If bank health is anything to go by, then the theory that Asia has decoupled from the US and Europe seems to be sound. While US and European regulators have been busy stress-testing their banks, Asian banks continue to outperform.
Asia bounced back quickly after the financial crisis, and the overall health of the region’s banks – and, consequently, their ability to lend – has played no small role in this.
“Overall, Asian banks and banking systems are in pretty good health and, perhaps, the best measure of that is Fitch’s individual ratings, with many ratings of C or above,” said Brett Hemsley, head of Fitch Ratings for Asia Pacific. “A ‘C’ rating or better means the key metrics of a bank are ‘adequate’, such as capital, asset quality, funding, liquidity, etc, and, therefore, are able to absorb future shocks in the operating environment.”
Low funding cost is one reason for the health of Asian banks. In most emerging markets, banks benefit from an excess of deposits over loans because these countries have high savings rates, which reduces banks’ dependence on wholesale funding markets. India, Taiwan, Indonesia and Malaysia are good examples of this.
However, while the headline measures of bank health look rosy for now, the medium-term outlook for lenders in some jurisdictions is more complex.
China’s banks, for instance, look good on a reported basis. They are profitable, enjoy low funding costs and, in many instances, have double-digit capital adequacy ratios. So, they could hardly be considered stressed. However, there are indications that stress is building up in the system. The biggest concerns revolve around the impact of rapid loan growth on asset quality.
Loan growth at Chinese banks has been running at 20%–30% in recent years, and directed lending was the primary means of channelling the Chinese Government’s fiscal stimulus to the economy.
“Chinese regulators have now taken steps to slow lending growth, especially to overheating sectors, such as the property sector, but, while this is a step in the right direction, loan growth remains significant,” said Hemsley.
Loan growth is fine on its own and should increase profitability, but it also increases a bank’s capital requirements at a time when regulators and investors are becoming more focussed on Tier 1 capital. As a lack of capital is not a problem that can be rectified quickly, it is likely that many Chinese banks will need to raise Tier 1 capital over the next 12–24 months.
The pace of loan growth in recent years also means that an increase in non-performing loans is almost inevitable – the question is how big that increase will be. NPLs are not a problem right now, but many loans in China have balloon repayment structures. It is easy for borrowers, often even for stressed ones, to service interest payments alone, but things may look different when the time comes for principal repayments.
Chinese banks have also undertaken a decent amount of informal securitisation, much of which will have to be brought back onto balance sheets in the coming year and that, along with the rapid loan growth, will take the gloss off some of the impressive headline numbers.
There are also concerns about the quality of risk-weighted assets at Chinese banks, especially the large amounts of money lent to state-owned enterprises. These loans carry low risk weightings because of the borrowers’ state-ownership. However, in many instances, this is the sole basis for such a low risk weighting.
If medium-term concerns belie the headline quality of banks in China, the same cannot be said for those in South-East Asia. Indonesia, Malaysia and Thailand – all which took a hard hit during the Asian financial crisis just over a decade ago – have impressively strong banking systems.
“Indonesia, in particular, has a well-capitalised and very profitable banking system with net interest margins several times higher than most developed markets,” said Hemsley. “That is why foreign banks, notably from Australia, Singapore and Malaysia, are interested in having a presence there.”
Even banks in Thailand seem to have shrugged off the impact of the political instability that ravaged the kingdom earlier this year. While the kingdom’s banks are solid, there were concerns that political problems would harm the broader Thai economy and lead to deterioration in asset quality. Remarkably, just a few months on, the lasting economic impact of the political turmoil seems to have been minimal.
Taiwan is the notable exception to this generally rosy outlook. Taiwanese banks are certainly not stressed, but they are not very profitable either. Low profitability constrains loan growth and, because most banks have excess funds, they are eager to lend. So, banks do not have much pricing power over borrowers. Low profitability looks like an issue that is not going to disappear any time soon.
“Taiwanese banks, much like Japanese ones, suffer from a flat yield curve and low interest rates, so there is no profitable carry to be had from borrowing short and lending long. That makes it hard for banks to be profitable,” said Hemsley.
Nachum Kaplan