of negative growth (a scenario never experienced before by Malaysia).
In the extreme L-shaped scenario, which assumes an NPL shock of five to six times NPL levels of 1% today (compared to AFC, when NPLs increased three-fold from their pre-stress position), the system Banking as a whole still has a considerable buffer, with a total capital ratio falling to 12.5%, which is still comfortably above the regulatory minimum of 8%. In 2019, the capital ratio stood at 18.3%.
“That gives you an idea of the resilience of the banking system,” says Chew, but he quickly adds that this is a “very fluid situation” and that the regulator is not accommodating, although he is comfortable with the results of the stress tests. .
“This crisis is difficult and complex to balance between health and economic considerations. It is global in nature and we do not fully understand epidemiology either. There is still a lot of uncertainty, so we must keep our ears on the ground and make sure we understand what is happening … The only way to do it in this environment is through direct engagement with banks and banks with their customers. ” , she says.
When asked about the red flags resulting from the stress tests at the banks, Chew says there are none at the moment.
“All banks are well capitalized. We see that they are managing their loan books aggressively and proactively. Many of them are doing their best to communicate with their borrowers to understand their recovery strategies and business profile – how that will change after Covid-19. “
Chew expects to see more loan modifications during this period.
“With the moratorium and relief measures in place, we are reasonably optimistic that many companies, certainly not all, have a chance to get out of the crisis and be able to continue meeting their credit obligations. What the banks do during these six months will be quite critical, “she says.
As the AFC encouraged bank consolidation, will the current crisis trigger mergers and acquisitions in the sector?
“We leave that [M&A] to market forces, so we’ll see how things go. It is not a political prescription. For some smaller institutions, we don’t rule that out, “says Chew.
“Compared to the AFC, it is day and night in terms of bank resistance, especially of the largest banks. They went through consolidation; That was a policy-induced consolidation then because we saw a critical need to strengthen national institutions. We are not in the same situation as then, so we left it to market forces. “
Good weather friends?
In fact, as a new normal has emerged from this crisis, banks must be agile and adapt.
They will have to review underwriting approaches and assumptions around revenue, particularly for the foreseeable future, as it will take time for companies to adjust and restart in the new environment, Chew predicts.
“It is an opportunity for banks to take advantage of segments and new businesses. In this new environment, there will be new opportunities. “
Banks must also manage their credit portfolio and credit risk in this environment so that they can respond pre-emptively to mitigate cost, he adds.
Chew believes the support borrowers need is being extended by banks right now, but the regulator stresses the importance of banks continuing to provide.
“We don’t want to see excessive risk aversion in the economy right now, as that may amplify the risk facing the economy.” It’s important that they have strong buffers, and that will substantially reduce their risk aversion. ” He adds that it is imperative that banks work with existing borrowers so that there is no subsequent shock to the banking system.
Chew expects banks to see some impact on earnings this year and next, as loan growth will slow and the cost of credit is likely to rise in the current environment.
The regulator sees opportunities for banks in the long term. “This is the opportunity for banks to build more lasting relationships with customers and not be friends with the good weather. Their borrowers and clients will remember how they were treated and supported during this difficult period, ”he says.
However, bank analysts have lowered their earnings forecast for the sector.
In a recent report, Credit Suisse says that, over the past month, it lowered its net profit estimates for fiscal year 2020 to fiscal year 2222 for banks by 8-14% on average. In its revised forecast, it took into account lower growth in loans, greater compression of net interest margin, higher cost of credit in anticipation of a rebound in default rates, and lower non-financial income, as it is likely that slowdown in capital market activity and slower growth result in lower rates.
Meanwhile, CSG-CIMB Research has lowered its net profit forecast for Malaysian banks by 8% for fiscal year 2020 and from 12% to 13% for fiscal year 2121 / 22F since February 13, as It took into account the 125-day cut in the overnight policy rate expected by its economist and reduced the projected growth of its loans by four percentage points for all banks.
This is to reflect the negative impact of Covid-19, which will affect credit demand and slow economic growth, it adds in a report dated April 30.
After the profit cuts, the local research house projects a 5.8% decrease in CY2020F net profit for the sector, from a previous 3.2% increase.
The local economy is expected to contract this year with near-stagnant commercial activity since the start of the Movement Control Order (MCO) on March 18. The country has lost around RM63 billion in revenue since then, Prime Minister Tan Sri Muhyiddin Yassin announced last Friday.
Despite companies expecting to lift some of the restrictions under the MCO this week, it is a fact that they will not recover quickly as consumers are still cautious about venturing out of their homes.
As such, it is worth considering what will happen after September 30, when the extended automatic loan moratorium on businesses and individuals ends. Will we see more defaults in the near future?
“In this environment, yes, we should expect NPLs to rise because there will be businesses that will continue to face difficulties,” says Negara Malaysia Bank Deputy Governor Jessica Chew.
However, she notes that NPL levels for the banking system are at an all-time low now. At the end of February 2020, the gross impaired loan ratio for the banking sector was 1.57%.
“With low NPL levels and strong buffers supporting the banking system, yes [stand] the system is good at handling challenges, “says Chew.
Dr. Yeah Kim Leng, professor of economics at Sunway University School of Business, believes delinquency rates could start to increase slightly even during the loan’s moratorium period, and potentially increase after it ends.
“As social and business activities are closed and movements are restricted to contain the spread of the virus, the loss of business income and reductions are expected to contribute to increased loan defaults.
“The defaults are likely to increase after the moratorium period, especially if over-leveraged companies or individuals are unable to continue paying their debts due to continued business losses and layoffs,” says Yeah. However, it adds that a stress test carried out by the central bank has indicated that the banking system can absorb these losses if they materialize.
Banco Negara’s 2S2019 Financial Stability Review (FSR) report released in March highlights that household debt levels had risen to 82.7% of gross domestic product compared to 82.2% of GDP at the end of June last year. Meanwhile, corporate debt levels had dropped to 99.4% of GDP.
However, how high the default rate will be is a question that no one can answer.
Bank Negara’s Chew comments that it is “really very difficult to predict” how high levels of NPL can increase at this juncture, but believes that there will be greater visibility and insight into the situation in a few months.
“But we certainly do not expect deficiencies to increase to a level that threatens financial stability, for all the reasons mentioned above. Strong buffers, better loan portfolio quality, and institutional readiness are in place to manage risk. defaults.
“All of these will be critical factors and will put us in a strong position to manage any impact of the NPLs,” he explains.
While there is a risk of higher delinquencies, Chew notes that corporate borrowers have been shown to have an interest coverage ratio that was 4.6 times total in late 2019, according to the review conducted before the escalation. de Covid- 19 situation. She says this is above the prudent level, which is generally about twice.
Even segments that the central bank has identified as facing high credit risk, such as oil and gas, palm oil, construction, retail, and wholesale, recorded an interest coverage ratio of more than three times.
“Obviously, that image may change due to the challenges we face, but they are entering the crisis based on this matrix with reasonably healthy finances. Now, it’s about how they adapt, “says Chew.
The small and medium-sized business sector, which has become a concern since the MCO’s inception, has seen an improvement in terms of its credit profile over the years.
“Some years ago, it was approximately 4%; now the deterioration rate is approximately 2.7% for the sector. But, this was before Covid-19, ”she says.
In the household sector, the FSR report states that household assets have continued to exceed their debts. Meanwhile, the sector’s debt at risk remains low, at around 5.2% of total household debt.
While many fearfully wait to see the effects after September 30, the hope is that the banking system will continue to function as a well-oiled machine, with everything in place.
