KUALA LUMPUR (March 29): Bank Negara Malaysia (BNM) said the stress test results reaffirm the resilience of financial institutions in the country even under severe simulated shocks.
According to the central bank, the aggregate capital ratios of the banking system will remain comfortably above the regulatory minima.
According to BNM's Financial Stability Review report for the second half of 2022, the vast majority, more than 80%, of banks in Malaysia would be able to maintain capital ratios above their internal capital targets, although 24 out of 54 banks, with a cumulative share of 25% of total banking system assets, would report losses in at least one year throughout the three-year stress horizon.
However, the central bank noted that two banks, which account for less than 1% of total banking system assets, are projected to breach the minimum regulatory capital requirements under these adverse scenarios.
“Overall, the results of the stress test affirm that banks can withstand significant macroeconomic and financial shocks and are well positioned to sustain lending to businesses and households,” said BNM in the review.
Bank capital ratios more than adequate
The stress test was conducted under two simulated scenarios — the first adverse scenario (AS1) and the second adverse scenario (AS2).
AS1 assumes that the domestic economy contracts sharply in 2023 by a magnitude larger than that seen during the Covid-19 pandemic. Under this scenario, a sharp contraction in global growth and heightened geopolitical tensions are expected to adversely affect Malaysia’s export and production levels. The gross domestic product growth subsequently makes a strong V-shaped recovery in 2024 and normalises thereafter, supported by the easing of global monetary policy as inflation falls and global economic recovery gains momentum.
Meanwhile, AS2 assumes a less severe but more prolonged economic contraction or slowdown than in AS1. It aims to assess the capacity of financial institutions to endure a difficult operating environment over a more extended period of time. In this scenario, the domestic economy contracts, instead of growth, in 2023 and 2024, before recovering mildly in 2025. Unemployment rate peaks at 6% in 2024 and remains high throughout the stress test horizon with severe scarring effects in the labour market from the weak economic conditions.
The outcomes show that banks’ total capital ratio will drop to 16.1% in 2023 but recover to 16.5% in 2024 and 16.7% in 2025 in AS1. However, in AS2 in which a prolonged slowdown is assumed, the total capital ratio will fall lower in a gradual manner. The ratio is projected to drop to 16.8% end-2023, 16.4% in 2024 and 16.3% in 2025.
The Common Equity Tier 1 Capital Ratio will slide to 12.5% in 2023 from 14.7% in 2022, but will bounce back to 13% the following year and 13.3% in 2025 under AS1, where a V-shape recovery is assumed in 2024. In AS2, the ratio is projected to be lower at 13.2% in 2023, and will slide further down to 12.9% in 2024 and 12.8% in 2025.
A financial institution shall hold and maintain, at all times, Total Capital Ratio of 8% and Tier 1 Capital Ratio of 6%, according to BNM’s Capital Adequacy Framework.
The stress test features the high credit risk that continues to drive simulated losses to the banking system plus rise in bond yields that will cause sizeable revaluation losses on bonds held in the fair value through other comprehensive income portfolios (FVOCI).
Cumulative credit costs over the three-year stress horizon are estimated to be RM53.1 billion (58% of total losses) under AS1 and RM58.5 billion (63% of total losses) under AS2. About 20% of the cumulative credit costs originate from banks’ overseas operations, the bulk of which were losses from defaults of large non-small and medium enterprises (non-SMEs).
Meanwhile, the projected revaluation losses on bonds held in FVOCI are projected to be RM36 billion or 39% of total losses under AS1, and RM33 billion or 36% of total losses under AS2. BNM noted that the large losses will directly reduce banks’ capital buffers.
About 65% of at-risk household borrowers earn below RM5,000
In the Financial Stability Review report, the central bank said over the three-year stress horizon, the macro stress test (MST) results indicate that by end-2025, overall impairments among the financial institutions are projected to increase to 6.9% (MST 2022: 6.1%) of total banking system loans under AS1 and 7.7% (MST 2022: 6.6%) of total banking system loans under AS2.
The increase in impairments were driven largely by households as about 65% of household borrowers projected to be "at-risk of defaulting" under both AS1 and AS2 are borrowers earning below RM5,000 a month given their thin financial buffers.
Nevertheless, BNM pointed out that these borrowers account for a lower share (42%) of new impairments by value, reflective of their smaller loan sizes relative to higher income groups.
Borrowers earning between RM5,000 and RM10,000 monthly would also be susceptible to distress under severe economic shocks, forming 29% of total at-risk borrowers and a higher share of 43% of new impaired debt by value.
For businesses, non-SMEs make up more than half of total business impairments, commensurate with their bigger outstanding loan sizes and the conservative cross-default assumption.
“SME impairments are notably higher under AS2 (1.7%) while AS1 (1.4%) of total banking system loans as their relatively smaller cash buffers are more severely eroded under a protracted economic downturn,” said the central bank.
Don't miss the other highlights of the BNM Annual Report 2022. Read the articles here.