Stress test reveals financial institutions remain resilient under adverse conditions

KUALA LUMPUR: The latest solvency stress test exercises affirmed that banks can withstand significant macroeconomic and financial shocks, and are well-positioned to sustain lending to businesses and households, said Bank Negara Malaysia (BNM).

In its Financial Stability Review report for the second half of 2022 released today, BNM said the stress test results reaffirm the resilience of financial institutions even under severe simulated shocks.

Every year, the bank conducts multi-year, top-down macro and micro solvency stress test exercises to assess the possible impact of protracted financial and macroeconomic stresses on individual banks and insurers, as well as on the broader financial system.

The latest top-down macro solvency stress test was conducted in early 2023 and covers a three-year horizon up to end-2025.

"The exercise is premised upon two adverse scenarios to evaluate the resilience of financial institutions to distinct paths of contractions or slowdown in economic growth,” it said.

The stress test results revealed that the aggregate capital ratios of the banking system will remain comfortably above the regulatory minimum.

"The vast majority (over 80 per cent) of banks would be able to maintain capital ratios above their internal capital targets, although 24 out of 54 banks, with a cumulative share of 25 per cent of total banking system assets, would report losses in at least one year throughout the stress horizon.

"Only two banks, which account for less than 1.0 per cent of total banking system assets, are projected to breach the minimum regulatory capital requirements under these adverse scenarios,” it said.

Results indicate that by the end of 2025, overall impairments are projected to increase to 6.9 per cent and 7.7 per cent of total banking system loans under the adverse scenarios, driven largely by households.

According to the report, most (65 per cent) of household borrowers projected to be at risk of defaulting are borrowers earning below RM5,000 per month, given their thin financial buffers.

"Nevertheless, these borrowers account for a lower share (42 per cent) of new impairments by value, reflective of their smaller loan sizes relative to higher income groups.

"Borrowers earning between RM5,000 and RM10,000 monthly would also be susceptible to distress under severe economic shocks, forming 29 per cent of total at-risk borrowers and a higher share of 43 per cent of new impaired debt by value,” it said.

As for businesses, non-small and medium enterprises (SMEs) make up more than half of total business impairments, commensurate with their larger outstanding loan sizes and the conservative cross-default assumption.

Credit risk continues to drive stress test losses to the banking system as cumulative credit costs over the three-year stress horizon are projected to amount to RM53.1 billion and RM58.5 billion, respectively (or 58 per cent and 63 per cent of total losses).

About 20 per cent of the cumulative credit costs originate from banks’ overseas operations, the bulk of which were losses from defaults of large non-SMEs.

Overall banking system profitability may decline by 60 per cent in the first year of stress as a result of higher credit costs and trading book losses.

"However, a subsequent recovery in net interest income would improve profits slightly.

"While expected losses from overseas operations remain sizable for large domestic banking groups, their impact is substantially mitigated by healthy capital buffers maintained by the respective overseas entities,” added BNM. - Bernama

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