Market volatility to affect financial sector

Banks will find it challenging to sustain revenue base

THE domestic financial sector is bracing for greater challenges in 2009 due to moderating economic growth and volatility in financial markets.

Sustained risk aversion may result in continued low trading liquidity in specific asset classes. Credit spreads in the corporate bond market may widen further, resulting in higher cost of funding.

Furthermore, corporate earnings have started to decline and weaker employment prospects could translate into broad-based increases in delinquencies and fraud, triggering a credit cycle downturn.

As credit outlook weakens and demand for financing, financial products and insurance protection moderates, Malaysian financial insititutions will face significant challenges in sustaining their revenue base.

Banking institutions will need to balance prudent standards and provide continued support to customers, particularly in easing temporary cash flow pressures.

Counter-cyclical practices will only exacerbate the economic conditions, which will in turn impact the bank’s balance sheet.

Meanwhile, domestic financial groups with regional operations will not only see lower profit contributions, but face new channels of risk transmission.

Nonetheless, revenue contribution from overseas remained small, at 11% of the banking system’s pre-tax profit.

Financial groups with foreign partners, however, have benefited in terms of increased sophistication in risk management capabilities and technology.

Similarly, the Malaysian insurance and takaful sector will also be affected by lower demand and higher competition.

In particular, the expected decline in vehicle sales will negatively impact the motor insurance and takaful business, which constitutes 45% of gross premium in 2008.

Premiums are also likely to be affected by the potential increase in surrender rates and lower sum insured. Claims are projected to intensify due to higher incidences of theft and fraud, as well as due to maintenance faults.

To face the rising challenges, Bank Negara has increased its supervisory and surveillance capacity to detect potential problems at an early phase and allow for pre-emptive actions.

While structural changes in the global and domestic financial landscapes have increased the complexity and inter-linkages in the financial system, Bank Negara closely engages other central banks, monetary authorities and supervisory agencies to monitor and respond, when necessary, in a coordinated manner.

Moving forward, macroeconomic surveillance and supervisory activities will continue to focus on several key areas:

Strengthening the robustness of risk transmission assessments from external developments to the local financial market, businesses, households and financial sectors, as well as spillovers of distress from non-regulated entities and markets;

Enhancing ongoing scenario analyses at both the system and individual institution levels;

Strengthening engagement and communication with various stakeholders including regulatees, business associations, small and medium enterprises (SMEs) and other regulatory authorities to enable early identification of signs of distress and emerging risks. This include ensuring continued access to financing;

Ensuring pre-emptive action plans are in place and implemented in effective manner; and

Intensifying regional and international cooperation and coordination in supervisory and regulatory activities.

--the star online