Banking: Prolonged deposit slowdown may lead to higher funding costs


PETALING JAYA: The slowdown in deposit growth to almost a three-year low is expected to put further pressure on banks’ net interest margins (NIM) which have been compressed in the last few years. The lower margins have to an extent impacted earnings due to the low interest rate environment.

Analysts expect competition to intensify in the deposit space to attract more deposits which has been on the downtrend resulting in higher cost of funds. One of the main reasons why banks are building up their deposit bases is that they are preparing to meet the Basel III liquidity requirements.

RAM Ratings co-head of financial institution ratings Wong Yin Ching (pic) said: “With the low interest rate environment and availability of higher-yield investment options, bank deposits have become less attractive for individuals.

“This has caused the competition for deposits among banks to intensify. In addition, banks are also building up their deposit bases to meet the Basel III liquidity requirements which will come into effect mid-2015. Notably, banks have been prioritising retail over corporate deposits as they have more favourable treatments under the regulatory liquidity ratio calculation.”

Wong told StarBiz that some banks had been offering higher rates for fixed deposits on a short-term promotional basis and were also paying interest on current account deposits which traditionally attract zero interest.

The higher funding costs invariably caused banks’ margins to come under pressure, she said. On a positive note, she added that the overnight policy rate (OPR) hike in July had offered some respite to the declining margins given that the repricing of deposits lagged that of floating-rate loans and also the majority of banks did not translate the entire quantum of overnight policy rate (OPR) increase into the deposit rates.

An industry observer agreed with views of some analysts that a prolonged slowdown in deposits could result in higher funding costs due to intense competition to shore up deposits and which could impact net interest margins (NIMs).

The average lending rate (ALR) and the three-month fixed deposit spread serves as a proxy for the sector’s NIM. Notably, the deposit growth that reached near 15% in 2012 had seen a slowdown ever since to an almost three-year low.

An analyst from Affin Hwang Capital Research said in a recent note that the slowdown in deposit growth, if prolonged and sustained moving forward, may feed into higher funding costs as banks may need to more aggressively compete against one another for short- and medium-term deposits.

This is because banks would need to maintain their loans to deposits (LD) ratio at a healthy pace, the analyst from the research house said, adding that the slowdown may be due to various factors such as the higher base or businesses and individuals deciding to park their savings overseas instead.

“It also could be that the businesses are opting to finance their capital expenditure investments through their own means rather than resorting to the bank borrowings on the possible hike in rates,” the analyst noted.

The current slowdown in deposit growth, according to analysts, is due to rising costs sparked by higher inflation from higher energy costs, among others, which has started to put a dent in the overall savings rate of consumers and businesses – the two biggest constituents to deposits in the country.

The impending goods and services tax (GST) scheduled to be launched next year will likely see inflation trending higher although modest demand could mitigate the price hike.

Affin Hwang Capital Research in its latest note said it expected the country’s headline inflation to average around 3.5% in 2014 (2.1% in 2013).

For 2015, the research house added that inflation was expected to rise in tandem with the introduction of GST, averaging around 4.5% in 2015.

Bank Negara may normalise its overnight policy rate (OPR) hike by another 25 basis points (bps) in the first half of next year to 3.5%, but it is likely to be premised on domestic economic conditions next year, according to Affin Hwang Capital.

The central bank at its recent Monetary Policy Committee meeting maintained its OPR at 3.25% after raising it by 25bps in July.

The central bank highlighted that “inflation is projected to trend higher for the remainder of the year and will continue to be above its long-term average next year due to domestic cost factors.”

On the LD ratio, Wong said: “RAM views the banking industry’s funding and liquidity to be still healthy. The LD ratio is one of the funding and liquidity indicators that we track to assess the health of the banking system. We have observed that the ratio has been on a gradual uptrend over the last few years given that deposit growth has trailed loan growth.

“The LD ratio increased from about 75% five years ago to 83% as at end-September though this is still within a comfortable threshold. Our system’s LD ratio also stacks well against other Asean banking systems,”

Kenanga Research, which is maintaining its neutral stand on the banking sector, said based on the September banking figures, the banking system’s LD ratio inched higher and excess liquidity was shrinking.

System deposit grew at a slower pace in September against loan (+5.9% year-on-year versus 9% in August), which caused industry’s LD ratio to inch upwards to 82.1% (August: 81.8%) while system excess liquidity narrowed by 6.1% (August: -6.3% ).

The research outfit noted that the percentage of current and savings accounts and excess liquidity to total deposit base stood at 25.8% (August: 25.5%) and 17.9% (August: 18.2%) respectively.

Interest spread for September widened temporarily. As a result of the 25bps hike in OPR on July 10, the interest spread between average lending rate (ALR) and three-month fixed deposit rate had widened to 1.6% (August: 1.57%) where the former increased to 4.72% (August: 4.69%) while the latter stayed flat at 3.12%.

However, Kenanga Research expected this trend to be short-lived given stiff price-based competition in the market.

Prolonged slowdown in deposits may result in higher funding costs

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