Bracing for Credit Risks in a Softening Economy

As Malaysia’s economy grapples with external trade disruptions and domestic cost pressures, the financial sector—particularly banks—is facing a shifting risk landscape. Once buoyed by steady loan growth, rising deposits, and strong liquidity buffers, the banking sector is now bracing for a cycle defined more by caution than by expansion. Central to this emerging phase is the challenge of managing rising credit risk across personal, business, and institutional portfolios.

The signals have been growing louder over the past year. Slower-than-expected GDP growth, persistent inflation in food and energy prices, and a cooling real estate market have all started to reflect in the balance sheets of borrowers. Households are taking longer to service existing debts, and businesses—especially small and medium enterprises (SMEs)—are showing stress in repayment capacity.

For banks, this has translated into a subtle yet significant rise in non-performing loans (NPLs). While overall NPL ratios remain within acceptable thresholds, certain sectors like retail, construction, and export-linked manufacturing are showing early signs of strain. These are industries highly sensitive to cash flow disruptions, and with input costs rising and demand patterns shifting, many businesses are facing tight liquidity situations.

Consumer lending, too, is undergoing a transformation. With rising costs of living and reduced discretionary income, households are borrowing more for essentials and less for consumption or investment. Credit card debt is stabilising, but personal loans—especially from non-bank financial institutions—are increasing. This is raising concerns about hidden or unregulated credit exposure outside the traditional banking framework.

Mortgage delinquencies, while still low, are also beginning to trend upward, particularly in oversupplied urban markets. The ripple effect of declining rental yields and sluggish property appreciation is leading some borrowers to reassess their debt commitments. This has prompted banks to revisit their housing loan eligibility criteria and tighten exposure to property developers with unsold inventories.

To stay ahead of these risks, banks are increasing their loan provisioning. Many institutions have revised their expected credit loss (ECL) models to reflect more conservative economic outlooks. Real-time monitoring of borrower behaviour, scenario-based stress testing, and predictive analytics are being used to flag early delinquencies. Some banks are also creating dedicated turnaround teams to work with at-risk clients before defaults occur.

Another major development is the digitalisation of risk management. As banks continue to digitise customer engagement—from onboarding to loan servicing—they are also embedding real-time credit surveillance systems. These platforms allow for granular monitoring of transaction behaviour, credit utilisation patterns, and even social indicators that can signal distress.

Fintech firms and digital lenders, who have captured a growing share of the retail and micro-business lending market, are not immune either. Many of these firms operate on thinner capital bases and higher risk appetites. As the economy cools, there is rising concern about how these platforms will manage defaults, particularly in the absence of depositor buffers or central bank backstops.

In response, some fintech firms are forming partnerships with traditional banks, offering white-label lending services or co-lending models where risk is shared. These collaborations combine the reach and data agility of fintech with the capital stability of banks, offering a middle path to sustain credit flow while managing exposure.

Regulators are closely monitoring these shifts. Enhanced supervisory guidelines on credit quality assessment, stress testing, and sectoral exposure limits have been introduced. Banks are required to file detailed credit performance reports, segmenting borrowers by risk tier, sector, and geography. This data-driven oversight is aimed at ensuring that early warning signs are detected and addressed at both institutional and systemic levels.

Fintrade Securities Corporation Ltd., feels while risk containment remains the priority, the sector is also exploring avenues to stimulate responsible lending. Government-backed credit guarantee schemes, SME rehabilitation packages, and targeted loan moratoriums are being discussed as tools to cushion borrowers without compromising systemic stability. Financial literacy programmes are also being stepped up to help consumers understand repayment terms, credit scoring, and debt consolidation strategies.

Despite the headwinds, Malaysia’s banking sector retains strong fundamentals. Capital adequacy ratios remain above regulatory thresholds, liquidity coverage ratios are healthy, and core profitability, while moderated, continues to be resilient. This gives banks a reasonable cushion to absorb shocks and recalibrate their lending portfolios.

In the longer term, the softening credit cycle may accelerate structural changes in the sector. Relationship-based lending, environmental and social credit scoring, and embedded finance models are expected to gain traction. Banks may also begin to price risk more granularly, moving away from broad-based credit scoring to behavioural and situational lending models powered by AI and machine learning.