After being low for many years, global key interest rates have started trending higher, goaded on by inflationary pressure.
For banks, generally, this is a good thing as higher interest rates tend to translate into higher earnings.
However, there is also the issue of a higher cost of funding for lenders as interest rates move north.
In its latest Financial Stability Review, Malaysia’s central bank Bank Negara warned that banks are expected to face some tightening in their funding conditions this year.
“Monetary policy normalisation in advanced economies could lead to outflows from emerging market economies, including Malaysia, and therefore, raise funding costs,” it said.
Domestically, a preference for higher-yielding fixed deposits among depositors as uncertainty subsides, and banks’ renewed competition for deposits to support loan growth as the economy recovers, could also put upward pressure on funding costs, the central bank added.
It did, however, say that the impact of the developments on banks is expected to remain manageable due to their strong liquidity and funding positions.
The cost of funding for banks basically refers to how much lenders have to spend to get funds which are then loaned out to their clients, enabling the lenders to make profits.
These funds are normally obtained from deposits made by customers on which banks have to pay interests.
In Malaysia, depending on the benchmark overnight policy rate (OPR), the higher the interest on the deposits, the more a bank has to cough up.
Industry observers however, have brushed off this concern for now.
“Cost of funds for banks will rise when the OPR increases.
“Usually, a big portion of a bank’s loan books will be based on floating rates, meaning they will charge a higher interest on mortgages and business loans when the OPR goes up, and they will also pay fixed deposit customers higher rates,” a former foreign bank CEO said.
“Typically, banks will have more interest-free deposits like current and savings accounts [CASA], therefore, they will on the whole, benefit from interest rate hikes,” he said.
He is “neutral” about whether banks will see any meaningful hikes in their cost of funds.
“Furthermore, the expectation was that OPR will increase in the first quarter of this year.
“We are protracting the action because of the Ukraine-Russia war and the Covid-19 pandemic,” he added.
MIDF Amanah Investment Bank Bhd research head Imran Yassin Yusof said while the rising interest rate environment would see higher cost of funds for banks, they will also see higher lending rates.
“This will negate the impact of the rise in cost of funds. Therefore, we do not see it as a challenge at this juncture,” he told StarBiz.
Imran said banks would increase their lending rates to maintain net interest margins going forward.
“The only black swan for the banking sector this year will be if there is a more deadly variant of Covid-19 such as what we had observed with the Delta variant last year. This will lead to potential movement control orders again. However, we believe the likelihood of this is low especially as our healthcare system is better equipped this time.”
AMMB Holdings Bhd (AmBank) group CEO Sulaiman Mohd Tahir said if rates were to rise, banks would expect more pressures on the cost of funding, particularly for those with a higher dependency on short-term funding.
“For AmBank, approximately 80 per cent of our loan book is at a variable rate and will reprice immediately. At the same time, our cost of funds will only reprice later as our fixed deposits and term funding costs have been locked in for the near-term,” he told StarBiz.
Sulaiman said AmBank’s asset quality and risk profile had been strengthened over the years, and as a result, the group has a more diversified loan composition, which is less susceptible to concentration risk and changes in interest rates.
“We see the domestic banking system’s earnings on a recovery track with higher profitability anticipated this year due to lower loan loss provisioning and higher net interest margin.
“In the longer-term, there could be potential write-backs of management overlays provided by the banks for Covid-19 credit risks if gross impaired loan ratios of banks do not increase significantly in 2022,” Sulaiman added.
That said, the mid-sized lender is actively augmenting its liquidity deployment strategy in order to manage the market price risk of rising interest rate trends.
“This is not only to manage risks but also to leverage on opportunities as part of our business as usual activities. With the cost of funding expected to rise, there will be higher competition for deposits,” Sulaiman noted.
He said optimising funding mix while focusing on more aggressive growth in CASA was needed to manage this.
“We are also focused on locking in longer dated funding via capital market issuances,” he added.
While Malaysian banks, in general, have negligible direct exposure to the geopolitical tensions related to Russia and Ukraine, banks may be indirectly impacted if energy and raw material prices are high for a prolonged period as they could in turn hurt global economic growth, according to Sulaiman.
“Hence, we are focused on asset preservation with targeted loan growth,” he added.
In its Financial Stability review report, Bank Negara said the banking system’s profitability was sustained in the second half of 2021, supported by the pick-up in lending activities and low funding costs which had helped to preserve net interest margins.
“Banks benefited from low funding costs throughout the year as the growth of cheaper CASA deposits outpaced that of higher-yielding term deposits.”
THE STAR (MALAYSIA)/ASIA NEWS NETWORK