KUALA LUMPUR – Bank Negara Malaysia’s (BNM) stress tests apply two hypothetical adverse scenarios to show that financial institutions continue to remain resilient under simulated severe credit, income and funding shocks, reported Bernama.
In its Financial Stability Review for Second Half 2020 report released on March 31, the central bank said stress testing is an integral component of BNM’s financial stability framework used to assess and manage risks to financial stability.
It said the actual severe economic fallout from the COVID-19 pandemic prompted BNM to shift the focus of its top-down, scenario-based stress towards assessing the ability of banks to withstand the unfolding stress based on assumptions around a likely recovery path at the time.
BNM said the first adverse scenario assumed a sharp economic downturn in the first quarter of 2021 of a similar magnitude to the downturn experienced in the second quarter of 2020 before recovering at a gradual pace akin to a V-shape.
It said under this scenario, the initial recovery, driven by pent-up demand, is unevenly distributed across industries before gradually normalising across all sectors by 2022.
The central bank said the second adverse scenario assumed a much sharper economic contraction in the first quarter of 2021 surpassing the deepest slump experienced in the crisis thus far.
It said in the second adverse scenario, the recovery was assumed to be sluggish and L-shaped, with GDP recording negative growth in 2021 and remaining below pre-pandemic levels even by end-2022.
It said given the extended lockdown restrictions, domestic demand suffered a prolonged slump with labour market conditions continuing to worsen throughout 2021.
BNM said both scenarios assumed sovereign rating downgrades in 2021.
However, it said the economic scenarios used in these stress tests do not represent BNM’s actual expectations for the trajectory of the economy but rather have been developed for the specific purpose of testing the ability of financial institutions to withstand more severe and prolonged economic shocks even as economic prospects are expected to continue to improve.
It said the tests also continued to assume no further repayment assistance to household borrowers after the first quarter of 2021 and any reschedulling and restructuring of business loans are assumed to end after the second quarter of 2021.
BNM said under the two adverse scenarios, banks might see overall impairments rise to 4% under the first scenario and 5.4% under the second scenario by the end-2022 with businesses driving the larger share of new impairments in 2021 and household contributing the larger share in 2022.
It said despite the greater degree of economic stress assumed in this exercise, impairments by end-2021 are ex[ected to be lower at 2.9% and 3.3% under the first and second scenario, respectively, compared with 4.1% in the previous exercise.
It said business impairments in the first adverse scenario are driven by the default of both small and medium enterprises (SMEs) operating in vulnerable sectors and several non-SMEs while in the second adverse scenario, higher impairments are mainly driven by SMEs as the prolonged weakness and sluggish recovery is expected to have a bigger impact on SMEs given their relatively thinner cash buffers and narrower profit margins.
However, it said middle-income borrowers drove the largest share of household impairments in value terms commensurate with the larger loan amounts when compared to lower-income defaulters.