Rich debt, poor debt: assessing household indebtedness and debt repayment capacity

In this study, we explore the relationship between the debt service ratio (DSR) and individual borrowers’ ability to withstand shocks in Malaysia. Using a micro-level dataset that matches borrowers’ debt and income, we quantify the financial resilience of individual borrowers and subsequently simulate a model of loan default and credit losses in response to generated financial and economic shocks on debt repayment, cost of living and variable income. The simulation allows us to differentiate the sensitivity of borrowers in different income segments to each shock and estimate the banking system’s exposures to borrowers who are more likely to default. The observations and findings could contribute towards the formulation of more targeted policies to manage household indebtedness in Malaysia. The results show that, in the pre-shock scenario, borrowers across all income groups are more likely to have a negative financial margin if their DSR is above 60%. However, for borrowers in the bottom 40th percentile income group, some borrowers with a DSR of less than 60% also recorded a negative financial margin. In the post-shock scenario, borrowers across all income groups are more likely to have a negative financial margin if their DSR is above 40%. On aggregate, borrowers are most sensitive to an income shock, particularly those in the middle income group.