IT is apparent that banks have had a tough couple of years. Intense competition, coupled with the challenging economic environment, has weighed them down.

Earnings growth has been tepid over the last few years and the operating landscape has become more challenging.

Year-on-year deposit growth has remained sluggish for more than 1½ years. In July 2015, it saw a significant fall to 3.82% from 7.32% the month before.

Since then, y-o-y deposit growth has not only failed to pick up but contracted early last year. Based on the latest available data (November 2016), it stands at a meagre 2.2%.

A closer study reveals that growth has been dragged down by business deposits, which have seen a contraction over the last few months. In contrast, retail deposits have managed to grow in single figures.

According to AmBank Research analyst Kelvin Ong, the contraction in business deposits is partly attributable to the outflow of liquidity. “This can be seen in the foreign capital outflows, which caused the MGS (Malaysian Government Securities) yields to increase recently.

“We believe business enterprises’ preference for high-yield assets and conservative financial management to lower their gearing [in the face of] slower economic growth are also contributing factors to the slowdown in business deposit growth,” says Ong.

He expects deposit growth to remain subdued in the near term as there could still be an outflow of liquidity given the potential hikes in US interest rates.

Some observers opine that the lacklustre deposit growth could be the result of the weaker ringgit, which has led to businesses and individuals parking their money offshore. As at last Friday, the ringgit was at 4.428 to the US dollar. Two years earlier, it was trading at a mere 3.52 against the greenback.

“In the current environment, I can see that banks are trying to win market share in deposits. Looking at this together with the deposit growth rate, it does imply that the pool of deposits is smaller now,” says an observer.

In this environment, one wonders whether banks can expand without putting themselves in a riskier position.

“Everyone has been talking about how Bank Negara Malaysia’s stringent lending rules have curbed loan growth. But if we look at the banking sector’s loan-to-deposit ratio (LDR), it tells us that banks have very little room to lend more anyway,” says a fund manager.

As at last December, the average LDR for local banks stood at 89.7%. Analysts say the optimal LDR should be between 85% and 90%.

“Banks have to be prepared for the eventuality of customers withdrawing their deposits, so they cannot lend out all the money that they have received from deposits,” explains an analyst.

Some observers take the view that slower deposit growth is not an issue for the banks given that demand for loans is not robust either.

“Liquidity is not really the issue. Approval rates have been low, so there is no point shoring up deposits and incurring more costs,” says an analyst with Kenanga Research.

Where loan growth is concerned, its gradual decline since August 2015 — when the y-o-y growth amounted to 10.21% — has reversed, according to recent statistics. It rose for two consecutive months, in October and November last year, from 4.5% to 5.3%.

“Positively, household loan growth was a stable 5.4% y-o-y while non-household loan growth gathered momentum to 5.2% y-o-y from 3.2% y-o-y in October. This pick-up in business loans had generally been expected, given positive guidance from the larger banks such as Maybank and CIMB of a stronger pipeline of such loans in 4Q2016,” Maybank Investment Bank Research says in a report.

However, analysts believe the earnings growth prospects for banks remain murky.

“It is hard to say. Loan growth does not look that great given that banks are being prudent about asset quality. Net interest margins (NIMs) are still under pressure. Also, it depends on whether there are write-backs on the impairments made last year,” says the Kenanga Research analyst.

AmResearch’s Ong expects the banking sector’s earnings to grow 6.8% y-o-y this year. The increment will come mainly from lower provisions for non-performing loans rather than top-line growth, he says.

“Further savings are likely this year in regards to operating expenditure due to cost initiatives. NIMs will still contract but a lower contraction is expected in 2017 compared to 2016. The pressure on NIMs will come from higher funding costs due to the resurgence of deposit competition while asset yield is expected to be more stable as we do not expect any further cuts in the overnight policy rate until 3Q2017,” says Ong.

“Lending is expected to grow modestly between 5% and 6% based on a gross domestic product growth of 4.5%. We continue to expect pressure on asset quality and we are cautious on the manufacturing, oil and gas, and property sectors,” he adds.

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