Banks gain from rate hikes but face headwinds

In Malaysia, on May 11, Bank Negara decided to increase the overnight policy rate (OPR) by 25 bps to 2%. Prior to this, and due to the Covid-19 crisis, the OPR was reduced by a cumulative 125 bps to an all-time low of 1.75%, mainly to provide support to the economy in times of great uncertainty.

INTEREST rates are rising everywhere as central banks around the world are seeking to contain inflationary pressures.

Following the US Federal Reserve’s decision to hike interest rates by three-quarter of a percentage point or 75 basis points (bps), pressure has mounted on other central banks to raise rates.

In Malaysia, on May 11, Bank Negara decided to increase the overnight policy rate (OPR) by 25 bps to 2%. Prior to this, and due to the Covid-19 crisis, the OPR was reduced by a cumulative 125 bps to an all-time low of 1.75%, mainly to provide support to the economy in times of great uncertainty.

But as conditions improve and people and businesses start getting back to normal, one of the immediate beneficiaries of rate hikes are banks.

Maybank Investment Bank Research (Maybank IB) notes there will be a positive short-term impact on banks’ net interest margins (NIMs) as a result of higher interest rates.

This is through higher loan yields on variable rate loans and higher bond yields. “Funding costs take, on average, about three to six months to normalise, this being the common duration of fixed deposits in the system,” it says.

The research group estimates an improvement of one bps to four bps in banks’ NIMs, from a 25-bps OPR hike, which translates to roughly 2% to 3% strengthening of earnings.

While RHB Research says: “Our sensitivity analysis point to an approximately 2% uplift to sector earnings from a 25-bps OPR hike over a 12-month period.”

Meanwhile, AmInvestment Bank Research is more positive on Bank Islam Malaysia Bhd. It sees Bank Islam as a stronger beneficiary of profit rate hikes compared to its peers with a higher sensitivity or increase in NIM by eight bps to nine bps for every 25-bps change in the profit rate.

Another impact from the rate hikes on banks is that they are having to report some investment losses as they mark-to-market (m-t-m) the fixed income papers that they own.

Banks tend to put some of their capital into Malaysian Government Securities (MGS) due to the high yields.

However, as bond prices decline, banks need to m-t-m those investments, although higher yields also mean higher returns for the banks.

“The three-year MGS yield currently averages 3.59% or 41 bps higher quarter-on-quarter,” Maybank Research says, adding its analysts are of the view that current MGS yields largely reflect the OPR hikes.

Projecting further rate hikes, analysts are optimistic on bonds at this stage, with expectations that yields will move down from current levels in the second half of the year.

“This would be positive for banks in that any m-t-m losses are likely to be minimal moving forward, if any at all,” it adds.

Maybank Research, however, does not rule out the possibility of deterioration in asset quality with rising interest rates.

“Amid domestic inflationary pressures and a volatile external environment, the rise in interest rates could serve to further crimp domestic consumption, as borrowing costs rise,” it says, adding it will result in a possible deterioration in asset quality.

Having said that, the research house believes banks have set aside sufficient provisions to buffer against such an eventuality, also noting that banks have set aside pre-emptive provisions over the past two years.

“Based on our sensitivity analysis, we find that current pre-emptive provisions and regulatory reserve levels are sufficient to cover up to a 20% default on current repayment assistance loans, when current defaults are less than 5%,” it says.

“As such, there is still much room for provisions to buffer against further asset quality deterioration arising from higher interest rates, if the need arises,” it adds.

Meanwhile, the US has led the way with stress testing its banks.

It has been reported that investors were less worried about whether banks there would pass the test, but how convincingly they would do so.

The annual test, put in place after the financial crisis of 2007-2009, requires banks to show they have enough capital to withstand a series of market and economic shocks.

In the test, the banks convinced the regulator that they had sufficient capital to face a combination of market and economic shocks.