A stress test by the Reserve Bank of Malawi (RBM) on the country’s 11 banks has found that credit risk is still a major threat to the country’s banking system.
The results also indicate that shocks to net interest income and income from foreign exchange trading have a large effect on most of the banks’ tier one capital and return on assets (ROA), exposing some of the banks to liquidity risk.
“The overall aim [of the stress test] was to establish the impact of macroeconomic shocks on banks’ conditions. The tests were conducted at two levels firstly, on the impact of a shock on a specific area, for instance, on foreign exchange income on tier one capital; secondly, at the impact of a combination of various shocks on banks’ position such as tier one capital,” said RBM in its latest financial stability report (FSR), covering six months from April to September 2014.
RBM said to test the resilience of the banking sector’s capital to credit risk, the loan portfolio of the banking sector was stressed to assess the impact of non-performing assets/loans (NPLs) on performance of the sector’s capital adequacy.
The report said performance of various sectors of the economy was emphasised based on incremental growth in NPLs.
“The results showed that with the minor and major shocks, the banking sector’s tier one capital ratio declined from 14.2 percent to 11.1 percent and 8.1 percent respectively.
“The results also showed that three banks’ tier one ratios [7.7 percent, 6.7 percent and 1.5 percent] fell below the regulatory minimum requirement of 10 percent in the scenario one,” said the report.
However, it said two of the three banks had their pre-shock tier one ratios below the regulatory minimum, which means that the two banks failed to meet the requirement under Basel II, the second of basel accord on banking regulations.
Under Basel II, the minimum regulatory capital requirements for total and core capital ratios are 15 percent and 10 percent, respectively.
But the RBM report said over the review period, capital for the banking sector remained adequate, despite slight decreases from the previous levels.
Core capital ratio stood at 14.3 percent as at end September 2014 compared to 14.8 percent in March 2014. Similarly, the total capital ratio against risk weighted assets decreased to 17.5 percent as at end September 2014 from the March 2014 position of 18.3 percent, said the report.
RBM said the decline in the capital ratios was on account of higher growth in risk weighted assets of nine percent compared to growth of 5.6 percent and 4.4 percent, in core capital and total capital respectively.
RBM Governor Charles Chuka said generally the country’s financial system was “sound and stable” during the review period, based on macroeconomic, financial system and payment systems infrastructure developments.
“Domestic macroeconomic developments were supportive of financial system stability. Nonetheless, inflationary pressures remained high over the review period. The banking sector remained stable over the review period,” he said in a foreword to the report.
The report has predicted a favourable outlook for Malawi’s financial system stability premised on strong growth prospects.