Thailand and Vietnam are the only two countries among nine emerging markets in Asia-Pacific where the rating outlook for banks is positive, according to a new report by Fitch Ratings.
The rating outlook is stable in the other seven countries surveyed: China, India, Indonesia, Malaysia, Mongolia, the Philippines and Sri Lanka. The overall banking sector outlook is stable in six countries but negative in China, India and Indonesia.
The sector outlook is stable for most Asia Pacific banking systems in both developed and emerging markets, Fitch said. However, most banks are increasing their risk appetite in response to pressure on profitability, while the outlook on four developed-market banking systems -- Australia, Hong Kong, Japan and Singapore -- is negative.
The negative outlook on Japan's banking sector reflects the growing difficulty for banks to boost earnings without taking extra risk, given the challenges to their business models and tougher overseas conditions, Fitch said.
Downside risk to financial performance has also increased in Australia, Hong Kong and Singapore, where common headwinds include weaker economic growth, lower interest rates and strong competition.
In the big emerging markets of China, India and Indonesia, asset-quality challenges are a major reason for the negative sector outlook. China and India are also under pressure to boost earnings and capital to support growth.
SOVEREIGN SUPPORT
Ratings, meanwhile, are more resilient than the direction of financial trends in 2020, with the vast majority of banks' issuer default ratings on a stable outlook. This reflects an assumption that the banks would receive sovereign or institutional support if needed.
"The most striking trend in recent years is banks increasing their risk appetite incrementally to support profitability in the face of lower interest rates, compression in net interest margins, softer growth prospects, strong competition and higher costs, especially in development markets," Fitch analysts wrote. "We expect this trend to continue in 2020."
Additional risk-taking is appearing in various channels, including expansion into riskier markets, higher loan concentrations in certain sectors, M&A, and holding higher-yielding investments. Banks are also raising their exposure to property, both directly and indirectly, via lending to non-bank financial entities.
Downside risk to ratings could increase if banks do not strengthen their loss-absorption buffers in line with this additional risk-taking, even though the implications may not become evident until the operating environment becomes less benign.
Fitch said it expected performance in the Thai banking sector to be broadly stable over the next one to two years, despite the relatively weak phase of the business cycle.
"Slower economic growth and muted business activity constrain upside prospects," it said. "Fiscal spending on infrastructure projects has been slow, and is only gradually supporting investment activity and credit growth."
The positive rating and sector outlooks are due to bank-specific factors, rather than improved sector performance overall. State-owned banks are on a positive outlook, mirroring the sovereign rating. Meanwhile, TMB Bank Plc (BBB-) also has a positive outlook as its profile is likely to improve meaningfully after its merger with similarly sized Thanachart Bank. On the other hand, Bank of Ayudhya (A-) has a negative outlook, driven by the outlook at its Japanese parent MUFG.
MARGINS SQUEEZED
Fitch foresees near-term challenges to earnings growth, with net interest margins constrained by sustained low interest rates, and weak fee income prospects due to economic conditions and stiff competition. Meanwhile, credit costs should remain substantial. However, many banks are investing heavily in digitisation to take advantage of future revenue growth channels, and to manage cost growth.
Pressure from new loan impairments is not expected to be significant, however. Loan growth has been limited, and central bank measures have reduced risk-taking in retail segments such as mortgages and unsecured consumer finance.
Asset-quality risks are mitigated further by high levels of excess provisioning, which also positions the banks for the new IFRS9 financial reporting standard due to take effect in 2020.
"Nevertheless, there is downside risk in banks' SME portfolios, should the government fail to maintain economic growth," Fitch cautioned.
To read the full report on Asia Pacific EM banks, visit https://bit.ly/386FINq