FINANCIAL institutions are well-positioned to absorb the potential deterioration in asset quality, given their strong reserves and capital position.

“We do not expect the banking system’s non-performing loans (NPLs) to rise to the high double-digit rates of 18.5% that was seen in the 1997 Asian financial crisis,’’ said Lee Heng Guie, chief economist at CIMB Securities.

One potential red flag could be household indebtedness which is on the relatively high side. Lee noted that the substantial reduction in interest rates would help relieve the repayment capacity of households.

However, the debt to gross domestic product (GDP) had improved to 66.7% at the end of 2007 from 69.3% at end-2006. Households’ financial assets are 2.2 times over debt.

Lee reckons the potential deterioration in asset quality in the residential property sector should remain manageable in the absence of a broad-based property price bubble. Also, retail loans are smaller in size and mostly secured by collateral.

Lee pointed out the corporate sector balance sheet was healthy, with the net gearing ratio coming down to 18.5% from 62.8% in 2001. In 1997, the total banking system loans to GDP was at 145.1% and that has dropped to 102.9% currently.

Ching Weng Jin, acting head of research at ECM Libra, added that loans to deposit ratio was close to 100% in 1997. The NPL ratio even before the crisis was already high and coverage ratios were significantly lower than they are today.

Now, coverage ratios (total provisions over NPLs) are at 334% while loans-deposit ratio is at 74%, indicating that the banks are not as over-stretched as before.

According to Julian Chua, senior banking analyst at Citigroup, the base case was that this NPL cycle would not be as severe as the 1997 crisis when GDP contracted 7.4%. “For the current downturn, we expect GDP to decline 1.5%,’’ Chua said.