MALAYSIA may have a set of well-capitalised banks but it has to watch out for non-performing loans (NPLs), particularly in the real estate sector.
NPLs in the real estate sector provide "poor indicators" and imperfect warnings ahead of a crisis as they are pro-cyclical - they drop in good times and they soar during the bad times, warned Lord Adair Turner, former chairman of the Financial Services Authority of UK.
Turner, who is senior fellow of the Institute for New Economic Thinking, was responding to questions raised during World Capital Markets Symposium, here, yesterday.
Minister in the Prime Minister's Department Datuk Seri Wahid Omar who raised the topic, said Malaysian banks have high core equity issues while the financial system continues to enjoy low NPL level measuring below two per cent for the household sector.
Turner responded that having high core equity issues is important as well as capitalised banks.
"The worst thing that can happen in a cycle is when they become poorly-capitalised, then they won't be able to lend and there is a supply and demand constraint in post-crisis lending."
But an "over extension" of credit in the real economy, an asset bubble cycle, post-crisis demand problem, deleveraging and low investment could still take place, he added.
"You should pay attention to the threats of leverage independently if they could threaten the banking system."
On the high household debt to GDP ratio, which stands at 80 per cent for Malaysia, Turner said Bank Negara Malaysia was right to tighten the loan-to-value ratio rules.
But I will consider the loan-to-income ratio as well, he said.
UK had household debt issues, too, and in the case of Ireland, Spain and the United States, the ratio rose to the 95 to 100 per cent bracket, providing more problems post-crisis.
With most analytical comments in the markets post-"asset bubble" burst, Lord Turner said it would be appropriate to develop a theory that overtly say there are bubbles and to prick them before they burst.
"Where there are asset bubbles combined with credit, that is a noxious combination, I think we got to look for and analyse them and then use a combined tool kit."
By combined tool kit, he said a preemptive interest rate advice is insufficient as interest rate elasticity of response is varied across the economy.
"You cannot do it by interest rate alone, you need to use macro prudential measures such as counter-cyclical capital and loan-to-value ratio limits."
While most central banks and regulators would be terrified by the responsibility to do so, he said it would be easier to construct such a theory.
It is important not to get into an "overleveraged" crisis as what the advanced economies went through as it would end up on a "deleverage" side, where countries have to face a "second best" arena, having to choose an imperfect policy.
In comparison, the US has been better at managing its private sector leverage compared with the eurozone or the United Kingdom, he added.
The world's largest economy found its private debt-to-GDP ratio rise from 70 per cent in 1945 to 300 per cent in 2007 while in the case of UK, the figure rose from 16 per cent in 1964 to 94 per cent in 2008.