In anticipation of a shock

by **Cals** Sat 30 Nov 2013, 17:13

Published: Saturday November 30, 2013 MYT 12:00:00 AM
Updated: Saturday November 30, 2013 MYT 6:59:54 AM
In anticipation of a shock
BY JAGDEV SINGH SIDHU

Is S&P right to downgrade banks’ outlook in the face of potential weakness?
A FEW weeks ago, a friend of mine was having a discussion with a property agent. He wanted to flip his condominimum after taking vacant possession but was told by the agent he will find it difficult to sell his property at the price he wants. She told him it’s a buyers market out there.
He then confided in me that he was paying RM10,000 to service his loan on the property. If he were to sell his unit at the price he wants, the buyer will probably have to pay a higher monthly instalment. Just how many Malaysians can afford to pay for such a property?
That issue of affordability was in part related to the crux of Standard & Poor’s (S&P) downgrade in the outlook of four Malaysian financial institutions.
It’s not that the banks are on the cusp of losing money or will find that their financial strength are going to be hurt. It’s the fact that high household debt and the high price of property will mean that people will find it hard to pay the asking price of properties these days. The situtation now, in short, represents the peak of a cycle.
S&P sees that household debt, which accounts for 55% of banking system loans, and mortgages, which account for 27% of total loans in the banking system, cannot go much higher in the current circumstances. Bank Negara is already taking steps to reduce household debt when it crossed 80% to GDP.
S&P sees that property prices, which have risen 10% per annum since 2010, have gone up annually more than the rise in household income. Prior to 2010, it found that property prices used to go up between 2% and 4% a year, somewhat tracking the rate of inflation.
In justifying its call, S&P’s Ivan Tan says the credit cycle is at its cylical best. Unemployment is low, interest rates are near historical lows and the base lending rate banks are charging customers are about 2.5 percentage points below the base lending rate.
Competition between banks has led to interest rates financial institutions are charging home buyers to be affordable. But just how much longer can that go on is uncertain, but should there be a future shock, then things are bound to change.
As it is, Malaysians are dealing with cost increases and that will affect the disposable income they will have. If interest rates were to go up or an economic shock were to hit Malaysia that will result in a loss of jobs, then the chances of non-performing loans will also increase.
Right now, non-performing loans are not a problem. In fact the banking industry has seen bad loans as a percentage of their loan book drop and the level now for the industry has never been lower.
The caution by S&P though has to be put into a different perspective. It is looking at the implications of a potential shock. Expectations are that the economy will grow and as long as household debt grows faster than nominal GDP, then the situation can get excerbated and risks get heightened.
If economic growth continues, then the chances of a shock diminishes. But that’s not to say it cannot happen. Inflation in October was 2.8% higher and it is surprising it’s already at that level. In fact, that rate of inflation is higher than Thailand and Singapore, and not that far away from the Philippines.
Should inflation rise further, then will interest rates be used to bring that under control? Should interest rates rise, then there will be implications on household incomes. The permutations of possibilities are quite varied. There lies the essence of the risks banks are facing.

Business editor (features) JAGDEV SINGH SIDHU wonders just how much elbow room there is should the economy experience a shock