Our lowest-loss financing carries our largest rate risk

Every Malaysian bank with a retail franchise knows the appeal of salary-deduction personal financing. A public-sector employee borrows for a car repair, a child's education or a family event, and the instalment is deducted from the salary before it reaches the borrower's account. Default is rare, because the payment arrives before the borrower can choose to spend it elsewhere. At Sejahra the book was RM7.4 billion at the end of 2021, more than a quarter of everything we had lent, and its annual credit cost was a fraction of what our SME portfolio produced.

I have spent the last five years arguing that this book is misunderstood, and the misunderstanding is not about credit. It is about time. Most of this financing is written at a fixed profit rate for terms of up to ten years. Most of the deposits that fund it are commodity murabahah term deposits that reprice within twelve months. A bank that holds a large fixed-rate book against short funding has taken a position on rates whether or not anyone decided to take one. Our credit reports describe that book as our safest asset. In rate terms it was our largest exposure.

Why the credit committee loves this book

The affection is earned. Salary deduction removes most of the borrower's discretion over repayment, and public-sector employment is stable. When repayment moratoria ended after the pandemic, these cohorts returned to normal behaviour faster than any other part of our portfolio. Product teams like the book because it is simple to sell through branches and employer relationships. Finance teams like it because it produces steady income with almost no provisioning drama.

The difficulty is that every committee which reviews the book asks the questions it was designed to ask. The credit committee asks whether borrowers will repay, and the answer is yes. The product committee asks whether pricing is competitive, and it usually is. Nobody in that chain asks what happens to the bank's earnings and value if the deposits funding a ten-year fixed asset cost 125 basis points more next year. That question belongs to the asset-liability committee, which tends to see the balance sheet in aggregate and rarely sees a product team's pricing sheet until after the rates are published.

In January 2022 our measure of value sensitivity showed that a parallel rise of 200 basis points would reduce the economic value of our equity by 17.8 per cent of Tier 1 capital. The salary-deduction book accounted for most of that figure. The overnight policy rate had been at 1.75 per cent since July 2020, and many colleagues reasonably believed it would stay low. Some argued that a rate rise would also lift the yield on our floating-rate home financing, which was true, but it did not help the fixed book, and it did not help our equity value.

What the margin report leaves out

Most banks measure rate risk in two ways, and most boards see only one of them. The first is earnings sensitivity: how much net financing income changes over the next twelve months if rates move. The second is economic value sensitivity: how much the present value of all future cash flows from assets and liabilities changes. A long fixed-rate book can look tolerable on the first measure, because only a slice of it reprices in any year, and alarming on the second, because the whole of its future income is now worth less against funding that costs more.

Our monthly margin report showed the first view, broken down by product. It showed the salary-deduction book earning a healthy spread over the cost of funds in the month. It did not show that the spread was locked for years on the asset side and open on the liability side. Directors reading it could fairly conclude that the book was both safe and profitable. It was safe from default. Its profitability depended on a rate view that nobody had written down.

We changed three things. We hedged RM3.0 billion of the book with Islamic profit rate swaps, documented under a master agreement our Shariah Committee had approved, and applied hedge accounting so that the instruments did not create volatility in reported profit. We raised pricing on new financing by 40 basis points and cut the maximum tenor from ten years to eight. And we added a value-sensitivity column to the product report, so that any committee looking at the book sees its rate position beside its credit performance.

The policy rate rose by 125 basis points between May 2022 and May 2023. Our net financing margin fell from 2.34 to 2.18 per cent; our unhedged projection had shown 2.02 per cent. Value sensitivity fell to 9.6 per cent of Tier 1. The cost was real: about RM19 million of carry in the first year, roughly RM1.1 billion of new financing we did not write, and some public-sector customers who went to banks still offering ten years. When the rate was cut to 2.75 per cent in July 2025, the swaps began to cost us carry again, which is precisely what insurance does in a year without a fire.

Questions a risk committee should ask

I do not argue that banks should stop writing fixed-rate salary-deduction financing. It serves borrowers well, and borrowers value the certainty of a fixed instalment. I argue that it should be priced and governed as what it is: a credit asset with low loss and a funding commitment with long duration. A director does not need a treasury background to test whether a bank has done that.

The first question is how much of the bank's value sensitivity comes from a single product, and whether the committee that approves that product's pricing ever sees the figure. The second is what share of the book is hedged, at what cost, and on what view of rates the unhedged share is being held. The third is whether new pricing reflects the cost of funding the full tenor or only the next year's deposit rate. The fourth, for an Islamic bank, is whether hedging instruments are documented and approved in a way the Shariah Committee is comfortable with before they are needed, rather than in a hurry after the policy rate has moved.

None of these questions is exotic. They are simply asked in the wrong room. The credit committee asks about borrowers; the asset-liability committee asks about the balance sheet; and the book sits between them, admired by both and owned by neither. My recommendation is to give it an owner who must answer both kinds of question in the same paper.