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This article first appeared in The Edge Malaysia Weekly, on November 7 - 13, 2016.

 

PERSONAL loans in the banking system have seen steady growth despite the weaker economy.

But there are increasing signs of stress bubbling in that space that bear watching. It is the only loan segment within the household sector where gross impaired loans (GIL), in absolute terms, are continuing to grow at a rapid double-digit annual pace this year. It is also the segment with the highest GIL ratio in the household sector.

As at September this year, GIL in the personal loan segment grew 31.7% year on year to RM1.37 billion, according to Bank Negara Malaysia’s latest monthly statistics on the banking system. The growth pace was much faster than that in the credit card (5% to RM496.3 million) and mortgage (2.9% to RM5.31 billion) segments.

On a year-to-date basis, GIL growth in the personal loan segment stood at 15.1%, compared with 3.4% in credit cards and 5.6% in mortgages.

A banking analyst points out that as far back as August 2010, only 3.2% of the banking system’s total non-performing loans came from the personal loan segment, but the proportion has since grown to 5.6% as at September this year.

“Bad loans in this space are climbing, for sure. There are reasons to keep a wary eye on this issue. It’s a low number, but it is rising. Is it alarming just yet? I think not, but it does imply that the segment is under duress,” the analyst says.

The GIL ratio for personal loans, while still relatively low, has crept up over the year from 1.87% as at December 2015. It deteriorated to 2.1% as at September, higher than the overall banking system’s GIL ratio of 1.6%. It was also the third highest GIL ratio of all loan segments after construction (7.21%) and working capital (2.5%).

Bankers who The Edge spoke to say they are closely monitoring the asset quality situation, but are also quick to point out that personal loans account for only a small portion of overall banking loans.

Indeed, to put things in perspective, Bank Negara’s data shows that as at September, personal loans accounted for just 4.4% or RM65.34 billion of total loans outstanding in the banking system. And, they accounted for about 9% of outstanding household loans.

As such, bankers and analysts say the growing GIL in the personal loan segment is unlikely to pose a systemic risk to the financial system.

Be that as it may, the size of the personal loan (or personal financing, as the shariah-compliant equivalent is known) market and its growing problems may be a lot bigger than what official numbers capture. This is because the banking system data that Bank Negara releases on a monthly basis — which analysts use to monitor trends — does not include the development financial institutions (DFIs) and non-bank financial institutions (NBFIs), which are in fact the biggest players in the personal financing space. The data includes Islamic banks.

Based on available company data, analysts estimate that DFIs and NBFIs are responsible for close to 60% of overall personal financing in Malaysia.

These DFIs include Bank Kerjasama Rakyat Malaysia Bhd (Bank Rakyat), which is the dominant player with an estimated market share of over 30%, and Bank Simpanan Nasional. Meanwhile, the NBFIs include Malaysia Building Society Bhd (MBSB), which is the second largest player, RCE Capital Bhd and AEON Credit Service (M) Bhd.

Bank Rakyat and MBSB’s individual market shares are by far bigger than that of commercial banks. Bank Rakyat’s total personal financing portfolio stood at RM53 billion as at end-December, almost close to the entire banking system’s RM63.7 billion.

Interestingly, a number of banks have increased their focus on personal loans this year in search of higher yields.

An analyst estimates that of the banking groups, Alliance Financial Group Bhd has the biggest share (6.7%) of personal loans as at the second quarter of this year, followed by RHB Bank Bhd (5.3%), Public Bank Bhd (3.9%) and CIMB Group Holdings Bhd (3.7%).

Another reason why the personal loan market is bigger than what Bank Negara’s numbers show is that there are other types of non-bank providers, such private moneylenders and pawnbrokers, that are allowed to operate under an archaic law — the Moneylenders Act 1951.

Moneylenders and pawnbrokers are licensed by and come under the supervision of the Ministry of Urban Wellbeing, Housing and Local Government. Players are subject to guidelines under the Act.

The Act came under the spotlight two months ago after the minister, Tan Sri Noh Omar, announced that property developers could seek moneylending licences from his ministry in order to offer loans to buyers. His comments not only sparked intense public debate over whether property developers should be allowed to do so but also had critics urging for the Act to be repealed.

And then, of course, there is the black market comprising the “Ah Long”, the colloquial term for illegal loan sharks that lend money to people who are unable to get loans from banks or other legal sources.

The many types of sources from which individuals can get personal loans, and the relative ease and speed at which the loans can sometimes get approved — RHB Bank’s Easy by RHB initiative, for instance, gives qualified people who apply online approval in 10 minutes — is another reason why growth in that segment needs to be monitored closely.

From an economic perspective, the rapid pace of GIL growth in personal loans in the banking system is not a healthy sign. This is especially so since it is mainly the lower-income group, particularly civil servants, that are exposed to personal debt. This is the group that is most vulnerable to defaults in an environment of slower economic growth and the rising cost of living.

“The demographics of this business is very different from other loans. We see a lot more correlation between people who have credit cards, especially the lower-income group, and those who take personal loans. The personal loan space is very much driven by the lower-income group. And I think the banks that played on the lower-income groups are the ones that are really feeling the burn at this point in time,” a senior banker who oversees consumer finance at a local bank tells The Edge.

He also makes an interesting observation. “People, we find, are borrowing less from their credit card and they’re shifting more towards personal loans because it’s easier to get cash than to take from a credit card line. A lot of them are trying to preserve their credit card line and take up personal loans instead. So, that’s driving the demand as well.

“I mean, if you think about 10 to 15 years ago — when personal loans were not that prevalent and credit cards were the main place where you could actually get credit — you could get cash through your credit card if you called up the bank and asked for a loan on your credit card line. You can still do this, but with more regulations on credit cards, it’s not as convenient as taking up a personal loan today. Also, when it comes to the loan tenure, a lot of banks can go up to seven years and up to 10 years, so that’s also driving the demand for personal loans.”

It should be noted, however, that while personal loan growth continues to grow at comfortable levels in the banking system, the pace has slowed somewhat. In September, personal loan growth had slowed to 4.6% on a year-on-year basis, compared with this year’s peak of 7.1% in February.

 

Higher margins

A number of banking groups, including Alliance Financial Group, CIMB Group and Public Bank, have increased their focus on personal loans this year, in search of higher risk-adjusted returns on capital. The business, if done right, offers the highest margins of all loan segments.

“It’s a lucrative business. Margins can typically range from 10% to 14%. The interest charged to consumers can start from 6% to 7% and can go all the way up to over 20%,” says the senior banker. 

Another consumer banker notes that the problem with this type of unsecured lending is that “if you get it wrong, you’ll get high loss rates”, especially in tougher economic times. “Chances are, it could become a loss-making product also. But personal loans, if you get it right, it’s very lucrative and offers very good returns on capital.”

The banks’ focus on unsecured lending comes amid falling margins in secured loans such as mortgages given the stiff competition.

But the rising stress in the personal loan space comes at a time when household debt is on the rise. Household debt has been growing in Malaysia since the 2008/09 global financial crisis. As a percentage of gross domestic product, the ratio had climbed from a low of 60.4% in 2008 to 89.1% in 2015 — one of the highest in Asia.

“Amid higher living costs, there is concern that individuals, be they in the government or private sector, may be overleveraged. As the younger members of the government civil service search for alternative employment or opportunities in the hope of higher salaries, the possibility of higher personal loan defaults increases,” observes Maybank Investment Bank Research in a recent report on RCE Capital.

Adding to the worry is that the unemployment rate in the country rose to 3.5% in August 2016, an increase of 0.3% from the year before.

 

Where the problem lies

Interestingly, while DFIs/NBFIs are the biggest players when it comes to extending loans for personal use, their growth in this segment has come down significantly after Bank Negara, concerned about the rise in household debt, imposed curbs on the industry in July 2013.

The curbs included imposing a maximum tenure of 10 years on personal financing — it could go up to 25 years before — and prohibiting banks from selling pre-approved personal financing products.

“We understand that it also encouraged banks and NBFIs to comply with a debt/service ratio (DSR) cap of 60% for urban borrowers with income of less than RM5,000 a month and suburban borrowers with income of less than RM3,000 a month. These curbs had the greatest impact on the businesses of the NBFIs, for with the DSR cap, a large segment of their would-be borrowers were no longer eligible for financing,” says Maybank IB Research.

The DSR refers to the percentage of one’s average monthly disposable income that is used to service his or her loans.

MBSB, for instance, saw its personal financing segment contract 1% year on year in 2015 after seeing a strong growth of 104% in 2012, and 32% in 2013. Bank Rakyat’s growth in this segment has been at a single-digit pace since 2013, after 15% in 2012.

In contrast, RCE Capital’s growth has been resilient — after negative growth in 2012 and 2013, the segment grew 11% in 2014 and 17% in 2015.

But the DFIs/NBFIs have zoomed in mainly on civil servants, whose repayments they are able to secure through automatic salary deductions. It is understood that about 80% of their customers are civil servants. In contrast, banks target individuals from the private sector.

“Our core target segment is different from that of the banks for personal financing. Our focus has been on civil servants whose repayments we are able to secure via salary deductions through BIRO and AG. The deductions are made upfront before the customers utilise their respective salaries for other purposes, so it is relatively secure. The risk arises when civil servants are unable or irresponsibly refuse to pay when they have left their employment,” says MBSB CEO Datuk Ahmad Zaini Othman.

He adds that MBSB’s total impaired loans and GIL ratio for the personal financing segment had, nevertheless, been increasing since 2015. “The main segments contributing to defaults come from lower ranking civil servants who have left their employment and decided to cease payment. On this, we pursue with the normal legal recourse.”

Other bankers point out that there is disruption of usually two to three months in the automatic deductions when civil servants transfer between departments. Problems also arise as an increasing number of young civil servants, generally aged between 23 and 30, leave to join the private sector in search of better pay and do not pay off their existing personal loans.

“Those two are the main issues , if you ask me. Generally, I don’t think personal loans are going that bad, except in the civil servant market, which is a huge market,” observes a consumer banker.

That said, Bank Rakyat, the biggest player, has managed to keep its overall GIL ratio for its personal financing segment low, at under 0.5% currently, its chief operating officer Khairuddin Arshad told The Edge in an interview last month.

MBSB’s Ahmad Zaini opines that there is increased risk of defaults in the private sector market.

“Moving forward, the area of rising risk is with the private sector portfolio while the civil servant sector remains resilient. If there was any concern from the authorities, it should specifically be on the private sector portfolio rather than a system-wide approach to personal financing.

“There would be increased risk of defaults in the private sector as the cost of living is rising with uncertainty in several industries such as oil and gas, airline, retail and banking. The retrenchment exercises in 2015 and 2016 by businesses will affect the repayment capacity of customers with all financing taken. This is especially after their severance packages are depleted without being able to secure another job. MBSB has exposure to the private sector but it is very low compared to the banks,” he explains.

With non-performing loans creeping up in the personal loan segment, some question if there is a need for more curbs to be introduced. Bankers are wary of this, though. “It’s a fine line to balance. I think the central bank also realises that banks need to be profitable because the cost of capital to run a bank is going to be very high. It’s so expensive to even lend these days … you don’t want a situation where banks are not motivated to lend,” the senior banker says.

Some quarters wonder if there should be stricter rules or enforcement of the way financial institutions reach out to customers to offer the loans. There is rising anecdotal evidence of individuals receiving unsolicited calls.

“I would say there’s a lot more calls and messages going out to access the customer than before. But all banks will tell you it’s not a very productive channel. It’s not sustainable because the penetration and the success rates are very, very low — and it hurts the banks’ brand image also. At our bank, we don’t make unsolicited calls … our marketing calls are made to our customer base mostly, and only if they opt for it,” the same banker says. 

 

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