KUALA LUMPUR (April 22): Malaysian banks have limited upside in profitability even as asset quality remains strong, though they are well placed to weather external headwinds, S&P Global Ratings said on Monday.

Return on assets will remain flat at 1.2% in 2024, S&P said in a statement on Monday. Net interest margins, a measure of profitability from lending, could decline further, especially if competitive pressures intensify in the country's saturated banking sector, the rating agency noted.

For now though, “funding conditions should stabilise as fixed deposit rates appear to have peaked”, S&P said.

Banks in Malaysia have been grappling with seasonal competition, as they fight for deposits by raising returns on deposits, pressuring net interest margins. Provisions for bad loans also rose, dragging on sector earnings, which barely grew in the final quarter of 2023 from a year earlier.

Economic growth of Malaysia, home to 30 dozen domestic and foreign banks, have also decelerated and missed official targets. Still, gross impaired loans in the industry were low at around 1.5%.

External headwinds, meanwhile, have intensified,  as Israel and Iran traded missile and drone attacks. 

“We anticipate a modest deterioration in asset quality,” S&P flagged. “This could come from restructured loans of low-income households and small businesses”, while sustained currency depreciation could affect import-reliant sectors, such as manufacturing, construction, and agriculture.

Economic conditions nevertheless are broadly stable in Malaysia, which will support credit demand, she said. Higher corporate demand, led by key infrastructure projects, and robust expansion in the retail segment may help push credit growth to 6% in 2024 from 5% in 2023, she noted.

"We expect the asset quality of Malaysian banks to stay stronger than that of their regional peers, both in terms of credit losses and non-performing loans," said S&P credit analyst Nikita Anand.

Strong labour market conditions and proactive write-off policy should continue to help banks maintain low non-performing loans ratios, while stable capitalisation also provides ample loss-absorption buffer, S&P highlighted.

Further, spillover risks from currency depreciation should be “manageable”, given the banking sector's limited direct exposure to external debt, S&P said. Further, the sector's exposure to corporates with unhedged foreign currency exposures forms a small 0.5% of total loans, the rating agency added.