Macro Solvency Stress Test Reaffirms Banks’ Resilience In Face Of Severe Shocks

KUALA LUMPUR, March 24 (Bernama) -- Solvency and liquidity stress test exercises have re-affirmed that banks in the country remain highly resilient even in the face of severe macroeconomic, financial, and liquidity shocks.

The banking system is expected to have sufficient capacity to maintain lending to the economy, even during downturns, Bank Negara Malaysia (BNM) said in its Financial Stability Review for the second half of 2024 released today.

In BNM’s macro solvency stress test, two adverse scenarios were applied to simulate the impact of different paths of economic contraction or slowdown on the resilience of financial institutions over a three-year horizon from 2025 up to the end of 2027.

According to the report, the first adverse scenario (AS1) is designed to test financial institutions’ resilience to a sharp but temporary shock in the operating environment, while the second adverse scenario (AS2) tests financial institutions’ resilience to a less severe but more prolonged economic contraction.

Under the severe macroeconomic environment assumed in the scenarios, the banking system is expected to remain resilient, while credit losses are expected to drive the bulk of projected losses.

“Overall, projected cumulative credit losses over the three-year horizon are estimated to be RM77 billion and RM90.8 billion under AS1 and AS2 respectively (equivalent to 58 and 63 per cent of total losses respectively).

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“In particular, banks are projected to face higher defaults post-shock from household borrowers contending with the higher inflationary shocks,” it said.

According to the report, overall banking system profitability is expected to decline sharply in the initial year of stress mainly from higher credit costs.

“While net interest income would also decline sharply amid elevated funding costs, this is expected to gradually recover in the subsequent years, leading to a recovery in profits and capital buffers.

“Expected losses incurred from overseas operations are notable for some large domestic banking groups (DBGs) but the impact is mitigated by the healthy capital buffers held by the respective overseas entities,” it said.

Meanwhile, the macro solvency stress test for insurers incorporates additional insurance-specific assumptions, which are largely similar to those applied in the 2024 exercise.

“Overall, the insurance sector’s aggregate capital adequacy ratio (CAR) is assessed to remain above the regulatory minimum. Market risk remains the key driver of losses for both life and general insurers due to their significant holdings of bond and equity investments.

“Increased bond yields coupled with the weak equity market performance under both scenarios continued to affect the investment performance of insurers,” BNM said.

According to the report, life insurers are expected to experience sustained net underwriting losses throughout the stress horizon under AS2 due to the impact from assumed benefit payouts, including those for medical claims and surrenders.

Nonetheless, it said, the downward revaluation of liabilities due to the increase in bond yields is expected to partly cushion the impact on their CAR.

-- BERNAMA