Announcement: Moody's: Outlook stable for Malaysian banks; stabilizing asset risks and profitability, strong capital

Moody's Investors Service says that the outlook for Malaysia's banking system is stable over the next 12-18 months.

"The key drivers of our stable outlook for the Malaysian banking system are our expectation that operating conditions will stabilize, on the back of a gradual recovery in global growth, resulting in more stability in the banks' asset quality and profitability," says Simon Chen, a Moody's Vice President and Senior Analyst.

"The banks' strong capital and stable funding levels, and our expectation of a continued high degree of government support, also underpin our stable outlook for Malaysian banks," adds Chen.

Moody's conclusions are contained in its just-released report titled, "Banking System Outlook — Malaysia: Stabilizing Asset Risks and Profitability, Strong Capital Drive Stable Outlook," authored by Chen.

The stable outlook is based on Moody's assessment of five drivers: Operating Environment (stable); Asset Quality and Capital (stable); Funding and Liquidity (stable); Profitability and Efficiency (stable); and Systemic Support (stable).

With the operating environment, Moody's says that operating conditions are stabilizing, with the improvement in global growth, recovery of global commodity prices, and continued growth in domestic demand.

Real GDP growth should register 4.3% on average in 2017-18, up from 4.2% in 2016, indicating that domestic economic activity will remain robust. However, ringgit volatility will likely persist — because of further adjustment in capital flows — and will weigh on business and consumer sentiment.

On asset quality, Moody's report says that asset risks are stabilizing, on the back of improving macroeconomic conditions. But the high leverage among corporates and households remains a tail risk, with risks mitigated by Malaysia's diversified economy and stable employment conditions.

As for capital, the banks will demonstrate stable capitalization, as capital generation exceeds consumption, owing to moderate loan growth. In particular, Moody's says that the banks' capitalization will remain sufficient to withstand asset quality shocks, even under various stress scenarios.

With funding and liquidity, the banks will show stable funding and liquidity profiles because of benign credit growth, and despite a tightening in domestic liquidity from volatile capital flows. So far, the impact of fund outflows since late 2015 has been manageable for the banking system, with retail deposits maintaining robust growth and offsetting pressure created by institutional deposit outflows.

Deposit competition among the banks remains healthy, and banks are positioned well to comply with Basel III liquidity coverage ratio requirements.

As for profitability, over the next 12-18 months, profitability will stabilize — as credit costs normalize from elevated levels — owing to stabilizing asset risks. However, margin pressure will persist, because of keen competition for deposits.

On the issue of government support, Moody's report says that the Malaysian government (A3 stable) will continue to demonstrate a strong capacity to provide support to the banks in times of stress, given its commitment towards fiscal reforms and a narrower fiscal deficit.

Moody's continues to view Malaysia as a high-support country, pointing out that there have been no bank failures since Bank Negara Malaysia was established in 1959. Moody's also notes that recent regulatory reforms have not suggested any shift in government policy on the resolution of ailing banks, outside of liquidation.

Moody's rates 11 banks in Malaysia: eight conventional commercial banks, one investment bank, one Islamic bank and one government-owned development financial institution. The rated commercial banks accounted for around 80% of Malaysian banking system loans and deposits at end-2016.