QE tapering continues to be among the policies to watch

Focus MALAYSIA WEEKLY ISSUE 055

THE WEEK OF DECEMBER 21 – DECEMBER 27, 2013

Review 2013 / Outlook 2014 -- BANKING

By: FocusM

Pong Teng Siew,
Head of Research
Interpac Securities Sdn. Bhd.

The banking sector has begun to face headwinds it has not faced since the Asian financial crisis.  Unlike US banks, most Malaysian banks still earn revenue the old-fashioned way, from transaction fees and a net interest spread income.  Net interest income has been declining because of competitive forces as well as due to nature of lending.  Consumer loans were very lucrative for a long spell after the Asian financial crisis because they offered better margins than corporate loans and represented better spread risks; and some (residential property loans) taxed capital less due to their lower risk weights.  However, competition has squeezed the margins on such loans and more recently, despite the profit imperative, the focus moved away from one of the fastest-growing segments, personal loans, because of the realisation that as the economic cycle matures, income growth will slow and household debt has accumulated to systematically worrisome levels after years of rapid credit expansion.

Malaysia’s banking system loans growth peaked at 13.8% year-on-year (y-o-y) in September 2011, and consistently outstripped nomical GDP growth (if that can be taken as a yardstick of income growth) in the period following a three-year spell of systematic deleveraging after the Asian financial crisis.  Nominal GDP growth stood at 4.7% y-o-y in Q3 2013 and pales in comparison to a loans growth of nearly 10% y-o-y currently.  Only in the “safe” lending segments of infrastructure construction and development and carry trade-type loans for purchase ASB / ASN units are local banks still lending aggressively.

Net interest income has been on the decline for what may be an eternity and no temporary relief from BLR hike is on the cards.  The central bank is decidedly pro-growth and takes pain to emphasise it is not an inflation-targeting bank.  It can be expected to resist any upward pressure on interest rates for as long as possible although for all countries, the long end of the fixed-income spectrum can be expected to clime as the US Fed contemplates a tapering off of its bond-purchase programme.

Asset quality remains well-behaved but recognising that the impaired assets ratio is ever closer to the zero bound, no further gain should be expected in this direction.  Scattered loan losses related to corporate failure will not cause systemic events but if global commodity prices take a beating in a global economic downturn, and if interest rates climb sharply in conjunction with an unexpectedly aggressive move to an end to quantitative easing in the US, which can cause a pronounced ringgit weakness, debt-service pressure could surface with respect to a smattering of corporations and individuals.  Disruptive currency moves that stoke inflation and corporate distress situations could also affect Malaysian banks now that many more have in recent years moved to expand regionally in search of profits.  Vulnerable emerging market economies include Turkey, Indonesia and India but it is instructive that even the isolated Blumont/Asiasons/LionGold episode in ”safe” economies like Singapore can cause unexpected and significant losses.

Specific prices of equity issues in the Asia-Pacific have risen sharply, some to bubble levels; and sudden and severe pullbacks could be disruptive even if the main indices remain relatively stable.  Most major banking groups in Malaysia have equity trading and derivatives exposure and unexpectedly large losses could arise if a generalized price correction suddenly takes hold.  Bank balance sheets are notoriously opaque to offering predictive qualities to any analysis of such risks.

Finally, banks cannot expect to rapidly expand their risk assets base as in earlier years, with the adoption of far stricter Basel III regulatory standards.  They are likely to settle down to being utility-line businesses, enjoying steady but unspectacular returns.