Aspiring afield: With a strong base at home, banks are now vying regionally

As the 2015 date for ASEAN integration draws nearer, a number of banks in Malaysia remain well positioned for regional expansion and leadership. They are large by regional standards, have experience derived from weathering several crises and hold sound balance sheets. They show willingness to bet on ASEAN markets and create regional champions. It is also imperative they succeed. Although there is room in some consumer-related finance and small and medium-sized enterprise (SME) segments, Malaysia’s domestic market is very mature and increasingly crowded. Therefore, banks have no choice but to focus on developing business beyond the country’s borders. A strategy predicated on ASEAN is both an opportunity and a necessity. While much of the groundwork in terms of acquisitions and branch openings has been completed, hurdles remain. The legacy of protectionism and knotty technical issues are hampering total ASEAN coverage and regional integration.

SOLID SECTOR: Analysts rarely call the fundamental strengths of the Malaysian banking sector into question. Official efforts to encourage mergers and create sound and credible institutions, initiated after the crisis of 1997-98, appear to have paid off. The central bank took the total number of banks from about 20, plus a handful of non-bank financials, down to the current eight. Academic studies indicate efficiency has improved as a result. The country now has a banking platform that is profitable, growing and stable. In the third quarter of 2012, the return on equity at Malaysian banks averaged 17.7%, up from 15.7% in the first quarter. Industry assets were up about 15.3% year-on-year (y-o-y) in 2011, compared with 8.9% in 2010 and only 6.7% in 2009. In terms of capital, the sector is well above the 8% ratio recommended by Basel III. For instance, CIMB’s risk-weighted capital ratio was 14.8% as of the third quarter of 2012 whilst Maybank’s stood at 14.41%. Public Bank’s 13.1%, AmBank’s 14.7%, RHB Bank’s 14.89%, Heong Leong Bank’s 14%, Alliance Bank’s 14.18%, and Affin Bank’s 13.72%. According to Bank Negara Malaysia, the central bank, the industry-wide ratio was 13% in the same period. “There has been stability in the financial system largely because of the emphasis of the central bank in terms of consolidation during the first Financial Sector Master plan, establishing and encouraging banking sector consolidation,” Yeah Kim Leng, group chief economist at RAM Holdings, told OBG. “Over the years, banks have also been placing strong emphasis on fortifying risk management practices in line with Basel II and Basel III capital requirements.” Other metrics confirm the sector’s soundness. The ratio of net impaired loans to net total loans fell to 1.4% in the third quarter of 2012, down from 1.8% at end-2011.

LOANS & CREDIT: This was achieved in an environment of relatively fast credit expansion with the number of banking system loans outstanding up 12.8% in the third quarter of 2012 y-o-y, 13.5% for business loans. These figures represent a slowing down from earlier in the year. Total loan applications were down 2.6% in the third quarter of 2012, after rising by 10.2% in the second quarter, and business loan applications fell some 5.3% after growth of 19.2% in the same two quarters. For the end of 2011, pre-tax profits for the sector rose by 14.2% to approximately RM26.2bn ($8.45bn). This compares to a 35.1% profit increase recorded in 2010.

“Bank Negara works closely with banks to make sure credit standards, sector concentration, and risk perspective are all well maintained so they don’t end up with subprime-type exposures,” Kellee Kam, group managing director at RHB Banking Group, told OBG.

With over a decade of steady development, the Malaysian banking sector is one of the region’s most mature. The IMF estimates the domestic credit provided by the industry as a percentage of GDP in 2011 was 132.1%. In the Philippines the number was 51.8% in 2011, while in Indonesia it was about 38.5%.

INNOVATIVE & COMPETITIVE: It has never been so important for banks to develop economies of scale. The cost of technology, compliance and risk management systems and programmes has made it necessary to grow in size to absorb massive capital expenses that all banks face. Stability was the original goal of consolidation, and it appears to have been achieved. Now it is also vital to ensure banks continue to be current and competitive.

In this respect, Malaysian financial institutions have done well. They offer multiple banking technology and innovative services, including lifestyle banking (CIMB), wireless ATMs (AmBank), social media channels for credit card management (Alliance Bank), phone banking and SMS banking. RHB Bank’s Easy, for example, is a programme with mini-branches and kiosk branches throughout the country. These outlets, costing 10-15% of a full branch, can deliver most products, the main exceptions being mortgages and car loans. A customer only needs their ID and their thumbprint, and they can get almost all banking services, up to and including personal loans, insurance and investments.

Many interviewed by OBG also noted that, while many Malaysian companies are subject to complaints, banks in the country receive relatively few. Despite the concentration of banking assets in so few institutions, the dominant positions do not appear to have been abused and competition has remained healthy.

FUTURE CONSOLIDATION: While consolidation of banks was once a government priority, at this point it has become purely optional. The government and central bank are no longer officially encouraging combinations between banks, instead allowing market forces to take the lead.

Some analysts OBG spoke with believe this means there will be no more mergers. They argue buying more assets makes little sense because banks have more than enough as it is, and that domestic expansion has become counterproductive. Any further consolidation will result in banks owning branches right next to each other. Furthermore, Malaysian labour laws make it difficult to shut branches or lay off employees. If mergers are purely driven by business, analysts argue, they probably won’t happen.

Others are not so sure and believe consolidation could continue. While commercial motivations are weak at this point and the central bank has vowed to stand back, these analysts tell OBG the country is not done building banking giants. One finance executive said more mergers could take place in anticipation of further liberalisation. The final number of domestic banking institutions could become as low as three. Another said there could be fewer banks because Malaysia has just 30m people.

“In the first stage, some of the consolidation was driven by regulatory signalling,” Yeah told OBG. “We are now entering the second stage, where it is likely to be more market driven. We think there is further room for consolidation, through mergers and acquisitions in the banking sector. This is largely because there are still too many banks in the country at present for a small country such as Malaysia.”

BOTH REGIONAL & GLOBAL: The limitations of the domestic market have bankers looking out internationally. They see the opportunity to grow in other markets and the chance to gain from cross-border business, especially as the ASEAN Economic Community (AEC) continues to develop. In some ways, the banks have no choice. Malaysia is a mature banking market that offers very little in the way of new business. Local institutions have to look abroad or face the possibility of stagnation. “Local Malaysian banks now compete on an equal playing field with the likes of Standard Chartered, HSBC and Citibank in the domestic market,” Kam told OBG. “The next step now is to compete with them not just on a domestic level, but on a regional one as well.” There is a growing awareness that ASEAN banks and ASEAN corporations are simply too small to be internationally competitive, and this is one of the concerns underpinning regional growth. ASEAN has no global brands or globally recognised multinationals. The hope is that by achieving a critical mass in regional banking a more powerful ASEAN could be achieved.

Given the weak recovery in the US, the slowing of growth in China, and a number of European countries mired in recession, banks are increasingly seeing ASEAN as the place where future economic growth is mostly likely to occur.

“The ASEAN countries have come together given the shakiness elsewhere,” Chuah Mei Lin, executive director of the Association of Malaysian Banks, told OBG. “Rather than looking to the West, one needs to rely more heavily on the region itself. There are benefits to be derived from the region.”

REGIONAL ASSETS: Malaysia’s two largest banks have substantial assets and operations outside Malaysia. Maybank, the larger of the two, has established itself in almost all the ASEAN markets. It has been in Brunei and Singapore since 1960, in Cambodia since 1993 (and incorporated there since 2012) and in Vietnam since 1995. It has large subsidiaries in Indonesia and the Philippines and has had a representative office in Myanmar since 1993.

CIMB also has a sizeable network in ASEAN. It has been in Singapore since 1947, Myanmar since 1995 with a representative office, Brunei Darussalam since 2005 and Cambodia since 2010. In Indonesia, it owns 78.3% of Bank Niaga, the country’s eighth-largest bank, while in Thailand it also owns BankThai, that country’s 10th-largest bank.

The latest addition to the CIMB stable is the Bank of Commerce in the Philippines, 60% of which CIMB acquired in May 2012. The Bank of Commerce, founded in 1963, is now ranked 16th in the Philippines and has 122 branches and 300 ATMs. The stake cost CIMB some RM881m ($284.2m). According to TA Securities, CIMB is now the most international of all Malaysian banks, with 43% of its pre-tax profits coming from non-Malaysian operations. For Maybank, that number is about 27%, while Public Bank comes in at around 6.1% and RHB comes in at approximately 5%.

ACQUISITION: For Malaysian banks, the acquisition of foreign banks is particularly attractive and important. Though they can certainly go the branch route, as they have done in some of the smaller markets, it appears to be far more beneficial for them and their customers if they buy existing operations. Banks in some of the larger countries in ASEAN are flush with assets, and these provide the cheapest and most stable form of local-currency funding.

Malaysian customers are keen to take advantage of the single market that is now being in the process of being created by the AEC, and Malaysian banks want to be able to serve those customers by expanding regionally. Local operations with local deposits appear to be the best and most profitable way to do just that for the present.

Indonesia, the Philippines and Thailand are the three main markets being targeted by Malaysian banks. In Indonesia and the Philippines, banking penetration is very low, with the number in Indonesia hovering around 32%, while in the Philippines it has been estimated to be as low as 27%.

In all these target markets, Malaysia can offer expertise in a number of ways. Its banks are some of the largest and most sophisticated in the region, and they can transfer technology and know-how to other less advanced banking environments. “We [Malaysian banks] can bring our expertise and products to other countries,” Chuah told OBG.

LIBERALISATION: As Malaysian banks go out, foreign banks are entering the market. Strictly speaking, the cap on foreign ownership of Malaysian banks is set at 30%. Australia & New Zealand Banking Group owns 23.8% of AMMB Holdings, AmBank’s parent, and Bank of East Asia owns 23.5% of Affin Holdings. DBS has been in negotiations to acquire 14.2% of Alliance Financial Group, which owns Alliance Bank Malaysia, the country’s smallest lender.

However, while foreign takeovers of local banks are prevented, the country has nevertheless been one of the most open in terms of granting new licences to non-Malaysian institutions. Bank Negara Malaysia issued five licences in 2010, bringing the total number of foreign licences to 19 – though only 18 foreign banks are currently up and running. (Indonesia’s Bank Mandiri has yet to establish itself in the country because of the restrictive nature of the licence offered.) According to Donald Lim Siang Chai, the deputy minister of finance, foreign banks currently possess around 22% of the total banking assets located within Malaysia.

ISLAMIC BANKING: The country has been exceptionally open when it comes to Islamic finance. While foreign shareholdings in existing commercial banks is capped at 30%, the limit was raised in 2009 to 70% in the case of Islamic institutions. In 2010 Bank Negara Malaysia also announced it would allow for the creation of two Islamic mega-banks, though to date there has been little movement on that particular front. Currently, the country has 16 institutions now practising sharia-compliant finance, along with five international Islamic banks, whose licences limit them to primarily non-ringgit business.

Islamic banking remains a priority and a growth area for the country. Assets in the sector were RM364bn ($117.4bn) in September 2012, up from RM308bn ($99.36bn) in September 2011. The sector is seen as vital; with 17m Muslims, Malaysia has a large potential base of depositors who would choose institutions for religious reasons.

At the same time, there is a growing interest in sharia-compliant banking as a result of the recent economic turmoil. The prohibition on interest and the limits on excess speculation are attractive to those wary of traditional commercial banks.

Recycling petrodollars may also be a motivation for many. Asset holders in the Middle East began to move money back home as they became more sceptical of the dollar as a currency and the US as a destination for capital. But the results of this included instability, imbalances and bubbles in their relatively small domestic economies. These players are looking for larger, more liquid and more international sharia-compliant markets, and Malaysia tops the list. Because of the country’s positioning in both the secular world and the Islamic world, it is able to offer highly competitive and sophisticated sharia-compliant services and products.

Some see Islamic banking, rather than commercial banking, as Malaysia’s edge. In commercial banking, they argue, it is tough for the Malaysian banks to differentiate themselves, but in Islamic finance, the country comes to the table with a unique set of capabilities, resources and skills. This advantage would be especially helpful for Malaysian financial institutions that are now building businesses in Indonesia, as that country has the largest Muslim population in the world and is also severely underbanked.

OVERSIGHT & COMPLIANCE: Credit for growth and stability in the sector largely goes to Bank Negara’s governor, Zeti Akhtar Aziz, who has kept a firm hand on interest rates since the 2008 crisis: a time when many economies globally pursued loose monetary policies, controlling speculative excesses. She has also been a proponent of liberalisation, especially in the Islamic finance sector. Bankers interviewed by OBG say that Zeti’s international profile and reputation have been important to the country and will help as it faces challenges ahead. The central bank governor received an A grade from Global Finance magazine in October 2011, an honour shared by only two others in the Asia-Pacific region.

Malaysian banks are currently in the process of preparing to become Qualified Intermediaries under the US Foreign Account Tax Compliance Act (FATCA) programme. According to Chuah Mei Lin, the executive director of the Association of Malaysian Banks, the industry has agreed in principle to the terms of the anti-money laundering guidelines, and is now discussing specifics, such as reporting thresholds, with a Beijing-based US representative. FATCA, among other things, requires non-US banks to collect information on US citizen depositors and assist US authorities in identifying those who are avoiding their tax obligations. While some countries, such as China, have vowed not to comply, Malaysia is cooperating.

THE PLAN: The Financial Sector Blueprint, announced in December 2011, aims to build off the strengths of the country’s banks. Malaysia came through the 2008 financial crisis in good shape. Its financial sector was strong throughout the turmoil, and its reputation emerged intact. The blueprint is designed to improve upon what Malaysia has. Its goals are wide-ranging and include internationalising Islamic finance, training more people for the finance industry, increasing electronic payments, regional and international financial integration, deepening financial markets, developing regulations to ensure soundness and stability, and enhancing and improving consumer finance. The central bank hopes to take the financial sector from 8.6% of GDP to as high as 12% by 2020 and increase the financial sector workforce from 144,000 to around 200,000.

TOO BIG TO FAIL: Despite the strength, growth and resilience of the Malaysian banking sector, there are concerns. The sector suffers from a number of imbalances and weakness. Some of these are currently being addressed, while others still need further action. Some problems are unintended consequences of success. Consolidation, for example, leaves the country with a potentially dangerous level of concentration. All banks are key to the industry and each is so large that none can be allowed to get in trouble. “Every bank cannot fail,” Yeah told OBG.

The country has countered the too-big-to-fail problem with a high level of supervision from the government. Bank Negara Malaysia keeps a close watch on the banks, adding almost another level of management and oversight. While there is no reason to question its prudent supervision of the sector, should the banks get in trouble, the central bank might have to backstop the entire industry.

Malaysian banks’ fundamentals remain sound, but there is growing concern about the state of Asian central banks in general. Many banks in the region have balance sheets bloated with foreign assets, raising questions about their long-term fitness, their reputation and their independence.

One of the ways for banks to address and avoid problems is by increasing their focus on training, through such organisations as the Institute of Bankers Malaysia. Established in 1977, this professional education body offers industry-focused professional certification and works with financial institutions to design development programmes covering all aspects of domestic and international banking.

KEEPING CALM: The industry is in many respects competitive, but excessive concentration can lead to gaps in performance. Because the institutions are so large, because there are so few of them and because the central bank keeps them on such a short leash, they tend to be quite conservative and not all that creative. Commercial innovations notwithstanding, the banks are largely prone to advancing in a predictable manner, trying the obvious, and are fearful of taking actions that might not work out.

This does not mean that Malaysia is heading for a downturn anytime soon. But there does appear to be a distinct lack of competitiveness. Malaysia is seen by many as a place where funds will remain safe, but may not post sizeable increases.

SME ISSUES: The SME sector may be one blind spot. Banks tend only to lend on collateral and the industry is not particularly experienced in doing credit analysis that involves cash flows or future prospects.

One difficulty may be that bankers in Malaysia lend based on an asset basis, such as by looking at a company’s property or cash. It is less common to determine lending based mainly on a firm’s cash flow, which can be problematic for SMEs, which are often less well established and therefore have less in the way of assets, even if their financial viability is secured in other ways.

The government has stepped into the breach and made a wide range of funding sources available. The Credit Guarantee Corps is running a “credit enhancer scheme” that will back up a certain percentage of a loan, depending on size of the loan, offered by a bank to an SME. The SME Bank, a wholly government-owned institution, provides direct financing and guarantees.

Another initiative, the Working Capital Guarantee Scheme, is a RM7bn ($2.26bn) programme that will back up to 80% of bank funding for companies with shareholders’ capital of less than RM20m ($6.5m). SMEs in this programme should have a business plan, and the government hopes the contribution of SMEs to GDP will rise to 41% by 2020, from 32% in 2010.

HOUSEHOLD DEBT: Household debt is also a concern. The development of the bond market over the past decade has helped to stabilise the financial system, but it has somewhat disintermediated the banks. They are flush with deposits and need to lend them. A lot of that money has found its way to individuals, and the total obligations are reaching a dangerous level. Household debt in Malaysia hit 76.7% of GDP in September 2012, relatively unchanged from earlier in the year.

The banking system is working to overcome this problem. On January 1, 2012, new central bank credit card guidelines came into effect. Under the rules, people earning less than RM24,000 ($7742) a year will only be allowed to have one credit card. Those earning less than RM36,000 ($11,600) will only be able to have two cards and will only be able to have credit lines totalling two times their monthly income on each card.

Moreover, credit analysis will be done based on net income, not gross. Growth in household debt has already started to drop. Total credit card loans are rising at about 5% y-o-y, down from 20% in 2007. Still, some analysts remain cautious, wondering whether the banks will really be able to moderate lending to consumers, as deposits are building up and there are few other options for them.

ISLAMIC BANKING WORRIES: While Islamic banking is certainly generating growth, there are some concerns that its development is not going as well as planned. The two mega Islamic banking licences first announced two years ago have not been executed. In June 2012, when reports surfaced that the central bank may ask Petronas to jump start one of the mega-banks by contributing some of the $1bn of start-up capital needed, the viability of the plan was brought into question. (It was originally expected that international investors would support the funding of the new institutions.) The move also raised a number of concerns about corporate governance and regulation. Several industry players have said it would be unusual and potentially problematic for a central bank to be so involved in the founding of a private banking institution.

Tony Pua, the policy chief for Malaysia’s Democratic Action Party, told the Malaysian Insider that the central bank’s proposal would only result in a conflict of interest as well as unfair competition with existing banks. “The central bank’s role is to regulate the financial services industry, not to get involved in setting up of a new bank,” he said in an interview featured in the magazine.

At the same time, larger questions about sharia-complaint finance are starting to emerge. Some financiers are beginning to question whether Islamic banking as it is now practised is truly in line with the religious tenets of Islam, and suggest that fund management would be a better vehicle for the devout.

Meanwhile, research is beginning to cast doubt on the benefits of Islamic banking to the investors. An IMF study published in 2012 using data through 2010 found that returns on equity were lower for Islamic banks in Malaysia while non-performing loans were higher when compared with Malaysian conventional banks. During period of the study (2006-10) leverage was only slightly lower at Islamic banks and was, for a time following the 2008 crisis, higher.

“In summary, the empirical analysis suggests that even though conventional and Islamic financial instruments are fundamentally different, they perform similarly in a competitive market,” the report by the IMF pointed out. “In other words, investing in sharia-compliant securities has no statistically significant downside or upside effects on investors’ wealth compared to conventional instruments.”

REGIONAL HURDLES: The biggest concern for Malaysian banks is that the regional integration project has stalled. In Thailand, Maybank has no banking presence, only a brokerage presence via Maybank Kim Eng, and it is having difficulty gaining a proper foothold. Despite rumours circulating in early 2012, the Malaysian bank did not buy the 31% stake that ING currently holds in TMB, with ING instead selling its Thai asset management unit, ING Funds, to Singapore’s United Overseas Bank for $12.8m. One neighbour, Thailand, remains a closed market. Foreign ownership there is set at a maximum of 30%, a limit only broken if a local bank is in trouble. The country also restricts the number of branches foreign banks can open. It allows up to three for banks with a branch presence in the country and up to 20 for local subsidiaries. CIMB was able to get in by buying troubled BankThai, and China’s ICBC received a special dispensation from regulators to acquire 97.24% of ACL Bank in 2010. Indonesia, which allows foreign investors to own up to 99% of local banks, is considering lowering the foreign ownership ceiling to 40%. While both CIMB and Maybank have established themselves quite firmly in the country, RHB is still trying to acquire Bank Mestika Dharma, while Affin Bank hopes to acquire Bank Ina Perdana.

CLOSER TO HOME: Controversy regarding Bank Mandiri’s Malaysian banking licence is complicating matters. In 2010 Mandiri received permission to open in Malaysia, along with BNP Paribas, Sumitomo Mitsui Banking Corporation, Mizuho Corporate Bank and the National Bank of Abu Dhabi. However, the bank found the terms of the licence to be somewhat onerous. Managers claimed that the minimum capital requirements were too high, the branch numbers it was allowed were too limited and the requirement that Mandiri ATMs could only be located within the bank’s own branches was too restrictive. All of this, the bank argued, made it impossible for it to truly compete in the sector.

While a number of concessions were granted by the central bank, no conclusion has been reached. Indonesian officials claim that Malaysia is treating the banks unfairly, and that there is no principle of reciprocity to be applied in this matter. Technical problems are also hampering regionalisation. While the vision of the AEC is almost universally accepted, getting the banks to coordinate has not been easy. Issues such as payments systems standards and a mechanism for the cross-border employment of fit-and-proper persons have become stumbling blocks.

Even getting a dialogue under way on ATM standards has proved difficult. One prominent problem is that while broad principles have been accepted, the ministries in charge of implementation are not part of the high-level conversations. For example, while the free movement of skilled labour is in the AEC Blueprint, the various immigration authorities still have to adjust their rules. Agreement by regulators on certain clear principles needs to be addressed before integration within the region can continue at a faster pace.

OUTLOOK: The banking sector appears to have very strong fundamentals for the region, and despite several challenges, such as SME support and household debt, its continued stability domestically seems assured. However, the next step – an expansion throughout the other countries of the general region – will require further regulatory cooperation throughout the entire ASEAN area.

“The financial crisis has highlighted a lot of regulatory refinements that need to take place as institutions move beyond their domestic markets,” RHB’s Kam told OBG. “Regulatory frameworks across the ASEAN region need to start to strengthen cooperation to ensure that cross border regulation is done in a more practical manner. This will continue to evolve as more regional banking giants are created.”