This article first appeared in Capital, The Edge Malaysia Weekly on October 27, 2025 - November 2, 2025

A number of particularly tough challenges this year — including rising costs, US tariffs on imports and global uncertainties — are expected to test the loan repayment capacity of borrowers, especially some segments of small and medium enterprises (SMEs).

Analysts contacted by The Edge say they expect to see a rise in non-performing loans (NPLs) within the Malaysian banking sector. Be that as it may, they are not alarmed as banks had already guided for a potential rise in NPLs, having anticipated that some of the more vulnerable borrowers — for example, certain types of SMEs and individuals from low-income households — could face problems with repayment.

Barring unexpected shocks — such as a US recession, which is not currently anticipated, or a sharp plunge in commodity prices — banks have sufficient loan loss provisions to buffer any asset quality deterioration, the analysts say.

Two big lenders, Malayan Banking Bhd (KL:MAYBANK) and CIMB Group Holdings Bhd (KL:CIMB), topped up their pre-emptive provisions in the second quarter as a precautionary measure. It remains to be seen if more banks will follow suit in the coming quarters. Maybank increased its management overlays to RM2 billion from RM1.8 billion, while CIMB’s rose to RM600 million from RM100 million.

“The reality is that NPLs will slowly creep up. It’s a given. But is it cause for alarm? Not at this stage, unless you think the economy is going to collapse,” a senior banking analyst opines.

Having experienced a very benign credit cost environment in 2024, most banks are guiding for higher credit costs this year, Maybank Investment Bank Research noted in a report last month.

“Despite credit costs having crept up [in 2Q2025], the overall experience has generally been milder than expected. As such, we have trimmed our FY2025/26 credit cost estimates to 21/21 basis points (bps) respectively from 22/23 bps previously [versus 19bps in FY2024]. There is room for positive surprises, given that all banks still have outstanding management overlays that could be redesignated to specific problem areas,” it said.

Essentially, the concern among analysts seems to be more on SMEs rather than large corporations.

“So far, if you look at the big corporates here and around the region, they are actually doing okay in terms of asset quality. We would, though, continue to keep an eye out on the SMEs, micro-SMEs and retail segment such as unsecured loans [like personal loans] to the low-income segment. I think that is where banks have been setting aside some [additional] provisions in case there are issues there,” says David Chong, a banking analyst at RHB Research.

“In the last quarter (2Q2025), there was a bit of an uptick in NPLs, but the banks believe it could be seasonal, with some banks pointing to improved collections post quarter-end. So, we will see in 3Q whether that is the case or not. But, so far, banks seem quite comfortable with their exposures and provisions.”

Provisions for such segments though, if required, are not as chunky as corporate loan provisions, as loan ticket sizes tend to be smaller and exposures are spread across many accounts.

“It’s when the chunky corporate loans go [bad] that provisions tend to be big and the impact is relatively more significant to banks’ earnings. Thus far, though, corporates seem okay, as mentioned earlier,” Chong observes.

Also, most Malaysian banks still have their overlay buffers to fall back on, he points out, adding: “For example, Maybank and Public Bank Bhd (KL:PBBANK) still have some sizeable overlays in their books. Notably, the loan loss coverage (LLC) ratios are still at decent levels for the majority of banks.”

Bank Negara Malaysia’s latest monthly banking statistics show that the banking system’s gross impaired loan (GIL) ratio — a measure of asset quality — stood at 1.43% as at end-August, about the same as a month ago and end-2024. The household GIL ratio, at 1.06%, was the same as a month ago but an improvement from 1.08% as at end-2024. The non-household GIL ratio, at 2%, held steady from the month earlier but deteriorated slightly from 1.98% as at end-2024.

At the individual bank level, almost all banks — the exceptions being Hong Leong Bank and CIMB Group — saw an increase in their GIL ratios in the second quarter compared with the first. Notably, AMMB Holding Bhd’s (KL:AMBANK) rose to 1.71% from 1.54%, while Alliance Bank Malaysia Bhd’s (KL:ABMB) increased to 1.96% from 1.83%.

The LLC ratio (including regulatory reserves) for all banks was above 100% in 2Q25 except for Affin Bank Bhd (KL:AFFIN) and MBSB Bank Bhd (KL:MBSB). The ratio stood at 80% and about 46% for the two, respectively.

CGS International Research notes that there has been no “crack” in banks’ asset quality despite tariff concerns. “The banking industry’s total provision rose by RM189.5 million in the two-month period ending August 2025 (from RM29.6 billion at end-June 2025 to RM29.8 billion at end-August 2025), compared with an increase of RM274.8 million in 2Q2025. Based on this, we estimate that loan loss provisioning was RM1 billion to RM1.2 billion for the banking sector in 3Q2025, slightly lower than the RM1.21 billion recorded in 2Q2025. This represents an increase of 12% to 35% year on year (y-o-y) from the RM887.7 million recorded in 3Q2024,” it said in an Oct 21 report.

Bank Negara, in its Financial Stability Review released two weeks ago, flagged tough business conditions in the second half of 2025 from cost pressures and global uncertainties. This year, Malaysia announced an expansion of the sales and service tax, increases in electricity and water tariffs, as well as mandatory Employees Provident Fund contributions for foreign workers — all of which are expected to raise businesses’ operating costs and weigh on profit margins.

According to the central bank, larger companies are better positioned to manage these headwinds, given their stronger financial positions compared with pre-pandemic levels. The concern was more for SMEs with existing financial vulnerabilities that continue to face repayment pressures.

A small number of SMEs were drawing down cash reserves to manage the rising costs and tightening cash flow due to delays in collections and shorter payment terms, Bank Negara highlighted.

“The reality is that when you look at the [loan] accounts of the banks, you can see that there is an uptick in terms of SME NPLs, but not really for corporates. However, the thing about the MSME segment, is that they account for about 15% to 18% of total system loans, so even if they do default, there won’t be a systemic impact,” a senior analyst notes.

Maybank IB Research, which did a deep dive into the micro, small and medium enterprises (MSMEs) segment in a report earlier this month, noted that MSME asset quality has been fairly stable so far.

“While we have seen a recent uptick in absolute MSME gross impaired loans (GILs), the rate of change is still fairly manageable, up just 4.3% y-o-y as at end-August 2025, as compared with the +10-20% rise in absolute impaired loans in 2022-2023, during the Covid pandemic period.

“The MSME GIL ratio has generally hovered within the 3%-4% range over the past five years, and averaged 3.7% as at end-August 2025. The upturn, while still moderate, warrants monitoring, especially amid the prospect of slower economic growth and inflationary pressures, which largely impact domestic consumption demand,” it said in an Oct 13 report.

Interestingly, Maybank IB noted that, excluding development financial institutions, the MSME industry’s GIL ratio would be lower at 3% as at end-August 2025, instead of 3.7%.

The manufacturing, construction, wholesale/retail and real estate sectors cumulatively accounted for 72.9% of MSME loans, and they contributed to 73.4% of total MSME GILs. The GIL ratios for each of these sectors stood at 2.8%, 6.7%, 3.6% and 2.5% respectively as at end-August.

“Where we see some stress is among small-sized enterprises, where absolute GILs have increased at a double-digit range over the past four months to August 2025 (+16.3% y-o-y) and where the GIL ratio was 4% as at end-August 2025. Small-sized enterprises make up 48.7% of total MSME GILs (23.8% and 27.5% for micro and medium-sized enterprises respectively),” Maybank IB says.

A check with several research houses shows that at least five (RHB Research, CGS International, Kenanga Research, TA Research and Hong Leong Investment Bank Research) have an “overweight” call on the sector, with most citing its attractive valuations and dividends as reasons. Two — Maybank IB and CIMB Research — have a “neutral’ call.

“Heading into 2026, we should see some margin expansion as deposits would be repriced [lower] after six to nine months following the OPR (overnight policy rate) cut in July 2025. As for non-interest income, the fee-based side should mimic loan growth pretty well since we are looking at GDP growth of about 4-odd per cent. The treasury business will largely be supported by FVOCI (fair value through other comprehensive income) reserves. And then, as for asset quality, we don’t expect any sharp deterioration, thus net credit costs will stay relatively stable.

“Hence, going into next year, we believe banks would chalk up about 5%-6% earnings growth and eke out a dividend yield of about 5%-6%. In addition, bank valuations are relatively cheap. The sector is a laggard compared with the broader FBM KLCI as well,” says Chan Jit Hoong, acting head of research at Hong Leong Investment Bank Research.

He notes that the US Federal Reserve is in an easing interest rate cycle, which should help boost the ringgit. “From a portfolio perspective, global fund managers would then look into Malaysia, given the forex tailwind and our country [being] a laggard in the Asean region. If you have foreign funds coming in, naturally they would buy the banks. So, we believe the stars are aligned for the sector.”

RHB Research, which upgraded the sector to “overweight” from “neutral” last week, had this to say: “While near-term earnings may not excite, banks are heading into 2026 on fundamentally sound footing with attractive dividend yields. Corporate banks (for example, CIMB Group) would benefit from strong loan pipelines while asset quality should hold up. Meanwhile, banks under the Standardised Approach (such as Hong Leong Bank and Public Bank) are set to adopt new capital guidelines next year, which could pave the way for capital management initiatives”.

The stocks most cited as top picks by analysts were Public Bank (down 7.7% year to date, as of Oct 23) and Hong Leong Bank (up 0.1% YTD). 

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