Malaysian Banking System Outlook Stable as Sector's Fundamentals Strong

Moody's Investors Service says that the outlook on the Malaysian banking system remain stable, reflecting Moody's expectation of a stable operating environment that will allow banks to maintain resilient asset quality, as well as strong capitalization levels and funding profiles.

Moody's expects the measures taken by the Malaysian government to implement fiscal reform and consolidation will moderate somewhat the pace of economic growth over the outlook horizon.

It also expects that inflation will accelerate mildly, as subsidies on fuel, electricity and sugar are phased out. Nonetheless, our central forecast for real GDP growth in 2014 is 5%, as domestic consumption and investment remain steady and exports rise in line with the ongoing recovery of the advanced economies.

In this context, the relatively high rate of economic growth will support the banks' asset quality as well as credit growth, which we expect to be slightly lower than the 11% recorded in 2013, according to Moody's.

Moody's conclusions were contained in its just-released "Banking System Outlook Malaysia". Moody's had originally assigned the stable outlook on 15 May 2013.

The report looks at the themes of operating environment, seen as stable; asset quality, with impaired loans near record low, further improvement is deemed unlikely; capital, with buffers adequate for withstanding stresses even under Moody's adverse scenario; funding and liquidity, seen as stable, reflecting disciplined asset growth; profitability and efficiency, with lower margins offset by higher fee-based income; and systemic support, wherein

policy actions to stabilise the country's debt dynamics should strengthen the government's ability to provide support.

On the other hand, on the risk side of the equation, the persistently high level of household debt and the appreciation seen in property prices could weigh on banks' asset quality in an economic downturn, or in an environment where interest rates are significantly higher, according to the report.

However, there are also reasons to believe that these risks will be contained as the banks are generally cognizant of these risks and have tightened their lending criteria, particularly for retail loans. Furthermore, Moody's expects interest rates to increase only modestly and gradually over the horizon of our outlook.

The report further notes that Islamic banking is Malaysian banks' main focus area for domestic business growth. All of the banks have Islamic banking subsidiaries, whose assets have been outgrowing the conventional banking assets of their parents.

As of March 2014, Islamic bank financings comprised 24% of total banking-system loans, and the country has a goal of expanding the proportion of Islamic financing of total domestic financing to 40% by 2020.

Moody's rates a total of 11 banks in Malaysia: eight are conventional commercial banks, one is an investment bank, one is an Islamic bank, and one is a government-owned development financial institution. The rated banks accounted for 73% of Malaysian banking-system assets as of end-2013.

The average (asset-weighted) standalone credit assessment of the conventional banks in Malaysia is baa1.

The average long-term foreign-currency deposit rating of the Malaysian conventional banks is A3, as Malaysia's A3 foreign-currency rating in effect caps the bank ratings.

The senior unsecured debt and deposit ratings of the banks receive one notch of uplift on average, because of our assumption of strong government support.

The outlooks on the foreign currency ratings of eight banks are positive, driven by the positive outlook on the A3 rating of the government of Malaysia.

The average (asset-weighted) local-currency deposit rating is A1, two notches higher than the foreign-currency rating. Local-currency ratings are capped by the higher local-currency ceiling for Malaysia (A1).

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