The industry-wide stress test (IWST) assumes two macroeconomic scenarios: a central one and an adverse one.
In the adverse scenario, banks are tested for intensification of geopolitical conflicts and trade tensions that exacerbates supply chain and trade disruptions for three years. The scenario assumes a quick succession of supply shocks reignites inflationary pressures, forcing major central banks to respond with tighter monetary policies. The global economy slips into a deep and protracted recession causing a pull back in investment, and depressed consumer sentiment.
The scenario takes into account a deterioration in outlook for the highly-leveraged commercial real estate (CRE) sector in major economies and significant declines in CRE prices.
In Singapore, the domestic systemically important banks’ (D-SIB) profitability would be adversely impacted by declining non-interest and net trading incomes. But net interest incomes would increase due to widening net interest margins (NIMs) in the high interest rate environment, with lending rates rising faster than deposit rates, according to the MAS’s stress test.
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Under this adverse scenario, the Singapore economy enters a recession amid weak external demand, rising commodity prices and elevated interest rates. A global recession leads to a sharp downturn in the external-facing sectors. Singapore banks face elevated market and funding liquidity risks via their extensive cross-border interlinkages.
MAS also conducted a cross-border interbank network analysis to assess first- and second-order contagion impacts on the Singapore banking system. The simulations show that banks have adequate capital buffers to cushion the additional impact arising from key contagion transmission channels (i.e. counterparty country banking system defaults, funding liquidity stresses, and fire sales of assets). “MAS will continue to refine its stress testing capabilities to ensure that stress tests remain relevant as a tool for risk assessment and management,” the FSR 2024 says.
The adverse scenario assumes that common equity tier 1 (CET1) capital adequacy ratio (CAR) for the D-SIBs would level-off at 9.8% in Years 1 and 2, and remain above MAS’ combined CET1 and capital conservation buffer (CCB) requirement of 9.0%. Each D-SIB’s CET1 CAR is also projected to remain well above the minimum CET1 regulatory requirement.
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The Bank of America report dated April 8 uses three scenarios to stress test earnings per share (EPS). In scenario 1, loans fall by 5% y-o-y, and EPS by 10%. This is highly likely, BofA says. In scenario 2 loans fall by 5%, but Sora falls to 1%. DBS is the most sensitive to rate cuts. In this environment, EPS declines by 20%. Scenario 2 would imply DBS’s valuation at 1.4x P/B and UOB/OCBC at 1.0-1.1x
In scenario 3, loans fall by 5%, but there are deep rate cuts and higher credit costs. EPS declines by 30%. “This would likely mean credit costs move above cycle averages (up to 20 bp and higher). DBS is probably better placed on credit costs given lower Asean onshore exposure,” the BofA report says. Scenario 3 would imply DBS at 1.2x P/B compared to 1.7x as of April 17, and UOB/OCBC at 0.8x versus 1.24x currently, BofA calculates.
”The macro-outlook has rapidly become too uncertain for us to change our earnings estimates yet. We could see further 10-15% cuts in a deep stress scenario if asset quality also worsens meaningfully. Dividend expectations might also come under risk if the macro-outlook worsens materially,” the BofA report says.
“On the OCBC side, we also do our own stress test, and it's almost like the religious process. We have armies of CFAs, we have armies of financial people, accountants, calculating all these numbers, for a one in 10 stress scenario. This process is done yearly and is audited,” chairman Lee assured shareholders.
“We have enough capital to cater for all these events, all these stress tests, all these challenges, by market events, and enough capital to grow, to invest, and in the case of the bank layer, sufficient for positioning. We are big listed company.”
