Housing bubble, affordability and credit risk to banks: a Malaysian perspective

Abstract

The continued rise in house prices has sparked increasing interest in housing affordability in Malaysia. Middle-income-earning buyers, who fear that house prices may increase to a level beyond their future financial capacity, took on excessive leverage and overextended their current financial capacity. This increases their probability of default, which is unfavourable to the banking industry providing these mortgages. This study examined the impact of rising house prices on housing affordability in three urban regions in Malaysia and found that house prices in these cities, especially landed houses, were unaffordable for middle-income-earners. This study also examined the impact of a collateral valuation loss to the banking system from the potential decline in house prices, by employing a solvency stress test. The study found that the banking system remained fairly capitalised to survive a mild single-risk factor financial shock of the equivalent of house price declines in the 1997 Asian Financial Crisis.

Keywords:

• Housing affordability
• mortgage
• credit risk
• solvency stress test

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Refer to Appendix 1 for detailed view on house price movements.

2 Housing affordability can be differentiated between normative and behavioural frameworks. For brevity, we only discuss the normative framework.

3 “Pangloss values” refer to high returns expected by banks in ideal circumstances. This situation may arise as competition from over-guaranteed but under-regulated banks base investment decisions on a project’s return in ideal circumstances, not its expected return (Krugman 1998).

4 Residential property values in the Klang Valley fell by about 12–15%, while less desirable locations faced a 20–30% decline in value (Bacha 1998).

5 The SMHI of Klang Valley is the average state median household income of Selangor and Kuala Lumpur.

6 HAI = 1.04, 70%:30Y

7 HAI = 0.48, 70%:35Y, HAI = 0.36, 70%:20Y

8 HAI = 0.80, 90% LTV:20Y

9 HAI = 1.06, 90%:35Y and HAI = 1.02, 70%:20Y

10 HAI = 0.98, 70%:20Y

11 HAI = 0.97, 90%:20Y

12 HAI = 1.10, 90%:25Y, HAI = 1.03, 85%:20Y

13 HAI = 1.04, 90%:35Y, HAI = 1.34, 70%:35Y and HAI = 1.00, 70%:20Y

14 HAI = 0.97, 90%:35Y and HAI = 0.96, 70%:20Y

15 HAI = 0.78, 90%:20Y

16 HAI = 1.00, 70%:20Y and HAI = 1.04, 90%:35Y

17 One-third of household income

18 AFFORD_{burden(4.50%;90%)} = 34%

19 AFFORD_{income(4.00%;90%)} = RM4,408, AFFORD_{income(4.50%;85%)} = RM4,449

20 AFFORD_{burden(4.00%;90%)} = 44% and AFFORD_{burden(4.50%;70%)} = 35%

21 AFFORD_{burden (5.00%;70%)} = 34%

22 AFFORD_{income(4.50%;90%)} = RM7,768

23 AFFORD_{burden(4.00%;90%)} = 32%, AFFORD_{burden(4.50%;85%)} = 32%

Additional information

Notes on contributors

Alex Kae Lun Lee

Dr. Alex Kae Lun Lee is a recent PhD graduate from Monash University Malaysia. He has 4 years of teaching experience with the same institution but is currently employed in a leading international bank, where he has taken on a strategy role. Dr. Alex's research interests include bank risk management and bank capital regulation.

Jothee Sinnakkannu

Dr. Jothee Sinnakkannu is an Associate Professor of Banking and Finance in Monash University Malaysia. He has over 35 years of experience in academia and had supervised 7 PhD students in the field of banking and finance. Dr. Jothee authored and co-authored papers in high-ranking journals in the areas of foreign exchange risk management and green technology financing. He currently specialises in international banking, investment risk management and Islamic banking.

Sockalingam R. Ramasamy

Dr. Sockalingam R. Ramasamy is a Lecturer of Banking and Finance in Monash University Malaysia. A senior banker turned academic lecturer, he has 32 years of experience in the bank from which he retired from a top management position. Dr. Sockalingam now have a decade of experience in academia and focuses his research on bank risk management and digital currencies.