How will an overnight policy rate hike impact bank margins in Malaysia?

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An Overnight Policy Rate Hike Could Expand Net Interest Margins for Malaysian Banks

CGS-CIMB Research anticipates that a potential increase in Malaysia's overnight policy rate (OPR) in 2022 could lead to an expansion in banks' net interest margins. This projection is also supported by expectations of improved loan growth. The research house estimates a decline in loan loss provisioning, as banks have largely accounted for credit risks stemming from the Covid-19 pandemic.
Understanding the Overnight Policy Rate and its Impact on Margins

The overnight policy rate (OPR) is the benchmark interest rate set by a country's central bank, in Malaysia's case, Bank Negara Malaysia. It influences the cost of funds for banks, meaning when the OPR rises, banks generally face higher costs for borrowing money. However, banks can often pass on these increased costs to customers through higher interest rates on loans. The difference between the interest income banks earn from loans and the interest they pay out on deposits and borrowings is their net interest margin. Therefore, an increase in the OPR can lead to a wider gap between lending and deposit rates, thus expanding the net interest margin, provided that lending rates adjust upwards more significantly or rapidly than deposit rates.
Economic Context in Malaysia

The Malaysian economy has been in a recovery phase, with the reopening of economic sectors and the relaxation of movement restrictions contributing to improved loan growth. For instance, the industry's loan growth recovered to 3.3 per cent year-on-year in October 2021, up from 2.5 per cent in August. This recovery in economic activity provides a more favourable environment for banks to potentially increase lending and benefit from higher interest rates. However, the pace and extent of any OPR hike would also depend on Bank Negara Malaysia's assessment of inflation, economic growth momentum, and global economic conditions.
Projected Loan Growth and Provisioning

Beyond the impact of the OPR, CGS-CIMB Research foresees improved loan growth for Malaysian banks in 2022, projecting it to be between four to five per cent, an increase from the estimated 2.5 to 3.5 per cent for 2021. This anticipated growth in lending activities can further bolster bank revenues. Furthermore, the research house estimates a decline in loan loss provisioning for 2021 to 2022, suggesting that banks have already set aside substantial provisions for potential credit risks associated with the Covid-19 pandemic since the previous year. This reduction in provisioning can free up capital and improve profitability.

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How will an overnight policy rate hike impact bank margins in Malaysia?

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