Shadow banking: It's a problem

A “shadow banking” crisis is looming if left unchecked and could potentially derail our financial markets and economy.

The reason for such concern is plain to see from the staggering numbers those institutions are now showing. Last year alone, non-banking financial institutions (NBFIs) gave out RM43bil in new personal financing facilities, up from 63.7% previously according to Bank Negara’s Financial Stability and Systems Report 2012. This is more than two times the loans disbursed by banks for personal loans at RM19.4bil for 2012. The central bank notes that such loans extended by the three largest NBFIs grew at a faster rate of 23.1% in 2012 versus 17.1% a year ago. That growth is faster than the 10.4% recorded by the entire banking sector.

The culprit for such high credit growth is personal financing. According to the central bank, NBFIs supplied 60% of personal loans to the country last year and growth in that segment by the shadow banks grew by 29%. Personal loans by the commercial banks clocked in at 9.1%.

Such lending has pushed household debt to GDP at a frightening 83% of GDP. That ratio is the highest in emerging Asia and was at 70% in 2009. Developed western countries have a higher ratio but are now mired in economic problems.

These numbers have caught the eye of the central bank which has for years looked nervously at how fast the shadow banking industry has grown.

Politics and a lengthy due process for legislation to be passed and control to be given may have delayed any intervention the central bank may have wanted to take, but it is no longer fighting on the sidelines.

It has now acted to oversee the shadow banking industry with the newly enforced Financial Services Act (FSA).

Zeti: 'We are catching household debt on time'

“It’s (household indebtedness) on the increase and not at an alarming level yet but based on the rising trend, it will be,” says Bank Negara Governor Tan Sri Dr Zeti Akhtar Aziz on the rising household debt.

The reason it has decided that the time for action is now was also because of the challenging economic horizon. Zeti says that with growth on a quarterly basis expected to be between 4% and 6%, household debt growth trend at the current pace will not be sustainable.

“We are catching it on time,” she says.

To tackle the debt issue, Bank Negara has been granted new powers under the FSA and has not wasted any time to put such legislative muscle to work.

“With the FSA there is consistency in rules for banks and the non-banks,” Zeti adds.

Trouble brewing

A shadow bank is essentially a term used to describe institutions that take on bank-type functions. They are lenders that are not governed by Bank Negara before this. (see table) but compete with the banks in lending money to the public. But not anymore as the new FSA has allowed the central bank to get the shadow banking industry to comply with its rules on lending.

In China today, a major banking crisis is unfolding and shadow banks’ overlending is said to be part of the cause. India has also taken steps to monitor its shadow banking activities after a sharp growth in such businesses over the recent years.

The size of the global shadow banking system, on a conservative basis, has grown to over US$67 trillion from close to US$26 trillion about ten years ago and accounts for nearly half the size of the worldwide financial system, media reports indicate. But economists say that while these activities provide a valuable alternative to bank funding, it can pose large-scale risks to the economy from past experiences.

In Malaysia, it isn’t clear just how large the shadow banking system is as they are not captured in any formal banking statistics. But some estimates put it at easily several hundred billions the amount of money loaned out. Among the more prominent shadow banks are lenders such as the Government-owned Bank Rakyat Malaysia Bhd (Bank Rakyat) and public-listed Malaysia Building Society Bhd (MBSB).

Here’s a telling fact: both these institutions have been reporting phenomenal growth at a time when mainstream banks have been hit by the central bank’s policies on responsible lending.

Cooperatives are also another player in the shadow banking sector.

Although the shadow banks were supposed to go ahead with implementing responsible lending guidelines, they did so without knowing the exposure borrowers had to loans granted by commercial banks.

Now, the shadow banks, including the cooperatives, will have to comply with new lending rules, which limit the amount of the debt of vulnerable borrowers to a maximum of 60% of their net income.

“The affordability test is now consistent with non-banks and banks and also to other entities that undertake bank-like activities,” says Zeti.

The Angkasa syndrome

The phenomenal rise of shadow banks over the last few years can be attributed to mainly one party or rather, a system of credit – Angkasa or Angkatan Koperasi Kebangsaan Malaysia Bhd.

This is the national umbrella body for cooperatives whose members make up of civil servants by virture of them being the bulk of cooperative members. It was formed in 1971 by Royal Professor Ungku Abdul Aziz, who is co-incidentally the father of Zeti.

While the original motives of creating Angkasa were noble, what has since transpired though is that Angkasa has become a major conduit for ‘wild’ lending to civil servants, and this is where the problem is. (The Angkasa scheme allows for deductions of as much as 60% of a borrower’s total income, net of statutory and other direct deductions from salary.) Angkasa had yet to respond to StarBizWeek’s query as at press time.

Bank Negara notes that 80% of the personal financing by NBFIs are given out to government servants with a monthly household income of less than RM3,000. This means that about RM34.4bil in personal finance loans were dished out to that group of lowly paid civil servants last year if Bank Negara’s RM43bil NBFIs figure is used as a guide.

Angkasa’s 2012 annual report showed that RM10.3bil was made via the automatic salary deduction scheme with the bulk of it going to the civil service. As a comparison the government was projected to have paid out RM52bil as salaries to civil servants last year.

But what are the sources of these funds? Do note that Angkasa is merely a conduit to these loans.

Industry sources say there are a multitude of sources from which these funds come from.

Judging from the low risk element in these loans, as Angkasa enables salary deductions to repay the loans, there had been a race by funders to lend to government employees. Even the mainstream banks have tried to get a slice of this pie.

Analysts note that the earnings of MBSB and Bank Rakyat have risen sharply in recent years primarily due to an increase in personal financing activity.

As a result of vast sums of personal loans being dished out to mainly civil servants, a number of NBFIs have become really profitable, even more than some of the banks in the country.

Bank Rakyat’s profit before tax and zakat of RM2.11bil in 2012 for example is comparable to RHB Bank Bhd which made RM2.2bil. MBSB and Bank Rakyat declined to comment.

It is estimated that over 90% of civil servants are in an “indebt situation” in various ways like credit cards, personal finance and high-purchase debt.

“The easy loan access in recent years has thrown civil servants deeper into debt. Wouldn’t this encourage corruption?” quips an industry observer.

The curbs will ease the rapid expansion of loans growth seen by the NBFIs. Zeti acknowledges that the new lending guidelines will also slow loans given to the household sector by the commercial banks.

“These measures are anticipatory and pre-emptive and are to avoid doom and gloom,” she says.

Bank Negara headquarters

Hope is that early action on controlling household debt and easy personal finance loans will be as successful as measures taken to address credit card debt some years back.

Credit card debt accounted for 5.2% of household debt before the central bank decided to act a couple of years ago. Today, such debt accounts for 4.5% of household debt and credit card debt grew by 1.7% last year from 15.2% in 2010.

Bank Negara is confident that it will nip the problem with its latest intervention. Some, however, believe the shadow banking issue has not reached a boiling point yet.

Anthony Dass, chief economist at AmBank Group notes there is hardly any risk to non-banking lenders in view of the automatic salary deductions via Angkasa from the civil servants salary in contrast to the normal bank loans where the risk of default is higher due to the absence of automatic salary deduction.

“What is of concern to us is the issue of governance, transparency and controls. Lack of these will result in rising cost-to-income ratios. It will weigh on the bottom line and cause distress to the non-bank lenders.

A crack in any one of them (non-bank lenders and credit cooperatives) will likely trigger a contagion effect resulting from panic withdrawal by customers who have placed funds in savings or fixed deposits. Should there be a contagion effect, we fear that it may knock on the doors of the banks given the high household debt to GDP of 83%.”

Related stories:
Angkasa in the news for overlending
MBSB under spotlight
Bank Rakyat aims for more balanced portfolio