KUALA LUMPUR – Malaysian banks have resilient capital and earnings buffers in severe macroeconomic and financial stress, which is a credit positive, says Moody’s Investors Service.

It said on Thursday Bank Negara Malaysia’s annual Financial Stability and Payment Systems Report for 2017 included the results of its solvency stress test on the country’s banks.

The stress test used three hypothetical domestic gross domestic product (GDP) rates – one baseline scenario and two adverse scenarios – with simultaneous shocks to revenue, funding, credit and market risks applied to banks’ earnings, balance sheets and capital levels, over the four years to 2021.

The first adverse scenario assumed a strong, V-shaped recovery to the baseline growth rate from a sharp recession in 2018.

The second adverse scenario simulated an L-shaped trajectory with the growth rate remaining low after a mild initial decline.

Under the baseline scenario, banks’ systemwide total capital adequacy ratio would decline by about 50 basis points over the four-year period, while the ratio would drop about 150 basis points in the first adverse scenario and about 200 basis points in the second adverse scenario.

“Still, under both adverse scenarios, the systemwide total capital ratio would remain above a regulatory minimum of 10.5% (including a capital conservation buffer of 2.5%) at the end of 2021.

“This shows that banks are resilient to potential shocks and tail risks, and have sufficient earnings and capital buffers to absorb potential losses,” said Moody’s.

According to Bank Negara’s report, more than 90% of capital losses under the stress test scenarios would result from credit losses.

In the adverse scenarios, the systemwide gross impaired loan ratio would jump to 5% in the first scenario and 9% in the second scenario from 1.5% at the end of 2017, and loss-given defaults would rise as high as 80%.

“Losses from household loans would account for 34%-38% of total capital losses, while around 60% of the capital erosion caused by credit losses would derive from corporate loans,” it said.

Moody’s said the latest Bank Negara data also show continued moderation in leverage among households and corporations in Malaysia, driven primarily by a slowdown in debt accumulation.

Household debt growth in Malaysia weakened to 4.9% in 2017 from 5.4% in 2016, a peak of 14.2% in 2010 and the slowest pace since then, because of a decline in higher-risk consumer loans such as personal loans, auto loans and mortgages on non-residential properties.

“Overall household debt as a percentage of GDP declined to 84% at the end of 2017 from 88% a year earlier.

“Banks’ exposures to the highest-risk households, such as low-income households, fell to 17% of total household loans in 2017 from 19% a year earlier.

“Similarly, growth in aggregate non-financial corporate debt slowed to 3% in 2017 from 9% the prior year, with total corporate debt as a percentage of GDP declining to 103% from 110% over the same period.

“The latest data suggest asset quality risks from household and corporate leverage are well contained, a credit positive for banks,” said Moody’s.