Growth constraints pose challenge for AsPac banks

MANILA, Philippines - Standard & Poor’s Ratings Services (S&P) is forecasting the profitability of Asia-Pacific’s banks to remain constrained in 2014.

Nonetheless, the international credit rating agency’s outlook on 71 percent of Asia-Pacific bank group ratings are stable, although the rating of banks in Japan, Malaysia and India are inclined on the downside.

“However, we do not necessarily expect negative economic trends to translate into rating downgrades; in Australia, for example, our outlooks on almost all rated financial institutions are stable,” it said in a report.

Challenges across the region include pressure due to intense competition that will squeeze net interest margins, loan growth will become subdued because households and the corporate sector in some countries are already highly indebted, and credit costs will likely rise.

Swelling property prices and household indebtedness in some systems have led to economic imbalances that have exposed banks’ loan quality to external shocks.

A sharp rise in interest rates, an economic slowdown beyond our downside scenario, and a plunge in property prices are key risk factors.

“Despite ongoing constraints on asset quality and earnings, we see the financial profiles of Asia-Pacific banks remaining sound overall and broadly consistent with our current ratings and outlooks. We believe adequate capitalization, strong liquidity, and government support will continue to underpin our ratings on most Asia-Pacific banks,” S&P said.

Meanwhile, a hard landing in China would lead to significant negative spillover effects for the economies and banking sectors in China, Indonesia, Japan, Korea, Taiwan, and Hong Kong. China is the most important trading partner for those countries, and a hard landing in China would lead to recessionary conditions in these countries that could severely hit the asset quality of their banks.

Hong Kong banks have relatively high direct exposure to China and would thus suffer significant credit losses on those loans. New Zealand and Indonesia would be adversely affected through collapsing commodity prices in not only a hard-landing scenario but also in a general economic slowdown.

By contrast, the banking sectors in the Philippines and India would be less affected because of these countries’ low dependence on exports to China.

S&P said that non-performing loan (NPL) ratios have risen modestly in the banking systems of China, Korea, Vietnam, and elsewhere, and loan quality is seen to keep eroding and credit costs to continue rising in 2014.

“Despite our forecast for slightly better GDP (gross domestic product) growth of 5.4 percent in 2014, still-fragile conditions in key economies including the eurozone (European Economic and Monetary Union) and emerging countries continue to weigh on growth in Asia-Pacific, which is susceptible to a slowdown in global trade. We expect GDP growth in China to slow to 7.4 percent in 2014 from 7.6 percent in 2013, which is lower than the 9.5 percent annual average of the past 20 years,” the global agency said.

For banks in Australia, New Zealand, Singapore, Hong Kong, and Malaysia, a plunge in real estate prices is a key risk factor because home loans and real estate-related loans account for about 30 percent to 50 percent of bank lending. A price decrease of 20 percent to 30 percent would inevitably hurt banks’ asset quality.

A spike in interest rates could trigger corrections in property markets, with a likelihood of a rise in interest rates in the Philippines and Indonesia.

In Singapore, where housing prices have increased sharply and affordability has dropped, moderate correction in prices is seen this year.

In general, banks have fixed-income portfolios that include government bonds whose values will decline as interest rates rise. Reduced unrealized gains in fixed-income portfolios may have minimal material impact on banks’ financial strength, except that of Japanese banks.

S&P said that Asia-Pacific banks generally have high levels of core capital, and the level of regulatory common Tier 1 capital of major banks in the region compares favorably against global peers.

“We expect adequate capital to serve as a cushion to absorb unexpected credit costs and sustain the ratings. The risk-adjusted capital (RAC) ratios of most large Asia-Pacific banks are higher than seven percent and close to our threshold for adequate capitalization,” it added.