Banks weather Middle East shock with asset quality intact

KUALA LUMPUR: Malaysia's banking sector asset quality remains broadly resilient despite the economic impact of the conflict in the Middle East, according to RHB Research.

The firm said any repayment strain remained confined to pockets of the economy rather than becoming systemic.

Citing Bank Negara Malaysia's recent assessment and engagement session, the firm said the main transmission channels from the conflict were through the real economy and global financial markets rather than direct bank exposures.

Higher input and logistics costs, coupled with softer demand, were putting pressure on business margins, particularly among small and medium enterprises (SMEs) in the wholesale and retail trade, construction and manufacturing sectors.

However, domestic demand and electrical and electronics exports continued to support overall economic conditions, while business and system impairment ratios remained steady at 2.8 per cent and 1.4 per cent, respectively.

RHB Research said Stage 2 loans had also eased, while household borrowers remained resilient.

Meanwhile, the banking sector could withstand higher bond yields, although a 100-basis-point rise could reduce the sector's common equity Tier-1 (CET-1) ratio by about 46 basis points after mitigation measures.

The firm said the impact would be manageable but banks would have thinner capital cushions compared with the 2021-2022 bond sell-off.

It estimated that a 100-basis-point parallel shift in bond yields could reduce sector CET-1 capital by about RM8 billion at the group level.

Bank Islam Malaysia Bhd, Alliance Bank Malaysia Bhd and Malayan Banking Bhd (Maybank) were among the most sensitive to higher yields at group level, with estimated CET-1 reductions of 88, 62 and 57 basis points respectively.

At the bank-entity level, Maybank was the most sensitive, with an estimated 104-basis-point reduction, followed by Bank Islam at 88 basis points and Alliance Bank at 70 basis points.

RHB Research said banks using the standardised approach, including Public Bank Bhd, Hong Leong Bank Bhd, Alliance Bank, Affin Bank Bhd and Bank Islam, should benefit from capital releases under Basel III reforms, cushioning much of the mark-to-market impact.

For banks using the internal ratings-based approach, corporate restructuring and dividend reinvestment plans (DRPs) could provide some capital relief.

RHB Research said the sector's buffers were thinner than during the 2021-2022 bond sell-off, when the 10-year Malaysian Government Securities yield rose to 4.07 per cent at end-2022 from 2.69 per cent at end-2020.

The firm estimated that banks incurred about RM16 billion in fair-value losses on securities classified as fair value through other comprehensive income (FVOCI) over the two years.

Despite this, the sector's CET-1 ratio remained broadly within 14 to 15 per cent, supported by strong net profit growth, sizeable FVOCI reserve buffers and DRPs.

Banks also shifted some new security purchases into held-to-maturity portfolios to reduce exposure to mark-to-market losses.

This time, however, the sector's FVOCI revaluation reserve has fallen to about RM3.9 billion from around RM9.7 billion previously.

RHB Research said AMMB Holdings Bhd (AmBank) was the only bank whose FVOCI reserves exceeded its estimated loss from higher bond yields, making it relatively more insulated from the risk.

On funding conditions, Bank Negara was said to have played down concerns that rising KLIBOR reflected thinning liquidity in the instrument, although average funding costs had increased.

RHB Research said regulatory liquidity ratios remained healthy, with the central bank comfortable with banks operating at lower levels rather than paying excessively to secure funding.

The firm's top picks in the banking sector are AmBank, Maybank and Hong Leong.