This article first appeared in The Edge Malaysia Weekly, on December 21 - 27, 2015.    

THE banking sector had the wind knocked out of it this year. Hurt by a sluggish economy and pressure to maintain higher levels of capital — factors that will continue to weigh on the sector in 2016 — banks saw earnings growth slow significantly as the pace of lending slackened and margins came down.

For the first nine months, the cumulative core earnings of the country’s eight domestic banking groups, minus one-off expenses and gains, fell by 1.3% to RM15.98 billion. MIDF Research predicts that earnings will be down by 0.2% for the full year.

Datuk Abdul Farid Alias, president and CEO of the country’s largest lender Malayan Banking Bhd (Maybank), described the year as an “extremely challenging” one for banks.

For the first time in many years, banks, in a bid to run tighter ships amid the tougher environment, cut their staff numbers sizeably through voluntary and mutual separation schemes. This added to the sector’s gloom.

CIMB Group Holdings Bhd started the ball rolling, cutting 11.1% (or 3,599) of its workforce in Malaysia and Indonesia. The RHB banking group trimmed 13.1% (or 1,812) of its permanent workforce in Malaysia, while foreign lender Standard Chartered Bank Malaysia Bhd shed 11%.

In October, the Hong Leong banking group was the latest to announce a downsizing scheme. It is understood that other banks too embarked on job-cut schemes, albeit on a more discreet basis.

What was clearly noticeable this year was the growing pressure on banks’ asset quality and the significantly higher provisions they made for loan impairments.

After years of trending downwards, the industry’s non-performing loan (NPL) ratio started ticking up as economic growth sputtered. Gross NPL ratio as an industry was still stable at 1.59% as at October. But the average gross NPL ratio of the eight domestic banking groups moved up to 1.76% at the end of September, from 1.70% as at end-2014.

There were mild signs of stress in the personal loans and credit cards space. This is something that bears watching next year, analysts say.

Indonesia proved to be a major thorn in the side of the two banking groups with major operations there — CIMB and Maybank. Both made much higher provisions this year, mainly for their Indonesian operations, and this took a toll on profits, particularly for CIMB.

Another interesting development this year was the shrinking liquidity in the banking system. A key sign of this was how banks have gone all out in recent months to ramp up deposits, with some offering promotional fixed deposits rates of 4.2% to 4.5% for 12-month placements, versus board rates of about 3.3%.

This comes as the industry’s loan-to-deposit ratio (LDR) hits levels not seen since the 1997/1998 Asian financial crisis. LDR hit a new peak of 91.2% in October, driven up by the fact that deposits have been growing at a very much slower pace than loans. As at October, the industry’s deposit growth on an annualised basis stood at just 0.3% while loan growth was 8%.

But another reason banks scrambled to shore up deposits more aggressively than before is that they are under growing pressure to maintain higher capital levels required by Basel III global banking rules. They will likely keep building their capital buffers over the next few years.

In October, Bank Negara Malaysia finalised new capital rules for financial holding companies (FHCs) and set timelines for them to meet the rules. The rules are an extension of similar capital requirements that have applied to banks since January 2013. From January 2019, FHCs will have to maintain a Common Equity Tier 1 (CET-1) capital ratio of at least 7%, together with Tier 1 and total capital ratios of at least 8.5% and 10.5%, respectively. These ratios include the capital conservation buffer of 2.5%.

Hong Leong Bank Bhd and its parent Hong Leong Financial Group Bhd, an FHC, raised funds via rights issues recently to raise their capital levels, as did RHB.

The year was also marked by mergers that didn’t happen, and some controversy.

In January, CIMB, RHB Capital Bhd and Malaysia Building Society Bhd (MBSB) called off their planned merger to create the country’s biggest banking group and a mega Islamic bank, citing a shift in the economic outlook. This came after six months of intense negotiations.

In July, The Edge, citing sources, reported that RHB and AMMB Holdings Bhd had started preliminary talks for a merger, under which RHB would be the acquirer. The plan, mooted by CIMB Investment Bank Bhd, was however put on hold due to political headwinds.

That month, AMMB was dragged into controversy after The Wall Street Journal reported that nearly US$700 million had been transferred from entities linked to embattled 1Malaysia Development Bhd into two bank accounts within the AMMB group in Prime Minister Datuk Seri Najib Razak’s name. Najib denied taking the money for personal gain and saw the allegations as political sabotage.

Four months later, AMMB disclosed that Bank Negara had slapped it with a hefty RM53.7 million penalty for “non-compliance with certain regulations”. It, however, has not revealed what regulations it had breached.

Meanwhile, bankers and analysts aren’t expecting next year to be any easier for the industry.

Fitch Ratings has a negative outlook on the sector in 2016 compared with “stable” this year. “We expect greater pressure on earnings and asset quality as GDP growth slows amid persistently low commodity prices, weak external demand and lacklustre domestic sentiment,” it says in its Dec 16 report, 2016 Outlook: Asia-Pacific Banks.

“Some borrowers may also face difficulty in adjusting to the significant currency depreciation over the past 12 to 18 months. We believe these developments translate into lower loan growth and higher credit costs in the next one to two years,” it adds.

It said its ratings outlook, however, remains mostly stable, reflecting its expectation that banks’ profitability and other loss-absorption buffers will provide a sufficient cushion against the projected rise in impairment costs.

“We expect the recent rise in NPL formation to continue into 2016. Delinquencies over the past 12 to 18 months have largely been from troubled industries offshore such as the commodity sector in Indonesia, but we expect deterioration in banks’ domestic portfolios to emerge in 2016,” Fitch says.

Among the emerging markets in Asia-Pacific, it has also turned negative on the sector in Indonesia, China and Thailand.

Maybank’s Abdul Farid expects the Malaysian banking system to remain “steady, safe and possibly leaner” in 2016. “Notwithstanding this, we see key challenges for the financial sector remaining, such as tighter liquidity and greater competition for deposits. We also expect some slowdown in loan growth as a result of slight moderation in the country’s overall economy. This development could impact asset quality as NPL picks up.”

There may be some M&A in 2016, especially in the Islamic banking space. Already, MBSB and Bank Muamalat Malaysia Bhd are in merger talks to create the largest standalone bank. Also, there could be developments with AMMB as it is widely known that its biggest shareholder, Australia and New Zealand Banking Group Ltd, is open to M&A opportunities.

Banks’ share prices took a beating this year, and given the tougher outlook, most analysts are maintaining “neutral” calls on the sector. In their outlook reports, many cited Maybank as one of their top picks for its attractive dividend yield.

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