The Malaysian banking system has weathered the global financial storm and proven more resilient than its counterparts under RAM Ratings’ coverage. For 2010, our core insights on the domestic banking sector include:

• An 8%-10% loan growth
• Healthy asset quality
• Improving profitability
• Ample liquidity
• Sturdy capitalisation
• More mergers and acquisitions (M&As)

“Moving ahead of the curve, we upgraded the ratings of 12 banks in November 2009; the country’s better-than-expected GDP performance in 4Q 2009 reinforces this view,” explained RAM Ratings Chief Executive Officer Liza Mohd Noor, at the launch of the fourth edition of its annual Banking Bulletin, which encapsulates RAM Ratings’ latest views on the banking sector.

“We have a stable outlook on the domestic banking system in 2010. Malaysian banks have reaped the benefits of financial reforms that had been put in place quite a few years ago,” elaborated Promod Dass, RAM Ratings’ Head of Financial Institution Ratings. “The Government’s accommodative monetary policies and Bank Negara Malaysia’s vigilance during the recent global financial turbulence have been instrumental in safeguarding our banking system, which had been sound to start with,” he added.

“Given that the worst is over, the country’s monetary policies are likely to shift towards normalising rates while maintaining an accommodative environment for borrowers,” opined Dass. As borrowing costs ascend along with the envisaged hikes in the overnight policy rate (OPR) this year, RAM Ratings expects this trend to test the banking industry’s asset quality. However, we still expect the domestic financial system’s gross non-performing-loan (NPL) ratio (on a 3-month basis) to be contained at a healthy 3% to 4% (end-2009: 3.2%).

RAM Ratings observes that ample liquidity and sound capitalisation have proven to be bastions of the Malaysian banking system, even when the rest of the world had been in crisis mode. The Malaysian banking system is relatively less dependent on wholesale funding, which had been crucial to the funding stability observed. Furthermore, the profitability and capitalisation of local banks had been spared the severe consequences of toxic assets. Bucking the global trend, our banking system’s capitalisation levels had risen, mainly driven by improving asset quality and sustained earnings. This is apparent from the industry’s risk-weighted capital-adequacy ratio (RWCAR), which strengthened from 12.7% as at end-2008 to 14.7% as at end-2009.

While we believe that the current level of capitalisation is healthy and should be able to support further loan expansion this year, the Basel Committee’s recent proposed changes in favour of more common equity-like capital by 2012 could prove onerous for banks, if implemented wholesale. On the flip side, these new rules will ensure a sufficiently strong capital base to ride through future shocks, if any. From a credit perspective, RAM Ratings views these recommendations as positive changes; we believe that Bank Negara Malaysia will adopt a pragmatic approach.

Looking ahead, RAM Ratings expects a pick-up in loans to corporates and SMEs in 2010. Nonetheless, consumer loans will remain the banking sector’s bread and butter. Overall, the quality of household loans, which account for just over 50% of the domestic system’s total loans, stayed sound with a lower default rate of 3.1% as at end-December 2009 (end-December 2008: 4.1%). The default rate for loans extended to the manufacturing sector had also eased from 7.2% to 6.8%, in spite of the difficult operating environment.

Meanwhile, Islamic banking is clearly a profitable and growing ”blue ocean” segment in the Malaysian banking arena, representing 16.4% of the entire domestic banking system’s assets as at end-2009. For 2008-2009, the Islamic banks rated by RAM Ratings collectively recorded better profits and asset quality. Nonetheless, the anticipated OPR hikes will constrict margins given that Islamic banks typically have higher proportions of fixed-rate financing compared to their conventional counterparts. Going forward, RAM Ratings views that efforts by industry players to develop new products and services as well as Bank Negara Malaysia’s championing of the Malaysia International Islamic Financial Centre will continue driving this segment’s double-digit asset growth.

Overall we anticipate better profit performances in 2010, with lower credit costs and stronger revenue lines. As more Malaysian banks seek opportunities overseas, contributions from abroad are also expected to gradually increase as these foreign ventures bear fruit over time. In line with this, we also expect regional M&As to continue, as observed in the last couple of years. On the domestic front, RAM Ratings anticipates financial institutions to begin their second round of consolidation in 2010, amid accelerating competitive pressures. Unlike the Government-led industry consolidation in the early part of the new millennium, this round will be market-driven as banks try to cement their footholds.

For a more detailed analysis, please refer to RAM Ratings’ Banking Bulletin – Anchors Away (published in March 2010), available at www.ram.com.my