BANK Negara’s decision to impose a more stringent provisioning requirement for banks by the end of next year might have caught many industry observers by surprise.
But with the economic environment turning increasingly unfavourable to the personal wealth of most Malaysians, some bankers believe the move seems like it couldn’t have come at a better time.
Bank Negara had early this month issued a directive to banks to set aside a minimum collective assessment (CA) plus regulatory reserve ratio of 1.2% over their total adjusted loans from Dec 31, 2015 onwards. The requirement, effectively, will put a stop to the present situation where banks are left to set aside their CA ratios based on their own risk assessment of their asset profile.
Bank Negara’s recent directive is widely seen as an initiative to improve the standards of prudence in the local banking industry.
As ALLIANCE FINANCIAL GROUP BHD (AFG) group chief executive officer and director Sng Seow Wah puts it, “Bank Negara’s latest directive on provisioning is a very prudent move; it is the right direction to go.”
Make no mistake: The Malaysian banking system is still sound, and most banks remain on solid footing, as evidenced by the latest industry statistics from Bank Negara.
For one thing, data shows that the country’s banking system remains well capitalised and the overall asset quality had strengthened towards the end of 2013, while impaired loans declined. For another, the sector had continued to enjoy healthy loan growth momentum on the back of a steadily expanding economy.
The positive fundamentals aside, though, one cannot ignore the rising red flags that can have a negative impact on the banking industry.
According to RHB Research analyst David Chong, Bank Negara’s recent directive for banks to raise the provisioning buffer may have been prompted by the trends in recent years.
Chong points out in his report that while the system loan growth has stayed relatively resilient, the CA ratio has declined significantly, especially from 2012, when all banks fully adopted the new accounting framework, called Financial Reporting Standards (FRS) 139.
“We believe the lower CA ratio may be partly justified by the improvement in asset quality. However, with the non-performing loans (NPL) cycle likely having bottomed out, and as we head towards a period of higher inflation and interest rates, the central bank appears to be taking a proactive and prudent step in ensuring that banks have sufficient buffers in place to meet any potential asset quality issues ahead,” he explains.
Red flags rising
There are evident signs that increasingly more Malaysians are struggling financially because of their high indebtedness amid the rising cost of living and sluggish pay growth. This poses an increasing risk of loan delinquency, and probably necessitates higher standards of prudence in the banking industry.
Credit Counselling and Debt Management Agency (AKPK) chairman Datuk Mohd Hanif Sher, for one, notes that many Malaysians have taken up more loans than they can afford with their salaries.
Statistics from AKPK – an agency set up by Bank Negara to provide money management, credit counselling, education and loan restructuring services to individuals – show that the number of Malaysians seeking credit counselling and debt management advice had risen to 248,491 last year from 207,997 in 2012.
What’s also worrying is the rising number of bankruptcies in Malaysia.
Statistics from Malaysia Department of Insolvency show that the number of Malaysians categorised as bankrupt had risen from 13,238 in 2007 to 19,575 in 2012.
The high indebtedness of Malaysians has often been pointed out as an issue of concern among economists.
According to reports, Malaysia’s corporate debt-to-GDP (gross domestic product) ratio is currently hovering around 96%, compared with 80% in 2007. The country’s household debt-to-GDP ratio, on the other hand, is currently hovering around 83% – which is among the highest in Asia – compared with 60% in 2008.
Of great concern is that Malaysia’s household debt service burden is at a precarious 40% of disposable income.
Over the week, Standard & Poor’s Rating Services (S&P) released a report arguing that Malaysian banks are particularly vulnerable to deterioration in household health, as the household sector accounts for about 57% of the banking system’s total loans.
According to the international rating agency, Malaysian banks face high credit risks, given the country’s fairly large private-sector debt burden relative to the country’s modest income levels.
“Malaysia’s households face challenges on several fronts. Household leverage has been increasing over several years even as income levels remain modest. The country’s per capita GDP of US$10,849 (RM33,632) is one of the lowest among ‘A-’ rated sovereigns,” S&P’s report said.
“Subsidy reductions for sugar and fuel will push up living expenses, while the threat of rising interest rates from monetary policy normalisation looms. Economic imbalances from high property prices will strain household debt servicing when the credit cycle turns,” it explained.
OCBC Bank (M) Bhd country chief risk officer Choo Yee Kwan is of the view that Bank Negara’s directive on a new minimum requirement of CA is needed to ensure that impairment provisions could keep pace with the strong credit growth in Malaysia.
In an email response to StarBizWeek, Choo says: “Adequate impairment provisions serve as necessary buffers against potential credit losses; hence, they can reduce the likelihood of systemic risk for the banking sector.”
Choo notes that while the sector could witness an increase in the overall level of impairment provisions, it should be taken as a positive development, as the higher credit buffers would now render the sector stronger.
On average, the industry’s CA ratio as at end-December 2013 stood at 1.43%, down from 1.93% three years ago.
It is noteworthy that prior to the full adoption of FRS 139 in 2012, banks in Malaysia were mandated to set aside a minimum CA, or general provisions, ratio of 1.5% of total loans. Interestingly, following the switch to a new accounting framework, several banks have since maintained a CA ratio of less than 1.2% because there is no floor set by Bank Negara.
As it stands, four banks, namely PUBLIC BANK BHD, Affin Bank Bhd, AFG and MALAYAN BANKING BHD (Maybank), have CA ratios of lower than 1.2%, while other banks have maintained buffers of more than what will soon be required of them.
It appears that Public Bank, with the lowest reserve in the industry, will be the worst hit among local lenders under Bank Negara’s new ruling on capital accumulation.
The third-largest lender by asset size in Malaysia boasts of a CA ratio of 0.7% as at end-December 2013, and that represented an estimated shortfall of RM1.1bil from meeting the minimum requirement of 1.2%.
For Affin, whose CA ratio stood at 0.93% as at end-September 2013, the shortfall stood at about RM96mil, while for AFG and Maybank, both of whom were not very far from meeting the minimum required CA ratio of 1.2%, their respective shortfall stood at RM27mil and RM85mil respectively.
The new ruling by Bank Negara provides two options for financial institutions to meet the 1.2% requirement – either topping up directly the CA or topping up through a combination of CA and regulatory reserve.
Alliance Research analyst Cheah King Yoong says his channel check reveals that banking institutions that have fallen short of the impending requirement will most likely resort to building up their regulatory reserve to comply with the new requirement.
Cheah points out in his recent report: “We believe that the new requirement will serve as an additional capital buffer requirement for banks, which could impact their respective balance sheet, rather than having a direct impact to their bottom line.”
Bankers contacted by StarBizWeek, however, remain divided at present on the impact that the 1.2% requirement would have on their bottom lines.
According to one banker, the move to comply with the ruling will not impact on profitability because the additional amount required to be set aside can be transferred from retained earnings.
“Funds out of retained earnings will not impact the profit and loss (P&L) account of banks. It’s not a P&L item,” he says.
However, he concedes that the move could affect the dividend payout ability of banks.
Another banker says his financial institution is presently seeking clarification from Bank Negara on whether to set aside the provisions from its profits. “If that were the case, then it would impact profitability,” the banker says.
In the case of AFG, Sng reveals that the group intends to top up its CA shortfall from its retained earnings.
“Under the current accounting framework, we’ve maintained our CA ratio at around 1%. The shortfall is not a big amount, so the impact on our group will really be immaterial.”
Meanwhile, Maybank KE Research points out that Bank Negara’s directive could set back Public Bank’s capital accumulation plan and impact its dividend payout.
“With this new directive, the bank will now have to top up its CA by 0.5 percentage points to 1.2%, which means transferring about RM1.1bil from its retained earnings to regulatory reserves,” Maybank KE says in its report.
“As a result of the transfer, we estimate a decline in Public Bank’s CET1 (core equity Tier 1 capital) ratio (as at end-December 2013) to 8.2% from 8.7%,” it explains, adding that it is possible that Public Bank’s dividend payout ratio of close to 45% might have to be scaled back to conserve capital.
Maybank KE, which has a “sell” call on Public Bank, says the latest directive on capital buffer has only reinforced its rating on the latter.
According to Nomura Research, Public Bank’s relatively low CA ratio could be attributed to the latter’s consistently lower-than-industry average non-performing ratio, which currently stands at 0.7% compared with the sector average of 1.8%.
Nomura says it expects a two-fold impact on Public Bank in order to comply with the minimum CA ratio of 1.2%. Besides, the impact on the latter’s CET1 ratio, Public Bank’s credit cost for 2014-2015 will also need to rise about five basis points to sustain a CA ratio of 1.2%. This, Nomura says, will have a negative impact of about 2% to Public Bank’s group earnings.
Analysts do not rule out a possible capital-raising exercise by Public Bank to build buffers in order to meet the minimum CA ratio requirement of Bank Negara.
“We understand that management is still waiting for further details from Bank Negara with respect to various further capital buffers (for example, counter-cyclical buffers) that it may require banks to hold. Upon further clarity, the group will proceed with its capital-raising plan,” RHB Research says in its report.
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