Banks equipped to deal with defaults

The central bank ran a stress test, under an assumed scenario of economic and financial shocks due to the pandemic, and found that overall impairments are projected to rise above 4% of loans by end-2021.

In its “Financial Stability Review – First Half 2020” report issued yesterday, Bank Negara said the test takes into account the effects of the blanket moratorium implemented in April and the subsequent targeted repayment assistance announced by banks in August.

Business impairments are expected to be driven by defaults of maturing bullet repayments of firms operating in vulnerable sectors, mostly in the services industry which is expected to experience a slower recovery, as well as exposures to several large borrower groups with weaker financials.

Meanwhile, household loan impairments are projected to double, from what are already historically low levels.

Higher household impairments are expected to emerge in the second half of 2021, when the extended repayment assistance programmes, that will remain through the first quarter of 2021 for individuals with a loss in income, ends.

“Overall, credit costs to banks could rise to RM29bil (1.4% of total loans) over 2020 and 2021.

“These projections assume conservative estimates of the share of loans under bespoke targeted repayment assistance (mainly for businesses) based on restructuring and rescheduling trends observed at the onset of the pandemic.

“With uncertain conditions persisting, banks have been much more proactive in extending repayment assistance, as seen in recent months. This was not taken into account in the simulations, ” it said.

Bank Negara said that since July, the number of businesses receiving repayment assistance from banks has increased seven-fold.

This would improve debt serviceability and mitigate credit losses.

It also pointed out that in anticipation of higher credit losses, banks have been shoring up their buffers, adding RM2.7bil to provisions in the first half of 2020.

“At an individual bank level, additional provisions by banks have already risen to an average of 16% of banks’ projected stressed credit losses over a 12-month horizon, based on their internal stress tests.”

It said the provisions could increase as banks get a better view of credit developments, with assessments done after the end of the blanket moratorium.

“The gradual build-up of provisions will also ensure that banks maintain healthy buffers to absorb losses and support continued lending to the economy, ” the central bank pointed out.

The impact of stressed credit losses on banks’ solvency would result in the aggregate total capital ratio (TCR) and common equity Tier-1 (CET1) capital ratio declining by two percentage points (ppts) and 1.4 ppts, respectively, over the next 12 to 18 months.

Under the bottom-up scenario analysis, the aggregate TCR and CET1 capital ratio as reported by commercial and Islamic banks are projected to decline by a larger extent of 3.4 ppts and 3.1 ppts, respectively.

Bank Negara said that by applying a sensitivity analysis to these results, individual banks are projected to have adequate buffers above the regulatory minimum capital requirement to withstand further losses associated with default rates that are eight times higher than the banks’ historical default rates.

These multiples are significantly more severe than Malaysia’s worst experience so far – the Asian Financial Crisis – when overall impairments rose by three to five times.