Fine line: The government is working to maintain a balance in consumer credit

The country has long benefitted from its fast-growing retail lending industry, which has kept consumer demand robust and reduced the economy’s dependence on volatile export markets. But as household debt has piled up to one of the highest levels in Asia, analysts are increasingly seeing credit growth as a source of risk and potential instability.

Big Spenders 

Malaysians tend to spend what they earn and borrow for big purchases. The household sector was a net borrower of 2.3-2.6% of GDP from 2006 to 2009, according to the most recent data available from the Department of Statistics (DoS). Household savings ranged from 1.5-1.7% of disposable income during that period. That compares to a US post-war low of 2.6% in 2005 and rates of above 20% in China and some other Asian countries.

Malaysia’s household sector debt has steadily risen, reaching nearly 87% of GDP at the end of 2013, the second-highest level in Asia after South Korea. Low interest rates in the aftermath of the 2008-09 global financial crisis have been a key driver, increasing affordability of cars and homes for middle-class buyers, as well as encouraging leveraged investment. Meanwhile, housing prices rose by 8% between the first quarters of 2013 and 2014 from RM256,199 ($79,959) to RM276,668 ($86,348), according to the National Property Information Centre (NAPIC). In Kuala Lumpur, home prices shot up 10.08% over the same period, from RM587,879 ($183,477) to RM647,189 ($201,987).

International ratings agency Standard & Poor’s raised the most serious warning yet in November 2013, when it issued negative ratings outlooks for three Malaysian banks, citing rising household debts, escalating housing prices and “the potential for deterioration in the banks’ asset quality and financial profile, if the consumer debt burden proves excessive in an unfavourable economic scenario.” Rival agency Fitch Ratings also issued a similar warning in March 2014 but said that banks were well-protected by strong capital buffers. The IMF also highlighted the issue in an April 2014 research note.

Being Cautious 

However, none of these organisations suggested Malaysia’s mortgage boom could be likened to the extreme risk taking that led to the property market crash in the US and parts of Europe in 2008. Malaysia has no subprime lending industry, and banks employ relatively conservative underwriting standards. The country’s central bank, Bank Negara Malaysia (BNM), has a good credit reference system with a centralised consumer loan database, which allows for banks to make proper credit assessments. Malaysia also has relatively little lending to developers and builders. Net bank lending to those sectors was less than 2% of GDP in 2013, compared to a peak of 12% of GDP in Spain in 2006. Malaysian residential developers prefer selling apartments off-plan before they are built.

Learning From The Past

Banks and developers still remember events in the 1990s, when a massive influx of international capital into “Asian tiger” economies lured Malaysians into a wave of speculation on equities and property. Average housing prices more than doubled between 1990 and 1996 to a peak of more than 12 times annual per capita income, according to NAPIC, compared to just over eight times per capita income in 2013. Then the Asian financial crisis struck in 1997, and international capital retreated from Asian assets and currencies quicker than it had come in. A sharp region-wide recession ensued as financing dried up and layoffs spread. Malaysia’s GDP dived in 1998 by 7.4% in real terms and 28% in dollar terms, while the banking sector’s impaired loan ratio climbed to over 14%.

Most mortgage defaults in the late 1990s were among speculative and buy-to-rent investors, a lesson that has guided authorities as they have sought to moderate the current mortgage boom. In 2010 the government reintroduced a capital gains tax on properties sold within five years of purchases, which had been suspended in 2007. Rates have increased every year since, up to 30% for properties sold within three years of purchase and 15% if sold within five years of purchase for the 2014 tax year. BNM also decided to cap loan-to-value (LTV) ratios in 2010 at 70% for personal mortgages on third or subsequent mortgaged properties. And in July 2013 the BNM reduced the maximum length of home mortgages from 45 to 35 years and banned marketing of pre-approved loans.

Taking Care

The government and central bank measures are aimed at discouraging speculation without limiting access or overly curtailing demand for credit. Banks continue to offer mortgages with up to 100% LTVs on up to two properties. Meanwhile, the pace of mortgage lending has continued to accelerate. Banks’ net issuance of home loans came to RM41bn ($12.8bn) in 2013, equal to 4.1% of GDP, according to BNM. That was up from RM35bn ($10.9bn), or 3.7% of GDP, in 2012. Net issuance came to RM10.7bn ($3.34bn) in the first quarter of 2014, equal to 4.2% of quarterly GDP. Outstanding bank home loans reached RM356bn ($111.11bn) by March 2014, equal to 35% of annual GDP. Separately, government home loans to employees came to RM37bn ($11.5bn) at the end of 2013.

Those numbers are far shy of what was seen in the US, where net home loan issuance surpassed 8% of GDP in 2005 and outstanding home loans reached 73% of GDP in 2007. However, Malaysia’s higher exposure to volatile global trade makes it more vulnerable to external shocks. The biggest worry is that many Asian countries could be approaching the limits of their ability to sustain credit growth. In an April 2014 report on Malaysia’s financial sector, the IMF wrote that six out of eight major Asia-Pacific economies it studied appeared to be in late (Malaysia, South Korea and Hong Kong) or very late (Australia, China and India) stages of the expansion phase of their credit cycles.

A more mundane concern is that when net issuance of credit to households inevitably slows down, the reduced contribution of credit will weigh on aggregate demand growth, similar to the drag on growth that results from fiscal consolidation. The IMF wrote, “The late phase of the expansion cycle does not necessarily imply that the countries will reel into a downturn or a recession, but a moderate growth scenario is possible.” Still, the IMF’s forecasts of Malaysian growth remained bullish, with a 5.2% rate expected in 2014.

Maintaining Balance

The good news is that Malaysia, like other Asian countries, has greatly reduced its dependence on foreign capital since the Asian financial crisis. The BNM built up foreign exchange reserves that stood at $131bn as of mid-May 2014. Domestic bank lending was hardly affected by the pullback of international capital from emerging markets in 2013, and though net issuance of corporate bonds went into reverse for several months as foreigners stopped buying, that was partly because issuers had other options. The bad news is that Malaysia’s high mortgage LTV ratios compound risk by making it much more likely for borrowers to default if housing prices were to fall. The IMF is pushing for tougher cooling measures. In an April 2014 report on Malaysia’s housing boom, the IMF said, “Should credit growth remain strong, additional macro-prudential measures should be introduced … Options include capping LTV ratios on second and first mortgages, explicit limits on debt service-to-income ratios, or additional capital charges on high LTV loans.”

However, the BNM appears reluctant to clamp down harder. It argued in a March 2014 report that the primary driver of household debt growth was income growth, and that the asset side of household balance sheets was also growing quickly. The BNM also pointed to banks’ high capital ratios, low and declining impaired loan ratios and a slightly slowing pace of household debt growth relative to the outstanding stock. The BNM is thought to be reluctant to raise interest rates. The consensus among analysts was that the BNM would raise base interest rates by 25 basis points in late 2014 or early 2015 to 3.25%, but stop there unless it saw signs of accelerating demand-driven inflation.

Long Term

A small, one-off hike is unlikely to affect domestic lending rates, which depend on bank deposit rates. When the BNM last tightened in 2010-11, lifting base rates in steps from 2% to 3%, average bank deposit and lending rates hardly changed. Average bank lending rates have since fallen from 4.9% in 2011 to 4.5% in early 2014 as competition among banks has lowered margins. The largest bank, Maybank, was advertising 35-year, variable-rate ringgit mortgages for as little as 4.3% interest as of May 2014, while annual consumer price inflation was running at 3.4% in April 2014.

There were signs in early 2014 that housing prices could be topping out. The national average home price grew by only 0.3% from the fourth quarter of 2013 to the first quarter of 2014 – the lowest quarterly price increase since 2009, according to NAPIC. In another sign of changing winds in consumer lending markets, outstanding bank credit card loans shrank by 3.7% in the first four months of 2014, according to BNM. Alan Tan, chief economist at Affin Investment Bank, told OBG strong forces would continue to drive consumer credit. He said, “We think consumer credit will continue to expand. The main drivers are accommodative monetary policy and the large number of young people reaching the age when they want to buy homes and cars.”