PETALING JAYA: The capital ratio of Malaysia’s banking system will remain above the regulatory minima, with sufficient high-quality liquid assets to meet heightened cash flow demands, should the domestic economy turn gloomy.
That is the conclusion of the annual multi-year, top-down macro solvency stress test of Bank Negara’s Financial Stability Report for the second half of 2023, conducted to evaluate the potential impact of adverse macroeconomic conditions and the resultant financial strains on individual banks.
The stress test assumes two adverse scenarios, the first (AS1) being a severe contraction in the domestic economy in 2024, followed by a rapid recovery in 2025 and a normalisation of the country’s gross domestic product (GDP) thereafter.
The second adverse scenario (AS2) takes the assumption of a milder but more prolonged economic contraction, where GDP records negative growth in 2024 and 2025 before commencing a sluggish recovery in 2026.
Both AS1 and AS2 simulate the maintenance of a higher-for-longer policy rate environment amid elevated inflationary pressure among major economies, large portfolio outflows from emerging market economies, as well as the weakening of the ringgit against the dollar beyond historical lows.
The adverse scenarios also assume that the FBM KLCI loses about a third of its value under both scenarios.
Under the simulations, the report predicted: “Over the three-year stress test horizon, the banking system is projected to incur substantial losses arising mainly from credit risk and revaluation of securities held at fair value through other comprehensive income.
“The cumulative credit costs are estimated to be RM63.1bil and RM70.8bil under AS1 and AS2 respectively.”
Losses from the domestic banking groups’ (DBG) overseas operations account for less than 20% of the cumulative credit costs, stemming primarily from defaults of large non-small and medium enterprises.
By the end of the stress horizon in 2026, the report assumed overall impairments are projected to rise to 7.8% and 8.6% of total banking system loans under AS1 and AS2, respectively, driven mainly by household impairments.
While net interest income would also decline sharply amid elevated funding costs, without the corresponding interest income gains assumed from the overnight policy rate hikes, it is expected to gradually rebound in the subsequent years, leading to a recovery in profits and capital buffers, said Bank Negara in the report.