Banks were among the gainers on Bursa Malaysia on Tuesday.
A Moody's vice president and senior analyst Simon Chen said the banks' operating conditions would continue to be challenging in Malaysia.
“Headwinds include lower crude oil prices, weak external demand, further weakening of the Malaysian ringgit, and rising concerns around governance highlighted by the controversy around 1Malaysia Development Bhd (1MDB, unrated)," he said.
"These challenges contribute to a worsening consumer and business sentiment in Malaysia and in turn weigh on domestic economic growth and growth prospects for banking system loans," Chen said.
Moody's conclusions were contained in its just-released report on Malaysia banking system outlook, entitled, "Banking system outlook - Malaysia: Strong capital, government support offset falling profitability to drive stable outlook". The report was written by Chen.
The stable outlook was based on Moody's assessment of five drivers: operating environment (deteriorating); asset quality and capital (deteriorating/stable); funding and liquidity (stable); profitability and efficiency (deteriorating); and systemic support (stable).
Moody's says the banks' asset quality will deteriorate from current strong levels but capitalisation will remain strong.
Downside risks stemming from high levels of indebtedness for corporates and households will be elevated under weaker macro conditions.
However, Moody's expects capitalisation will remain sufficient to withstand asset quality shocks even under various stress scenarios.
Moody's also expects the banks' funding and liquidity profiles will remain stable, with funding to remain as a key strength of the banking system.
Even when domestic liquidity tightened in Q4 2015 due to capital flight driven by market volatility, the impact on banking system liquidity was manageable.
Profitability will also deteriorate over the next 12-18 months, says Moody's.
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