Challenges in financial sector

Despite fluid developments in the global economy and financial markets, Malaysian lenders expect to do more business in 2011. Datuk Seri Abdul Wahid Omar, president and CEO of Malayan Banking sees numerous opportunities in Malaysia and in regional economies.

Sustained profitability, high levels of capitalisation and low non-performing loans are testimony to the solid foundation of Malaysia's banking system.

The local banking sector has proven its resilience despite the global financial crises and ensuing worldwide recession. This can be attributed to the strong fundamentals of the system built in the aftermath of the Asian financial crisis in 1997-1998.

Nevertheless, it is essential that the sector remains vigilant to manage any uncertainties that may arise in the coming year. In my view, some of the challenges facing the domestic financial sector in 2011 include the need to monitor volatile external conditions, support domestic economic transformation that encompasses liberalisation, reform and restructuring, as well as manage the attendant risks from these external and internal developments.

The global economic and financial markets are fluid amid the following risks:

* Sustainability risk, especially that of the US recovery which necessitated the extension and expansion of monetary and fiscal stimulus in the form of QE2 (quantitative easing 2) and the two-year tax relief and cuts.

* Solvency risk to the public and banking sectors, in reference to the eurozone sovereign debt crisis that have resulted in Greece and Ireland bailouts, and heaped pressure on other vulnerable peripheral economies like Portugal and Spain.

* Stability risk, particularly to the macroeconomic and financial conditions in emerging markets - including Malaysia - arising from the enlarged flows of short-term capital as a result of the monetary stimulus of major economies. This may, in turn, feed into excessive and volatile movements in the currency and financial markets, as well as cause inflationary pressures in both general and asset prices.

Domestically, increasing competition from the liberalisation of financial services, as part of the government's Economic Transformation Programme (ETP), is resulting in the proliferation of new players and the introduction of more innovative products and services into various industry segments which will impact both the asset and liability ends of the balance sheet, particularly via the compression in net interest margin.

On stability risk, the financial sector concerns include a growing household debt which comprises an estimated 75 per cent of the gross domestic product (GDP) in 2010 (2009: 76.6 per cent; 2002-2008 average: 66 per cent). While this is mitigated by a stable 'household financial assets to household debt' ratio of around 2.5 times, Bank Negara Malaysia has taken various pre-emptive measures in the form of normalisation of the Overnight Policy Rate (OPR) to prevent interest rates from being too low for too long and introducing the 70 per cent loan-to-value cap for third residential property mortgages.

Individual banks also need to step up their vigilance in the risk-based pricing of loan products and application of due diligence and risk management procedures when giving out loans. All these are to ensure that the economy is on a stable growth trajectory and that financial resources are allocated productively.

In facing all these challenges, the good news is that the healthy domestic banking sector supports Bank Negara Malaysia's gradual liberalisation of the financial services industry. It also provides the confidence for local financial institutions to face the competition from foreign banks setting up operations in Malaysia, and gives them the impetus to go global.

Another important issue facing the industry must surely be developments pertaining to Basel III. Although the Basel Committee targets its guidelines to be fully implemented by January 2019, it is encouraging to note that the majority of Malaysia's banking institutions are already operating well above the new regulatory minimums.

Despite the challenges outlined above, the financial services sector should be aware that there remains numerous opportunities for its continued growth.

This includes the large financing and funding possibilities for investments expected in Entry Point Projects (EPPs) and Business Opportunities (BOs) under the ETP which will benefit all banks.

In addition, corporate activities remain well supported by a buoyant capital market and the ample domestic liquidity currently, benefitting the financial institutions with larger investment banking operations.

Beyond the country's border, the industry is taking advantage of the better mid- to long-term development prospects for the region by expanding their presence in high-growth and high-potential regional economies especially China/Hong Kong, Indonesia and Indochina.

In particular, Indonesia offers an attractive opportunity for Malaysian banks, including Maybank, due to its population size (8 times of Malaysia's) but where loan-to-GDP is only 27 per cent (versus Malaysia's 115 per cent), signalling a potentially big upside in credit demand.

Indonesia also offers a high net interest margin of >5 per cent versus Malaysia's 2+ per cent, stronger loans growth of 20+ per cent versus Malaysia's 8-10 per cent growth into 2011, and low non-interest income suggesting largely untapped treasury and investment banking businesses.