Asia Pacific banks' outlook dims as uneven recovery impacts asset quality and profits

The COVID-19 crisis has plunged the world into a recession that World Bank Prospects Group Director Ayhan Kose described as “singular in many respects and is likely to be the deepest one in advanced economies since the Second World War and the first output contraction in emerging and developing economies in at least the past six decades”.

However, with the approval and start of COVID-19 vaccine distribution and inoculation at the end of 2020, the prospective end of the pandemic or at least the effective control of it, is finally within sight. After almost a year of disruption and slowdown, more sustained economic recovery may now start.

Ayhan Kose,

Director,

World Bank Prospects Group

Helen Qiao,

Head of APAC Economics,

Bank of America Global Research

Ayhan Kose, Director, World Bank Prospects Group

This suggests that 2021 may likely be a better year than 2020, from both a public health as well as an economic and financial system recovery perspective. This is especially likely when it can be sustained by strong national fiscal and monetary policies as well as coordinated regional trade enhancement measures that will provide financial relief and stimulus to drive growth and employment in the region.

A good example is the Regional Comprehensive Economic Partnership (RCEP) signed by the 10 member countries of ASEAN, Australia, China, Japan, New Zealand, and South Korea.

Helen Qiao, head of APAC Economics at Bank of America Global Research expects the RCEP to open a new window for more comprehensive regional supply chain over the medium-term and set the stage for closer regional economic integration. All members would benefit from lower trade barriers and strengthen their participation in the regional value chain.

She added, “In particular, we expect trade with China and ASEAN around intermediate goods and final goods to further accelerate with the ratification of RCEP, in addition to ASEAN being China’s largest trading partner as of first half of 2020. At the same time, RCEP could also accelerate separate bilateral/multilateral free trade agreement (FTA) procedures within the bloc such as China-Korea-Japan FTA.”

Helen Qiao, Head of APAC Economics, Bank of America Global Research

Moreover, historical low interest rates as a result of quantitative easing and economic stimulus measures combined with a number of effective coronavirus vaccines point to the start of the regional recovery process.

Uneven recovery weakens outlook for banks in APAC

However, recovery in Asia Pacific (APAC) will be an uneven K-shaped one where some sectors of the economy less affected by COVID-19 will recover and grow faster than others. Wealthier economies with lower debt burdens, higher per capita income and the resources to stimulate growth in these sectors may also recover faster than others.

Uneven economic recovery in APAC means that banking systems in the region will also recover at different speeds, while problem loans will increase moderately.

Moody’s Investor Services expects gross domestic product (GDP) to contract or significantly slow in 2020 in APAC economies, followed by recovery in 2021 that will generally result in GDP remaining below its pre-pandemic level. It projected that India, Thailand, Hong Kong and the Philippines will face the most significant GDP contraction in 2020, while China will be among the few countries that will avoid a recession thanks to ongoing policy support and decisive measures to contain the coronavirus outbreak. Vietnam’s economy will also fare better due to early containment of the outbreak.

“As such, asset risks for banks will grow substantially. Loans that will deteriorate the most in quality include unsecured personal loans, vehicle loans and loans to small and medium sized enterprises (SME) and large corporates active in industries disrupted by the pandemic the most, such as transportation, hospitality, leisure, retail and some commodities,” remarked Moody’s senior credit officer for financial Institutions, Eugene Tarzimanov.

Eugene Tarzimanov,

Senior Credit Officer for Fnancial Institutions,

Moodys

Jonathan Cornish,

Head of APAC banks,

Fitch

Eugene Tarzimanov, Senior Credit Officer for Fnancial Institutions, Moodys

Banks in India and Thailand will see the largest increases in NPLs due to the greater severity of economic shocks to their economies and the historically poor performance of certain loan types, such as SME loans in Thailand.

Non-performing loan (NPL) growth will be the mildest in South Korea, Japan and Vietnam. This is partly because economic damage has been less significant in the case of South Korea and Vietnam, while traditionally strong underwriting practices are paying off for Japanese banks during this downturn.

Banks’ profitability will take a hit from increases in credit costs and contraction of margins

Moody’s forecasts the impact of the pandemic will amplify rises in credit costs and declines in net interest margins that had been underway before the crisis began. As a result, banks’ profitability, as measured by return on total assets (ROTAs), will deteriorate significantly across APAC in the coming years. Credit costs will increase the most at banks in Thailand, India and Indonesia which already had the highest credit costs in APAC before the pandemic. It says that nearly half of rated banks in Thailand and India are likely to make annual net losses during 2020-2022.

At the same time, revenue generation will weaken due to decrease in interest rates across APAC and a flattening of yield curves that makes it more difficult for banks to profit by borrowing short term at low rates and lending long-term at higher rates.

“We estimate that APAC banks’ preprovision income will decline 5%-10% in 2020 from 2019 before recovering modestly in 2021-2022. The combination of higher credit costs and lower revenue will drag down APAC banks’ average ROTA by about 50 basis points by 2022 from 0.9% in 2019. At the onset of the coronavirus crisis, banks in Indonesia had the highest average ROTA, while those in Japan and India had the lowest. The stronger a bank’s profitability, the better its first line of defence against credit losses, which explains why Indonesian banks have the highest capital ratios,” said Tarzimanov.

He added, “Key variables for our projection are when banks will recognise new NPLs and how actively they will book lifetime expected credit losses (ECL) under IFRS 9, except in Japan, India, Vietnam and Bangladesh, which have not adopted the accounting standard. Regulators in many APAC economies have allowed the banks to create ECLs gradually, which should smoothen the impact of higher provisions on bank earnings”.

Delays in asset quality recognition add to profit headwinds

Fitch Ratings (Fitch) expects further assetquality deterioration to be manifested in loan reclassifications, including impaired and higher loan-loss provisions, if not already provided for pre-emptively or written off. Impaired loans could rise to recent highs, but without significant spikes in most APAC emerging markets in 2021.

“Risks are greatest for borrowers in vulnerable sectors like those associated with tourism, retail or commercial property. SMEs, which can span many sectors, tend to be most vulnerable to economic volatility. Moreover, emerging markets remain exposed to relatively high levels of SME loans, but often also benefit from support in stressed periods (eg state guarantees or policy bank lending). Relief measures have further reduced transparency around asset quality, which was already opaque pre-pandemic in China, India and Vietnam, such that we often adjust problem-asset metrics,” commented Jonathan Cornish, head of APAC banks at Fitch.

Jonathan Cornish, Head of APAC banks, Fitch

Beside the impact of a deterioration in asset-quality, banks’ profits will also come under pressure in the next few years from continuing economic volatility, lowerfor-longer interest rates, higher leverage damping loan demand, rising investment costs and competition.

Capitalisation to remain strong

Among the emerging market banks, capitalisation and leverage level will continue to be sustained in Indonesia, the Philippines, and Thailand –from improvement in profitability that will create adequate lossabsorption buffers. However, challenges to keeping capital levels above minimum regulatory requirements will be greater in India, China, Vietnam, and Sri Lanka.

Government support can be expected in India and China – particularly for stateowned and systemically important banks. “We also expect liquidity to be most stable for the largest banks in each system, but risks becoming more stretched for smaller, faster-growing banks where deposits may not keep pace with asset growth,” said Cornish