Asia’s strong banks labeled 'risky and opaque'

  • By Elizabeth Fry

Asia’s homegrown banks continue to grab market share from their big European and US rivals but face an increasingly harsh climate just when confidence in them is fading. 

The Asian banking sector can look back at an outstanding trajectory over recent years. The sector has expanded its size, measured in total assets, by about 70 per cent since the global financial crisis. 

And after banks in North America and Europe reduced their risk-weighted assets, Asian banks today account for 40 percent of total global assets, compared to 27 per cent in 2009. 

Accordingly, global banking profits have shifted towards Asia and the market capitalisation of Asian banks has grown substantially in recent years. Further, banks have achieved this top-line growth while maintaining an average return-on-equity above 10 per cent, clearly higher than US or European peers.
 

Urgent action

However, the road ahead looks much less predictable as growth is slowing down, according to Bernhard Kotanko, an Oliver Wyman Asia-Pacific partner.

“Past growth has pushed debt-to-GDP ratios into critical territory. Non-performing loans are rising and a stronger US dollar and looming protectionism are challenging global trade and capital flows,” he said. “As a result, metrics like net interest margins are coming under pressure and confidence in Asian banking has been dented.”

To keep growing and maintain ROE above 10 per cent, Asian banks have to take urgent action.

“Parts of Asian banking are currently seen as risky and opaque. Rightly or wrongly, perceptions sometimes turn into reality,” argued Kotanko.

Banks suffer from concerns over the quality and stability of their books, he said, because of high corporate and private leverage, rising bad loans in several markets and potential asset bubbles.

“While China is in the centre of the discussion, we are seeing similar trends in India, Indonesia, and other markets," he said. “While the current negative sentiment may be exaggerated and published bad loan ratios are at relatively low levels, the trend is still evident.”

Estimates of Chinese banks’ true non-performing loan ratio range from 5 to 20 per cent. As a result of the concerns, many Chinese banks are traded at price-to-book ratios of substantially below one in spite of good ROE levels. 
 

Greater transparency

To regain confidence, Kotanko advised Asian banks to proactively provide greater transparency over the quality of their balance sheets and tackle high leverage and bad debts head-on. The risk partner said Asian banks must design their international strategies amid a changing global political landscape.

“Global trade and capital flows are being challenged, but Asian commercial integration is continuing, fostered by bold initiatives such as One Belt, One Road," he said. “Foreign exchange markets have become volatile, and the renminbi’s growth as a currency for trade has slowed a bit.

"Some global banks are retrenching, and many Asian banks have the scale to fill the gaps left over – but they might be hesitant because of mixed experiences in the past.”

In his view, Asian lenders must seize selective international opportunities in four areas: they should serve intra-Asian trade and business connectivity; pursue select international businesses as others retrench; prepare to work with multiple currencies, especially the renminbi; and develop networks in the regional and global banking communities.

Importantly, the traditional funding and lending model is running out of steam.

“On a regional scale, growth has been fuelled by increasing corporate leverage, which led to a rise in private income levels. These, combined with the availability of plain-vanilla funding from high private and corporate savings ratios, have enabled banks to expand their balance sheets substantially," said Kotanko.

"However, leverage in many countries is reaching a level for concern, and funding from deposits is reaching a limit, as loan-deposit ratios have risen in many countries.”