The proposal to lift the loan moratorium at the end of September is a difficult decision for the government and is likely to have a negative impact on consumer spending and investment. But to maintain the moratorium is also a difficult choice because it puts severe pressure on bank balance sheets.
An extension of the loan moratorium may have a lower negative effect on banks than higher rates of default if the moratorium ends abruptly. This is a delicate balance for the government and Bank Negara Malaysia, and one that requires detailed analysis.
The moratorium, which began in April, was designed to help households and small and medium-size enterprises (SMEs) delay loan servicing obligations while also giving the opportunity to convert credit card balances to term loans and restructure corporate loans. The loan packages are part of the Prihatin stimulus programme and also extend to other financing facilities offered by government agencies, but these are not subject to clear deadlines.
Malaysia has the highest consumer debt ratio among Asean countries, in the range of 80%-86% for the past six years, and the government’s decision to end the six-month loan moratorium is likely to hit consumer spending because of this large debt exposure.
Bank Negara research shows that at the end of 2019, more than 50% of household debt consisted of housing loans. The remainder was credit cards and vehicle loans and borrowing to finance securities and non-residential real estate assets. Total debt in 2019 was RM1.25 trillion, supported by financial assets worth RM2.71 trillion. Only 20% of households had debt servicing ratios (ratio of debt to income) exceeding 60%.
These positions are sustainable only under three conditions: first, if income and financial wealth continues growing with the economy; second, if financial markets are performing reasonably well and the overall risk remains under control; and third, if there is healthy price inflation and relatively low real interest rates. We believe that these three conditions are looking less likely by the day and it is doubtful if they can remain until the end of 2020.
The estimated real interest rate in the pre-Covid-19 period is approximately 2.5%. Given our forecasts of Consumer Price Index (CPI) deflation and our expectation of the three-month interbank rate, real interest rates would remain at roughly 4% for the rest of the year. This is a 150-basis-point increase in real interest servicing costs or an extra RM32.5 billion on the outstanding debt figure of RM1.25 trillion in 2019.
A large part of Malaysian financial wealth is liquid financial assets — deposits, insurance policies, equity holdings and unit trust funds. Other categories of assets depend on the performance of local and global financial markets.
The International Monetary Fund’s latest World Economic Outlook suggests that this time is “a crisis like no other”, especially when there is still a risk of a second wave of Covid-19 infections taking place on a larger scale. As global economic conditions remain uncertain, we do not expect bullish financial markets to support household balance sheets. The Malaysian stock market is fluctuating around similar pre-crisis levels and other stock market indices give a similar picture.
Loan default is a possible and dangerous scenario for high-risk households — those earning less than RM5,000 per month with a debt servicing ratio greater than 60%. Those previously not considered high risk can also be pushed into the high-risk category by sharp deteriorations in income, employment and financial distress.
Housing market conditions will also hit household balance sheets. Forecasts of aggregate house prices range from the optimistic moderate growth of 1.1% to the pessimistic drop of 10%-15%. Households that have taken large housing loans in proportion to the property value face negative equity. This occurs when the housing debt exceeds the market value for the house, making it uneconomical for households to liquidate housing assets to finance consumption in emergency situations.
All these considerations lead us to believe that a sharp increase in non-performing loans is likely after September when the loan moratorium ends. Fortunately, the banking sector is in far better shape since the financial crises in the mid-1980s and 1997/98 but a further negative shock to consumption that directly hits the banking sector is definitely likely. The balance to be struck is whether the extension of the moratorium will have a bigger negative effect on bank balance sheets compared with higher rates of loan default if the moratorium ends.
Not all Malaysian banks are alike and the impact on the banking sector is likely to be staggered and asymmetric. Weaker and less efficient banks will bear the bigger brunt of the negative shocks. In the first quarter of 2020, there is a very wide variation in the financial positions among the major banking groups with a clear and distinct ranking emerging in terms of profitability, liquidity, asset quality, cost efficiency and capital adequacy position.
While banks may likely avoid a crisis, there is the spectre of a downgrade by credit rating agencies if loan defaults continue to pile up. If this event does not hit the stock markets, there would still be shocks to liquidity and funding access from the money markets, precipitating a credit crunch.
A proactive assessment of possible risk scenarios by Bank Negara is necessary to understand and mitigate the impact of debt deterioration at sector and economy-wide level. It is important for Bank Negara to design pre-emptive interventions to support bank capital ratios and minimise the possibility of financial contagion. Ending the loan moratorium abruptly risks triggering another round of negative shocks to the economy. Bank Negara must lead on best-practice risk management to provide breathing space to banks as well as consumers and businesses.
Dr Paolo Casadio, Dr Hui Hon Chung and Dr Geoffrey Williams are economists at HELP University based in Kuala Lumpur. The views expressed here are their own.