IT was a turbulent year for banks as Covid-19 wreaked havoc on the economy and, inevitably, took a toll on the lenders’ earnings.

In a first for the sector, banks extended a blanket loan repayment moratorium to individual and small and medium enterprise (SME) borrowers for six months, from April to September. The move was aimed at easing the cash flow of those affected by the virus outbreak.

There were three main reasons bank earnings took a hit this year.

One, was the modification loss (ML) that banks had to incur — as per the MFSR 9 accounting standard — from not having been able to impose additional interest/profit charges on hire purchase and fixed-rate Islamic financing during the moratorium period.

The MLs were pretty sizeable for some banks. For instance, Malaysia Building Society Bhd incurred a net ML of RM512.6 million in the second quarter, the highest among the banks, pushing it into a position of net loss for the period. Cumulatively, the 10 public-listed banks incurred a net ML of RM2.31 billion in the second quarter.

Two, was the surge in banks’ credit costs, mainly as a result of them doing heavy pre-emptive provisioning.

And three, was the decline in the lenders’ net interest margins as a result of Bank Negara Malaysia cutting the overnight policy rate four times this year, by a total of 125 basis points (bps), to support the economy. The sharpest cut was in May, by 50bps, with the rest — in January, May and July — at 25bps each.

Banks’ cumulative core net profit fell 19.2% year on year to RM5.37 billion in 3Q2020, says CGS-CIMB Research. It was the third consecutive quarter of double-digit decline. While the sector’s return on equity recovered from a trough of 5.6% in 2Q2020 to 7.7% in 3Q2020, the ROE was still lower than the 9.5% of 3Q2019. Banks will release the final quarter earnings only next year.

This year, dividends were noticeably lower or entirely absent from some banks.

While many central banks around the world instructed banks to temporarily suspend or cut dividends this year to preserve capital amid all the Covid-19 uncertainties, Bank Negara took the stance of assessing Malaysian banks’ ability to pay dividends on a case-by-case — rather than blanket — basis.

So far, only four banks — Hong Leong Bank Bhd (HLBB), Malayan Banking Bhd (Maybank), BIMB Holdings Bhd and, just last week, RHB Bank Bhd — have announced interim dividends. Notably, for Public Bank Bhd, it was the first time since FY2005 that it did not declare an interim dividend in the first half of the year.

HLBB declared a final dividend per share (DPS) of 20 sen for its final quarter of the year ended June 30, 2020, bringing the total DPS for the full year to 36 sen, which worked out to a conservative payout ratio of 30%. Its DPS was 50 sen in the previous year.

Nevertheless, it was not all bad news for the sector. The Covid-19 outbreak was an unexpected catalyst for faster adoption of digital channels in the country.

According to Bank Negara, between August 2019 and 2020, there was a 47% increase in the volume of transactions made through internet and mobile banking, and a 260% increase in active e-wallet users.

“Prior to the crisis, there was always the concern that it would be hard to convince the B40, senior citizens and rural folk to use digital services. But now, many have been forced to adapt to the changing circumstances. So, a change in mindset is already happening and that is only going to speed up,” Shankar Kanabiran, a financial services advisory partner at EY Malaysia, told The Edge in April.

Given the uncertainties arising from the Covid-19 pandemic, investors shunned banking stocks for the most part of the year. However, things turned around from November as investors started chasing banking stocks on the back of optimism about an economic recovery, with Covid-19 vaccines arriving soon.

The Bursa Malaysia Financial Services Index had shed 22.34% over the year to end-October, before gaining 28.09% to close at 15,383.58 points as at Dec 21. For the year to Dec 21, it shed a marginal 0.52% compared with the benchmark FBM KLCI’s 3.72% gain over the same period.

What 2021 holds

Analysts expect a rebound in the sector’s profitability next year as the economy recovers. RHB Research’s projection is for earnings to grow 27% y-o-y, after an expected 30% y-o-y decline this year.

“The earnings uplift is largely driven by better net interest income (from the absence and unwinding of MLs) and lower, albeit still elevated, credit cost assumption,” it says in a Dec 17 report. It has an “overweight” call on the sector.

Nevertheless, the research house acknowledges that there are still downside risks to the recovery. “Although we believe most banks would have brought forward the provisions to 2020, we are mindful of the risk that 2021’s actual credit cost could still come in higher than what we are expecting. The time lag between approval and wide deployment of Covid-19 vaccines means sporadic resurgence of infections and the reimposition of lockdowns will weigh on earnings through higher credit cost.”

Indeed, while a few research houses have turned more positive on the sector, others continue to be cautious and hold a “neutral” investment stance because of the expectation that provisions will remain high.

Banks’ underlying asset quality will only become clearer once all targeted repayment assistance, extended to borrowers upon the expiry of the blanket moratorium, comes to an end on June 30 next year. Bank Negara’s stress test projects that the banking system’s gross impaired loan ratio will rise to 3.1% by the end of 2020 from 1.6% as at end-June, before moving up further to 4.1% in 2021.

The Association of Banks in Malaysia (ABM) chairman Datuk Abdul Farid Alias, who is group president and CEO of Maybank, the country’s largest bank by assets, says the local banking industry will continue to operate within an environment of uncertainty in 2021.

“While the impending availability of the vaccine holds some promise, we need to remain cautious given that the full rollout will take time. Hence, SOPs (standard operating procedures) and social distancing guidelines need to be adhered to, to ensure we can continue to be productive and support economic growth within this environment, in a safe manner,” he says in a statement to The Edge. He was commenting on what the industry could expect next year.

“The expectation is that the economy will bounce back to normalcy within the next two years. While demand is expected to pick up, so will prices, and therefore it is likely that interest rate trends may reverse. We will need to watch out for inflation, and at the same time manage our indebtedness better as interest rates rise,” he adds.

Abdul Farid says that from an organisational standpoint, the lessons from the Covid-19 pandemic will remain of immense importance to banks as they will need to adopt some of the new practices for the longer term, given that threats of another epidemic or pandemic can emerge at any time.

“A key area would be the need to focus more on sustainability — not just in terms of the environment but also in promoting equality and inclusivity, and ensuring diversified and robust supply chains. At the same time, the industry will have to adjust to an environment in which work practices and cultures will continue to evolve rapidly, as will customer needs and expectations,” he says.

He adds that banks will have to remain nimble and alert in managing costs and risks efficiently while strengthening capital and liquidity levels to improve resilience for unexpected events. “Of course, spanning across much of these will be the need to accelerate our efforts in digitalisation further, not just in terms of providing customers accessibility to financial services or an enhanced customer experience but also to achieve better productivity and operational excellence so that we can remain relevant in a world where competition and change will only intensify in the years ahead.”

Digital banks and ESG in focus

One of the developments that will be closely watched next year is digital banks.

Bank Negara is expected to release its licensing framework for digital banks — meaning, those without a physical presence — by this year-end or early next year, after which it will invite applications for such licences. It plans to issue up to five licences.

Among the non-banks that have expressed interest in pursuing a licence are Grab, Axiata Group Bhd, Razer Inc, BigPay, Sunway Bhd, Green Packet Bhd, GHL Systems Bhd and PUC Bhd. Property firm Paramount Corp Bhd and US financial start-up MoneyLion Inc are also reported to be interested.

There will also be stronger investor scrutiny on the banks’ environmental, social and governance (ESG) practices next year, particularly on climate change. More banks are expected to announce their respective ESG frameworks and strategies in 2021.

According to Elaine Lim, financial services leader at PwC Malaysia, there is a clear economic case for building resilience to climate change, considering that 10.3% of the total assets of banks — one of the most vulnerable industries — are potentially exposed to climate change. She was citing data from Bank Negara.

“Banks need to move from ambition to action and take a more aggressive approach to transformation in managing climate risk by integrating climate risk more explicitly into their risk management frameworks, setting a net-zero strategy and conducting scenario analysis to provide clarity on climate-related impacts on the business,” she tells The Edge.