Marginal impact seen on banks if key rate cut materialises

This article first appeared in The Edge Financial Daily, on April 1, 2019.
-A +A

KUALA LUMPUR: Malaysian banks’ earnings are not expected to be severely impacted if Bank Negara Malaysia (BNM) decides this year to cut the overnight policy rate (OPR) — which was last raised in January 2018 — to ease the pressure of downside risks to the economy.

A reduction in OPR would cause an immediate impact on bank’s loan margin, which is based on a floating interest rate. But Hong Leong Investment Bank analyst Chan Jit Hoong’s stress test shows that the impact would only be as much as 3% on the earnings of the banking industry as a whole.

“We are not expecting any rate cut, but given that the Fed (US Federal Reserve) has turned dovish, the market thinks there is room for BNM to cut rate. So, assuming there is a symmetrical 25 basis points (bps) OPR cut for both variable loans and non-CASA (current account savings account) deposits, while all other factors remain constant, the average impact on banks’ earnings, on a sectoral basis, would be 2% to 3%.

“From our sensitivity analysis, the two banks that might see the most impact would be Alliance Bank Malaysia Bhd and BIMB Holdings Bhd, while the two banks that would see the least impact would be Affin Bank Bhd and AMMB Holdings Bhd,” Chan told The Edge Financial Daily when contacted.

The estimated impact, albeit marginal, is based on the sector’s previous reaction when the OPR was last cut, which showed an usually larger reduction in lending rate compared to the reduction in deposit rate. “Historically, we noticed that quantum-wise, deposit rate did not come down as much as lending rate,” Chan said.

In his note to investors last Wednesday, CIMB Research Winson Ng estimated that a 25bps cut in OPR would lower banks’ 2020 forecast net profit by about 3.2%.

“This is based on the assumption of a 25bps reduction in base rate [and base lending rate] and an average of 22bp reduction in fixed deposit rate,” he said.

Ng, similarly, is of the opinion that Alliance Bank and BIMB would be the two most affected banks in the event of a rate cut, as they have relatively higher floating-rate loans in their loan portfolio.

“Based on our estimate, a 25bps rate cut would trim Alliance Bank and BIMB Holdings’ FY20 (financial year 2020) forecast net profit by 7% to 8%.

“The impact would be smallest for AMMB, as its floating-rate loan ratio is one of the lowest among peers at 71.6% [for FY20]. We expect a 25bp cut in OPR will reduce AMMB’s FY20 forecast net profit by 2.3%,” he said.

“The impact from the rate cut would also be relatively smaller for Maybank and Public Bank [compared to most other banks], partly because some portion of their loans (42% for Maybank and 7% for Public Bank as at end-December 2018) are from their overseas markets, which will not be impacted by the rate cut in Malaysia,” he added.

Inter-Pacific Securities Sdn Bhd research head Pong Teng Siew, meanwhile, pointed out that when BNM raised the OPR last year — the rate was raised by 25bps to 3.25% in January — the impact on banks’ earnings was limited, with many still reporting decent profits in 2018. This was due mainly to banks’ cost-cutting measures, and lower loan loss provisions, Pong said.

While a lower OPR could potentially entice more businesses to raise borrowings since financing costs would be lower, Pong said the higher volume of loans may not be sufficient to offset banks’ lower margins.

“Higher volume may help offset banks’ loss in margin, but we expect the amount of loan to increase only marginally if BNM cuts the OPR. Also, do note that this marginal increase in loan may not be due to more business activities or economy expansion. It could just be because of a weaker ringgit.

“Because of the weaker ringgit, some manufacturers have to borrow more working capital to buy the same amount of inventory they procured before,” he noted.

Last Friday, the ringgit was seen trading at 4.082 against the US dollar, which is 5.5% weaker than when it was trading at 3.8692 a year ago.

Market talks of the central bank’s potential decision to cut the OPR has been rife since the Monetary Policy Committee’s latest statement on March 5 this year, in which it mentioned “tighter global financial conditions and elevated political and policy uncertainty could lead to financial market adjustments, further weighing on the overall outlook”.

“Materialisation of downside risks from unresolved trade tensions, heightened uncertainties in the global and domestic environment, and prolonged weakness in the commodity-related sectors could further weigh on growth,” the statement also noted.

Since then, investors have been pricing in the risk of a cut in the key rate, which is reflected in the Bursa Malaysia Financial Services Index. The index has fallen 4.25% to 16,969.13 points last Friday, from its close of 17,722.22 points on March 4 this year.