Banks to rise above challenges


PETALING JAYA: The banking sector is expected to hold up despite an expected uptick in non-performing loans (NPLs) and slower loan growth this year, as rising inflationary pressures and headwinds mount.

NPLs are expected to rise towards year-end, as inflation dampens consumer spending and affects the bottom lines of businesses, banking analysts said.

Economists are anticipating the inflation rate to hover between 3% and 3.3% this year, coupled with more interest rate hikes in the offing.

Headline inflation, measured by the consumer price index, rose to 4.4% year-on-year (y-o-y) in July this year compared with 3.4% y-o-y in June, mainly on rising food and non-alcoholic beverage costs. Core inflation stood at 3.4% y-o-y in July against 3% in June.

UCSI University Malaysia assistant professor in finance Liew Chee Yoong, who is also a research fellow at the Centre for Market Education, told StarBiz he expects NPLs to rise towards year-end if inflation continues to climb higher.

He said rising inflation would dampen consumer spending and reduce profits. When profits fall, he said the ability of companies to service debt payments would be reduced.

This increases the NPLs, he said, noting that the rising inflation rate also reduces the disposable spending of individuals as well as their available cash flow for personal usage.

When an individual’s cash flow is reduced, Liew said this decreases the person’s ability to service debt payments and results in a spike in NPLs.

He expects the overnight policy rate (OPR) to be raised by 25 basis points (bps) if inflation continues to increase this year.

“If this occurs, this will raise the borrowing costs and the banking system’s loan growth will be negatively impacted as a result of the increase of borrowing costs.

“When the borrowing cost increases, the demand for bank loans will reduce as companies and individuals that are willing to undertake higher risk will prefer to invest the money that they have in interest rate products, which can yield them higher returns due to the increase in interest rates, rather than taking a loan and paying higher interest on their debts,” Liew said.

The banking industry’s loan growth continued to improve from 5.6% at end-June to 5.9% at end-July. The industry’s loans expanded by 3% in the first seven months of this year.

Moody’s Investors Service in a recent report said inflation would result in higher interest rates, hence widening Asean banks’ net interest margins (NIMs). However, it said asset risks would also increase, with problem loans rising modestly.

RAM co-head of Financial Institution Ratings Wong Yin Ching.RAM co-head of Financial Institution Ratings Wong Yin Ching.RAM Rating Services Bhd co-head of financial institution ratings, Wong Yin Ching, said there was a broadening in NIMs in the latest round of banking sector second-quarter financial results, underpinned by the 25-bps hike in the OPR in May.

NIM is a measure of the difference between the interest income generated by banks and interest paid out to depositors. A wider NIM indicates higher earnings for banks.

The average NIM of eight selected local banking groups under RAM’s coverage climbed five bps quarter-on-quarter to 2.33%.

Wong said margins are slated to widen further amid the 25-bps increase in July and the rating agency’s anticipation of two more hikes (of 25 bps each) for the rest of 2022.

“While higher interest rates may temper credit demand slightly, they should not significantly derail the current loan growth momentum. Loans expanded by a strong 5.9% y-o-y in July 2022, partly due to a low base effect as the country came under a strict lockdown in the middle of last year.

“We are maintaining our earlier conservative projection of 4.5% to 5% loan expansion in 2022,” Wong said.

On the asset quality front, she said upward inflationary pressure and bigger loan instalments would test certain borrowers’ repayment capabilities as broad-based, regulatory relief measures had expired.

Those from vulnerable business sectors, lower-income groups and the small and medium enterprise segment may be more challenged. That said, she said targeted loan assistance by banks remained available to viable customers.

After peaking at 28% in December 2021, the average proportion of assisted loans for the eight banks declined sharply to around 5% in July 2022. “Delinquencies would continue to inch up in the coming quarters with the system’s gross impaired loan ratio potentially reaching 2.2% by year-end (end-June 2022: 1.79%), which is still a healthy level,” Wong said.

“While persistently high global inflation and ensuing aggressive interest rate hikes by central banks worldwide will cast a shadow over economic growth prospects, Malaysian banks’ profitability should stay intact.

“The anticipated margin expansion and tapering of provisioning expenses will lend support to banks’ profit performance even as weaker trading and investment income and the one-off Cukai Makmur erase some of these gains,” Wong noted.

OCBC Bank (M) Bhd country chief risk officer Thor Boon LeeOCBC Bank (M) Bhd country chief risk officer Thor Boon LeeOCBC Bank (M) Bhd country chief risk officer Thor Boon Lee said he expects NPLs to rise, but this would not only be due to inflation, but also from the resumption of repayment post-Covid-19, pandemic-related financial assistance programmes, which could see some being unable to service their loan instalment payments.

On the loan front, he said in a rising interest rate environment, demand for loans would be affected and may see some moderation. This could have the trigger effect of accelerating repayment as well, he said.

As for NIM, Thor said it would be impacted by the adjustment in the OPR, adding that there is expectation of the OPR being raised which would naturally have a bearing on NIM as well.

UCSI’s Liew said the NIM would be reduced if interest rates continued to rise until the end of the year due to the reduction in the demand for bank loans. This reduction would lower banks’ interest income and average earning asset value, namely, the amount of bank loans that are lent to borrowers.

“An increase in the interest rates by Bank Negara will reduce the demand for bank loans by companies and individuals, as the cost of financing becomes more expensive. On the other hand, banks have to continue paying interest to risk-averse depositors who will prefer to put their money in banks during times of economic uncertainty like what is happening now. All these will reduce the NIM of banks,” he said.

Liew foresees serious challenges to the local banking industry this year. The energy crisis that European countries are facing will increase the chances of a severe recession occurring in Europe, he said.

He said this would have a spillover effect on Asian markets and would negatively affect the banking industry in Asia, as well as in Malaysia.

“Business and consumer spending will be further reduced as a result of this spillover effect aside from the inflationary pressure that the country is facing. This will further dampen loan growth and NIM of the banking industry in this country. Generally, the outlook is challenging for the banking sector for 2022.

“Stagflation (inflation and a slowdown of the economy) which could be due to the external financial contagion, remains a huge risk for the sector in the short and medium term. Commercial banks have to perform more stress tests to ensure that they have sufficient capital to survive this risk,” Liew said.

Meanwhile, CGS-CIMB Research is reiterating its “overweight” call on the sector, with potential re-rating catalysts from strong growth in net interest income in 2022-2023, underpinned by robust loan growth and hikes in the OPR and the downtrend in loan loss provisioning. The research house is projecting a loan growth of 5% to 6% for 2022.

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