OREANDA-NEWS. Malaysia's banking system exposure to the troubled government development fund 1MDB is a manageable risk, says Fitch Ratings. The nation's banks have reasonably prudent lending practices that ought to limit the potential impact of a default by any single borrower.

There is uncertainty about the level of 1MDB's debt, while market estimates of an upper limit of around RM42bn (or just over USD11bn) appears manageable when compared with the size of the banking system. Some of the exposure could be sensitive to currency risk, although these estimates represent approximately 20% of system equity or 3% of loans. This forms an upper limit for the banks' exposure based on the estimates, since not all of 1MDB's debt is held by the domestic banks.

Actual direct risk to the banking system would be even lower, given that some of the exposure is either guaranteed by the Malaysia sovereign or collateralised in some way.

Adequate capitalisation and healthy profitability mean Malaysian banks are currently well-positioned to absorb a significant increase in credit costs; their risk management policies - including rules set by the central bank that limit lenders' exposure to any one entity - should be sufficiently robust to contain the fallout from a large but isolated default.

The issues at the highly indebted IMDB are idiosyncratic and not indicative of broader systemic risk, but its troubles add to the more challenging Malaysian operating environment in the near term. The build-up of household debt in the last few years may become a bigger medium-term challenge for the system if real credit growth is not contained and if economic volatility intensifies.

Recent commodity and financial market volatility has caused greater uncertainty over the nation's economic outlook, and the gloom was cited as a reason for the cessation of merger discussions between CIMB Group, RHB Capital and MBSB in January.

We believe that these risks should be manageable for the system without a prolonged economic downturn or significantly higher unemployment, as the government has attempted to address some of these issues with macro-prudential measures and tightened regulations in the past few years.