More headaches for banks

More headaches for banks

Coronavirus complicates life for a sector whose performance indicators were already weakening.

Fitch Ratings has revised its operating environment mid-point score for Thai banks to bbb from bbb+, reflecting the significant pressures on the banking sector stemming from the coronavirus pandemic.

The ultimate trajectory and duration of the pandemic remains unclear, but Fitch believes that risks to economic growth and business activity are still skewed to the downside, as evident from the Bank of Thailand's latest forecast for GDP to contract by 5.3% in 2020. Our revised score already incorporates such a possible contraction.

The coronavirus pandemic comes at a relatively challenging point of the business cycle for Thai banks. The sector's performance indicators had already been weakening in recent years due to muted economic conditions, sustained low interest rates and competitive forces that reduced growth in fee income.

The outbreak has added considerably to these pressures, with the recently announced shutdown intensifying a macroeconomic slowdown that started late last year due to US-China trade tensions, delayed passage of the budget and drought. This will lead asset quality and earnings to be significantly worse than previous expectations.

Asset-quality metrics had been on a negative trend for many years, and the industry now faces a re-escalation of non-performing loan growth due to the pandemic. The repayment capacity of weaker borrowers would be particularly vulnerable to a prolonged economic downturn.

In Thailand, this includes small and medium enterprise clients, which account for about one-third of bank loans. Loan impairments among SME clients had been trending upward before the start of the coronavirus outbreak.

The retail client segment will also be affected, particularly non-mortgage consumer lending (about 16% of loans), if unemployment increases.

The Bank of Thailand has implemented several measures in response to the crisis. It has cut its policy interest rate to record lows, relaxed regulatory requirements to encourage debt restructuring in all client segments and provided liquidity support to financial markets.

These initiatives will help prevent an immediate jump in loan impairments, and they will be important in restoring confidence to domestic markets. But they will be unable to fully reverse the significant shocks caused by coronavirus-related disruptions to economic activity, which should be felt by the banks this year and next.

This weakened operating environment, alongside deteriorating asset quality and earnings, will also lead to pressure on banks' stand-alone credit profiles and ratings, including capitalisation through higher risk-weighted assets from credit migration.

Banks' credit profiles may be supported to some extent by their respective loss-absorption buffers. The sector's common equity Tier 1 ratio at the end of 2019 was 16%, and loan-loss allowance coverage was 145%.

Furthermore, many banks' issuer default ratings or national long-term ratings are driven by support from the sovereign or from higher-rated parents, rather than from stand-alone factors.

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