BNM Financial Stability Report 2014: Banking system pre-tax profit at RM32b

KUALA LUMPUR: Malaysia’s banking system's pre-tax profit, including Islamic banks, expanded by 7.6% on-year to RM32.02bil in 2014, underpinned by net interest/profit income from financing and funding activities and fees, and commission revenue from financing-related activities.

In its Financial Stability and Payment Systems Report 2014 issued on Wednesday, Bank Negara Malaysia said the banks' returns on assets were 1.5% and equity at 15.2%, similar to levels recorded in 2013. 

“The main drivers of earnings performance were net interest/profit income from financing and funding activities (+5.3%), and fees and commission revenue from financing-related activities (+5.7%). 

“Revenue from other fee-based businesses, mainly investment banking and payment-related services, has continued to grow steadily in importance. This now accounts for almost 13.5% of gross income, compared to about 9.5% two years ago,” it said. 

BNM said these helped counteract compressed interest margins on revenue in recent years, particularly in the retail lending market, but contribution to income from these activities remains relatively small vis-a-vis core financing activities.

“Despite more volatile market conditions, banks recorded aggregate net gains of RM4.1bil from the trading and investment portfolios,” it said. Banks’ profitability also benefitted from continuing initiatives to improve productivity and operational efficiency. 

Banks continued to keep a lid on overhead costs, which increased modestly by 6.3% (2013: +5.7%) amid lower incremental investments in risk management and IT systems, having largely made these investments in earlier years. 

“One of the areas that BNM continues to keep a close watch on is the impact that cost control measures are having on risk management capabilities and compliance functions to ensure that these are not compromised,” it said.

The insurance and Takaful sectors registered mixed performance in 2014. The life insurance and family Takaful sector recovered from significant investment losses incurred in 2013, to record a growth of 4.5% in excess income over outgo totalling RM13.8bil in 2014. 

BNM said lower capital losses on the investment portfolio had the most significant impact on the performance of life funds. Such losses amounted to RM924mil for the year, 38.7% lower than losses incurred in 2013. 

For the life sector, BNM noted that investment-linked business expanded to account for 42% (2013: 39%) of new business premiums or 35.7% (2013: 32.8%) of total net premiums. 

The profits of the general insurance and general takaful sector declined slightly by 2.3% to RM3.2bil due to higher net claims incurred and lower net profit from disposal of assets. 

Although the overall loss ratio has been contained below 60% for the past three years, mainly reflecting improvements in the fire and motor “Others” (which formed bulk of net claims incurred) businesses, losses from the compulsory motor third-party liability insurance (motor `Act´) business continued to pose strains on overall claims experience. 

The loss ratio for this segment remains well in excess of 100%. Greater pricing flexibility resulting from the progressive deregulation of the motor premium tariff is expected to be positive for the performance of the industry as a whole. 

BNM pointed out while this may also lead to the under-pricing of risks by some insurers to capture or retain market share, this risk is mitigated by the premium bands that will continue to apply for a specific period of time. 

Multi-year stress test

The central bank said the multi-year stress test affirmed financial institutions’ shock absorbing capacity.

Stress tests conducted by the Bank affirm the strong capacity of financial institutions, both at the system and institutional levels, to withstand severe macroeconomic and financial strains

At the end of the stress horizon, the post-shock aggregate total and CET1 capital ratios of the banking system were above 11% and 8% under the first adverse scenario (AS1), and above 10% and 7% under the second adverse scenario (AS2) respectively.

At the institutional level, more than 80% of banks remained above the minimum Basel III total, Tier 1 and CET1 capital ratio requirements of 8%, 6% and 4.5% respectively. Pre-provision net revenue contracted by 18.3% and 22.4% relative to the baseline scenario in AS1 and AS2 respectively.

Losses were driven primarily by credit risk shocks – forming more than 97% of overall losses in both scenarios. Of this, the defaults of selected large corporate borrowers constituted between 10% and 20% of total credit losses.

The results indicate that even under severe macroeconomic and financial strains, banks on the whole continue to be well-positioned to absorb the impact of losses from available capital buffers, without taking into account any additions to capital throughout the period.

For the insurance industry, the post-stress CAR similarly remained above the minimum regulatory requirements under both AS1 and AS2. 

The impact on capitalisation for general insurers was more pronounced from the impact of shocks applied in relation to higher provisions for motor claims. The resulting operating losses reduced the CAR for general insurers from 279% in end-2014 to about 140% by 2018 under the most severe shocks applied on general insurance risk. 

Life insurers on the other hand were more affected by volatility in financial markets in 2015, but maintained a strong CAR throughout the stress test horizon, with the CAR declining from 260% at end-2014 to 184% by 2018.