Asian Banking and Finance (April-June 2015)

DISPLAY TO JUNE 30, 2015

Customisation in

cash management maybank & anz on providing customised solutions to corporate clients

from brick-and-mortar

to click-and-mortar indonesia’s megabank

merger muddle banking tech report:

dbs & cimb on IT investments financial insight Asian appetite for M&A deals to be stronger in 2015

analysis APAC banking sector outlook: Six shape shifters

COUNTRY REPORT Chinese banks to suffer from thinner NIM

PEOPLE PROFILE National Australia Bank’s Christy Tan

PAge 18

PAge 30

PAge 20

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C2 SINGAPORE BUSINESS REVIEW | JANUARY 2014

FROM THE EDITOR In this issue, we talked to bankers and analysts to find out what trends are shaping Asia’s Cash Management landscape. With Asian corporates facing a minefield of regulations that force them to provide a large amount of data, banks are often called for to act as creative guides.

Banks are then expected to provide clarity and propose customised solutions that will meet a corporate client’s increasingly complex needs.

Publisher & EDITOR-IN-CHIEF Tim Charlton production EDITOR Roxanne Primo Uy Editorial Assistant Joana Rizza Bagano ADVERTISING CONTACTS Rochelle Romero rochelle@charltonmediamail.com

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Meanwhile, in the Banking Technology front, non-bank entrants remain to be significant players in the payments space. But despite the more daring offerings of these ‘FinTechs,’ analysts believe banks are still better positioned to be the leaders due to their large client databases, relationships, and the privilege of access to larger institutional clients.

We also looked into the latest trends and challenges faced by the Chinese banking sector and found out that banks are predicted to suffer from thinner net interest margins. But if China banks are unhappy at the prospect of leaner bottom lines in 2015, they can find some comfort in the fact that this could be a catalyst for better asset quality and higher share prices.

Find out more about Indonesia’s megabank merger muddle, Taiwan banks’ consolidation concerns, Singapore’s ‘stagnating’ wealth management sector, and more as you flip through the pages.

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ASIAN BANKING AND FINANCE | JUNE 2015 1

CONTENTS

REPORT IN ASIAN CASH MANAGEMENT, CUSTOMISATION IS NOW KING 26 SECTOR

ANALYSIS

06 Indonesia’s megabank

12 Is Singapore a ‘stagnating’

wealth centre?

07 Asia rallies behind RMB use

14 Why Asian banks must move

08 Consolidation not the answer for

from brick-and-mortar to click-and-mortar

Taiwan banks

08 Asian banks now more

conservative in raising salaries

10 Banks struggle to keep up

28

sector report Banks urged to make digital services accessible

FIRST

FIRST merger muddle

24

ANALYSIS HONG KONG BANKS AT AN INFLECTION POINT

16 HSBC braces for another

hammering in 2015 as profit pains persist

30 APAC banking sector outlook:

Six shape shifters that may reset the region’s course

COUNTRY REPORT 20 Chinese banks to suffer from

thinner NIM as the central bank’s rate cuts take effect

with more daring third party payment firms

Published Bi-monthly on the Second week of the Month by Charlton Media Group Pte Ltd, 101 Cecil St. #17-09 Tong Eng Building Singapore 069533

2 ASIAN BANKING AND FINANCE | JUNE 2015

For the latest banking news from Asia visit the website

www.asianbankingandfinance.net

News from asianbankingandfinance.net Daily news from Asia most read

retail banking

ASEAN banks still likely to outperform despite headwinds While most of the ASEAN region is seeing an economic slowdown, some of the ASEAN banking sectors have the potential to outperform because of the change in the direction of interest rates. Nomura specifically believes Singapore and Indonesia banks will benefit from the interest rates changes.

retail banking

Is India’s banking sector nearing recovery?

Revival in private sector investments and credit growth, and a reversal in the trend of rising nonperforming loan ratios for India’s banks is likely to take time.

S&P says this is despite improving operating conditions for banks.

4 ASIAN BANKING AND FINANCE | JUNE 2015

foreign exchange

Asian countries that are fuelling RMB internationalisation When it comes to handling global payments in RMB, Hong Kong still takes the lion’s share with over 70% of the market by value.

According to SWIFT, over the last two years, however, an additional set of countries have given chase, gradually increasing their share to 25% in February 2015.

retail banking

Korea’s financial regulator keeping hands off banks’ loan pricing The new head of Korea’s Financial Supervisory Commission (FSC), JongRyung Lim, noted that the financial regulator will not intervene on banks’ loan pricing, fee structures, and dividend pay-out ratios, according to Maeil Business.

retail banking

Thai banks’ sector loans edged up by a measly 0.5% According to Maybank Kim Eng, TMB, BAY and KBANK reported higher loan growth than others.

Auto lenders still posted loan contraction MoM due to weak auto demand as new credit demand could not offset the on-going debt repayment. Maybank expects auto loans to recover gradually in 2016.

retail banking

Earnings of Hong Kong’s top 4 banks drop 19.57% to HK$128.07b According to SNL Financial, HSBC, BOC Hong Kong, Standard Chartered Bank (Hong Kong). and Bank of East Asia Ltd. reported a 19.57% decline in combined net income attributable to parent companies for 2014.

FIRST loyalty issues

Chinese banks need to explore more initiatives to maintain customer loyalty, as a McKinsey research reveals that the average number of banking relationships per Chinese consumer has risen from 2.5 in 2011 to 3 in 2014. Less than half of Chinese consumers will remain loyal to their primary bank when offered more attractive pricing terms from competitors, compared with nearly 70% in emerging Asia. As a result, the primary bank’s share of wallet across products has eroded.

“Products are now driving loyalty rather than specific institutions; in other words, Chinese consumers are willing to try new products and services that are offered at better terms than what their primary bank has proposed,” says Kenny Lam, an analyst with McKinsey.

To better understand Chinese banking customers, McKinsey conducted in 2014 a personal financial services survey of more than 3,500 consumers across Tier 1, 2, 3, and 4 cities.

The Big Four banks’ eroding market share The survey further pointed out that China’s largest four stateowned banks remain the primary financial institutions for more than 70% of Chinese consumers, but this share continues to erode.

The trend is playing out across the tier cities and wealth segments although it is most pronounced in Tier 1 and the affluent and mass affluent segments.

According to Lam, “The beneficiaries are China’s joint stock banks – their market share in primary banking relationships has increased from just 6% in 2007 to 16% in 2014. Consumers rate their product and service offerings higher than those of the Big Four.”

6 ASIAN BANKING AND FINANCE | JUNE 2015

Islamic banking consolidation up ahead

consolidation could progress, according to Marina: through merger; through the establishment of a bank holding company; or through the establishment of a so-called ‘holding function’. The market is also keeping its fingers crossed for an Islamic banking consolidation.

Investors have welcomed recent news that there were plans to combine the Islamic units of PT Bank Madiri, PT Bank Rakyat Indonesia and PT Bank Negara Indonesia sometime in 2015, says SNL Financial.

It adds that the plan has gone down well with investors, with stock prices climbing for all three banks. Bank Rakyat’s stock rose 9.2% through 4 March, Bank Mandiri shares climbed 4.4%, and Bank Negara’s market value has increased 3.5%, outpacing a 3.0% gain in the benchmark Jakarta Composite Index.

The positive market reaction can be seen as a key supporting factor for the merge, suggests SNL Financial, Bank Mandiri in contrast to a similar deal involving would have as many companies in Malaysia, that better synergy collapsed following drops in shares of with Bank the trio. CIMB Group Holdings Bhd Negara Indonesia, based shares plummeted 17.6% in the four months following the disclosure of on the business the plan on 9 October. RHB Capital model of the Bhd and Malaysia Building Society four stateBhd also saw their shares fall 12.1% owned banks. and 8.9% respectively, in the same period – compared with a drop of only 4.8% in the Kuala Lumpur Composite Index.

“In the run-up to the deal termination, media reports had hinted at difficulties in getting shareholders on board amid unfavourable changes in circumstances, including the stock price losses,” says SNL Financial.

Indonesia’s megabank merger muddle

I

ndonesia’s consolidation of its state-owned banks seems to have stalled for now as the new government eases into power, but the merger’s merits could be too convincing to shelve the plans altogether. “Up till now there is no clarity on the timeline of this whole consolidation, but we believe it will remain in the blueprint for the country’s banking architecture,” says Rahmi Marina, analyst at Maybank Kim Eng. Talks on consolidation of stateowned banks regained momentum in early 2014. It was further pushed when Bank Mandiri submitted a proposal to acquire Bank Tabungan Negara, the country’s largest mortgage lender, later that year. The government, however, chose to leave the decision to the newly elected administration.

Three possible scenarios Marina views the said proposal as suboptimal. Instead, she believes that Bank Mandiri would have better synergy with Bank Negara Indonesia, based on the business model of the four state-owned banks. Meanwhile, Bank Tabungan Negara would fit better with Bank Rakyat Indonesia’s model. There are three scenarios on how this

Growth of Islamic banking in Indonesia since 2008

FIRST Top 5 countries using RMB for documentary credit in January 2015 Value sent and received with the rest of the world, excl Central banks

Source: SWIFT Watch

RMB is the 7th world payments currency

Asia rallies behind RMB use

W

hile it is far too early to crown the renminbi as the next global payments and documentary credits currency, it has been steadily gaining traction worldwide – with the strongest support coming from Asia. In February 2015, RMB ranked as the seventh world payments currency with an activity share of 1.81%, according to SWIFT data.

It is also the second most used currency for documentary credit transactions, with its activity share for documentary credits jumping in value to 9.43% in January 2015

from 7.32% in January 2013.

China, Singapore and Hong Kong have been leading the charge in using RMB as currency for documentary credits, with the Asian countries exchanging nearly 95% of all RMB documentary credit transactions worldwide in value. Far behind were Macau and Taiwan with 0.88% and 0.86%, respectively. “Letters of credit and documentary collections are widely used instruments to finance trade flows across Asia,” says André Casterman, global head, corporate and supply chain markets at SWIFT.

RMB trade settlement has risen from 12% of total trade at the end of 2012, to 22% by the end of 2014.

Another possible catalyst for the currency is companies’ increasing talks about the use of RMB. “Although current RMB usage remains primarily driven by Asia Pacific markets, we are now seeing RMB discussions elevated to the boardrooms of over 20% of surveyed corporates around the world,” says Joseph Arena, head of global trade and receivables finance at HSBC Singapore.

HSBC data show that RMB trade settlement has risen from 12% of total trade at the end of 2012, to 22% by the end of 2014, despite a reversal of steady RMB appreciation against the US dollar.

“Businesses are trading in RMB because it offers a number of practical benefits, rather than for short-term speculation. We expect that the continued liberalization of the currency will help drive spur awareness and greater usage among corporates globally.”

the chartist: hong kong banks’ credit cost and npl ratio to rise While the asset quality of the Hong Kong loan portfolios remains solid so far, Barclays analyst Sharnie Wong sees a rising risk of deterioration if US interest rates rise, as borrowing costs will increase for corporates and households.

“We believe the riskier parts of the loan book include SMEs and unsecured personal banks. Going forward, we remain cautious on asset quality, reflecting a potential slowdown in Hong Kong and China’s economy, and the eventual rise in benchmark interest rates in the medium term. We have factored in a gradual increase in credit cost and NPL ratio for the Hong Kong banks in FY14E-16E,” says Wong.

HK banks – credit cost to rise

HK banks – NPL ratio to rise

Source: Company data, Barclays Research estimates

Source: Company data, Barclays Research estimates

ASIAN BANKING AND FINANCE | JUNE 2015 7

FIRST

Consolidation not the answer for Taiwan banks

Survey

CLUELESS ON CASH

T

he Taiwanese banking sector is fraught with thin margins and moderate capitalisation but not even consolidation between several state banks will resolve these structural weaknesses. Though creating one to two large, regional banks may improve the country’s competitiveness in Asia, Fitch Ratings director Cherry Huang says Taiwan’s state banks are less capitalised than the larger private banks. This means they are not in a strong position to withstand potential shocks that could emerge from overseas operations, especially in emerging markets.

Taiwan’s Financial Supervisory Commission has made tentative steps over the past year to consolidate the banking sector. The FSC measures, says Fitch, include selecting better performing state banks - Mega ICBC and First Bank - as potential acquirers, lifting overseas investment caps for Taiwanese banks, and a series of rights issues for state banks to meet stricter capital requirements for offshore expansion. Fitch expects the consolidation to remain slow, due to labour issues and political hurdles.

According to Huang, consolidation will increase the scale of some of

If not consolidation, then what?

Taiwan’s lenders, but there is less likelihood for substantial operational synergies to improve the sector’s structural weaknesses. Implicit policy roles, including branch presence in unprofitable regions, will continue to burden the profitability of the state banks.

“Less flexible compensation has also contributed to their limited product differentiation and significantly lower fee income generation than at the large private banks. Resistance from labour unions and political opposition will constrain the operational efficiency gains in the form of branch and staff rationalisation from mergers,” she adds.

Implicit policy roles, including branch presence in unprofitable regions, will continue to burden the profitability of the state banks.

innovation watch

Send and receive money via Facebook Messenger Facebook recently added a payments feature to its Messenger platform that allows people to send and receive money easily. While the new feature’s convenience is most welcome, security remains one of the top concerns. Lafferty Group’s head of innovation John Egan says establishing trust will be a challenge. “Social data is typically valued far less than financial data.”

However, a Facebook spokesperson assured users, “We use an encryption between you and Facebook at all times and encrypt your card information when you ask us to store it.”

Gilles Ubaghs, Ovum’s senior analyst, reckons Facebook is pretty explicit on growing payments as a revenue stream. “This won’t be the last thing Facebook does in payments so expect to see further development in the coming months ahead.” The service is only available in the US for the time being, but who knows how soon we will also have this in Asia?

8 ASIAN BANKING AND FINANCE | JUNE 2015

Gilles Ubaghs

John Egan

Ask corporates anywhere in Asia about their company’s real-time cash position, and you’d most likely receive a shrug of the shoulders in response.

The Cashfac Operational Cash Index, a survey conducted by research firm East & Partners Asia, interviewed 364 chief financial officers and corporate treasurers and reveals that almost 2 in 3 of these corporates lack a clear idea of their cash positions.

The Cashfac Operational Cash Index highlights issues around clarity on cash positions and the realities of managing multi-bank systems for large corporate treasuries in the region. It also found high levels of frustration with the linking of bank accounts and with the cost of bank product solutions and upgrades.

It was also revealed that only 35% of corporates surveyed had access to a real-time view of their transactions and cash and that only 23% of cash is physically pooled in Asia Pacific. Notional Pooling, where possible, is not fully exploited.

Patchy solutions East & Partners found that high costs, proprietary banking systems and patchy workaround solutions were all seen by corporates as undermining the accuracy and confidence in data, and impacting the ability to achieve real-time cash visibility.

Lachlan Colquhoun, chief executive, East & Partners Asia, says, “Due to the complexities and shortcomings of managing multiple banking relationships regionally, our research found that many Asia Pacific corporates lack a line of sight to their cash positions.”

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FIRST

Banks struggle to keep up with more daring third party payment firms

A

libaba’s “Smile to Pay” app, which requires users to just take a selfie to authenticate transactions, is a prime example of how customers and merchants are going for payment methods that are quick and efficient, with as little inconvenience as possible. This ease of access, security, and intuitiveness brought to the table by third-party systems raises a critical question: will banks eventually lose relevance in the customer-merchant relationship?

China’s third-party payment industry usage has grown by a 61% CAGR, from RMB 2.9 trillion in 2009, to RMB 19.7 trillion in 2013.

While the figure is dwarfed by the RMB 2,940 trillion processed by the payment systems of central banks, retail banks, and other clearing institutions, the more daring, competitive, and innovative services of third-party payments are enough to threaten the stability of traditional banks, who are struggling to keep up.

Mobile payments The three main segments of the thirdparty payment industry are offline card acquiring, online payment, and the mobile payment market. Of these three, mobile payment is the most promising field. “We

believe mobile payments as a percentage of total payments will continue to rise, thanks to increased penetration of smartphones,” says May Yan, an analyst with Barclays Research. She argues that online-to-offline, near field communication, and better data connections allow smartphones to function as digital wallets, eliminating the need for physical cards and cash.

The bank cards’ relatively short time in Chinese pockets – 50% current penetration versus only 10% a decade ago – also means that users can easily adapt to other modes of payment.

Bank loan vs P2P lending Even lending, the banks’ oldest function, is seeing a challenger in the form of peerto-peer (P2P) lending, a system where borrowers are financed, not by licensed institutions, but by private entities. As the borrowing rate is lower than the banks’, and income interest is higher than deposit and savings accounts, it’s a win-win for all parties involved.

However, UOB Kay Hian analyst Edmond Law expresses his doubts regarding the advent of online finance, noting that 275 out of 1,575 P2P platforms shut down in 2014 because of defaults and security

Mobile ‘norm’as e-banking rises A more payment proactivebecomes stance is the required

reasons. He adds that the measly profits gained through loan commissions and handling fees make these kinds of endeavours unsustainable.

Additionally, the third-party payment industry has to overcome hurdles such as the PBOC’s final guidelines on online payments, regulation of private banks, and the impact of established international brands like Apple Pay and Google Wallet, before they become top-of-mind payment options for customers.

Bank watch

IndusInd Bank opens three new branches

IndusInd Bank has recently launched three new branches in Chandigarh, Panipat and Mohali. The bank now has a total of nine branches in Chandigarh, 67 in Haryana and 37 branches in Punjab as of February 28, 2015. According to Soumitra Sen, head of branch banking at IndusInd Bank, “This would be a step ahead to support the Bank’s strategy to extend the reach and offer entire gamut of financial services including credit, savings, investments and insurance products in these areas,” he said.

Soumitra further said that the launching of the new branches will allow more customers to avail of IndusInd Bank’s full range of services in savings & current accounts, loan products, etc. There are also innovative facilities such as ‘Video Branch’, ‘My Account, My Number’, ‘Choice Money ATM’, “Direct Connect’, “Check on Cheque” and ‘Cash on Mobile’.

10 ASIAN BANKING AND FINANCE | JUNE 2015

IndusInd executives and guests at the Mohali branch

Chandigarh branch inauguration

Panipat branch inauguration

FIRST NUMBERS

MasterCard, in partnership with Prime Research, has surveyed mobile payments conversations across social media annually for the past three years.

Singapore’s net new assets grew $40 billion

Is Singapore a ‘stagnating’ wealth centre?

W

ith Singapore remaining stuck behind Hong Kong in the world’s wealth management rankings for the third straight year, analysts have begun to ask: is Singapore now a less attractive haven for investors, compared with Hong Kong? Daniel Kobler, partner and head of banking strategy consulting at Deloitte, says Singapore has been described as a “stagnating centre,” based on market volume from 2008 to 2014. “Despite a strong increase in client assets of 24%, Singapore fell by one position and is now ranked sixth, with $0.5 trillion assets booked,” says Kobler.

Hong Kong, on the other hand, has been tagged a “growth leader”, achieving its highest growth since 2008 and elbowing Singapore out. “Fifth-placed is Hong Kong, which achieved growth of 146% ($0.4 trillion) in cross-border client assets during the period, more than any other centre,” Kobler notes.

Different propositions But Alvin Lee, managing director, regional wealth management at Maybank, notes that apart from the generic investment products, Singapore and Hong Kong offer slightly different propositions to HNWIs. “Hong Kong’s proximity to China and its deeper capital markets will always appeal to investors who are looking 12 ASIAN BANKING AND FINANCE | JUNE 2015

for China exposures, while Singapore is in the heart of ASEAN and is continuously attracting offshore investors to not only park their funds, but also to consider setting up base. The key driver for Hong Kong’s stellar growth is due to mainland Chinese banking in Hong Kong,” adds Lee. Thus, it would be too early to count Singapore out of the wealth management game simply because of Hong Kong’s robust performance. Kobler notes that except for Hong Kong, the only other international wealth management centre attracting net new assets was Singapore, with a growth of $40bn.

Further, Singapore’s financial services sector continues to perform well, an indication that the country still deserves its position as a leading wealth management centre in the region. “I do not think that Singapore is a stagnating centre in wealth management. The financial services sector is a very key component of Singapore’s GDP and our policies have always been very forward looking to continuously promote Singapore as a regional financial hub, if not a global one,” says Lee. “Market shares of financial centres in wealth management will always fluctuate in the short term, but the overall soundness and conduciveness of Singapore will make this centre a very important and relevant one in the long run,” adds Lee.

Despite a strong increase in client assets of 24%, Singapore fell by one position and is now ranked sixth, with $0.5 trillion assets booked.

Source: MasterCard

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FIRST

Why Asian banks must move from brick-and-mortar to click-and-mortar

B

efore 2011, the transaction split between physical and online banking used to be 70-30, with most customers visiting branches or using phone banking. Fast-forward a mere 3 years, and the ratio has come down to about 50-50, according to Sonia Barquin, an analyst at McKinsey & Company.

Customer interactions with their banks through online channels has more than doubled to 4.7 times per month in 2014, from 1.85 times in 2011, with the average bank customer interacting with his or her bank at least twice a day for matters related to payments.

As smartphone penetration and the quality of internet service increases in Asia, the frequency of interaction is bound to increase the accessibility of financial services. Despite the rapid growth in online transactions, banks have been quite slow to adapt, with very few Asian banks launching fully-integrated digital banking platforms. This has opened the door for numerous disruptors, such as Paypal and other non-bank financial services providers, to enter the online transaction space and take market share from banks.

Why digital banking matters The pressure for bank executives to raise profitability is mounting, and increased regulatory scrutiny has limited the available tools to do so. Banks’ ROE in Asia ex-Japan are now in the low teens,

14 ASIAN BANKING AND FINANCE | JUNE 2015

and even Japanese banks’ are dipping below 10%. With trading gains gone, and net interest margins on lending being compressed by tight competition, banks must now make the shift to building their fee income-based revenue streams.

Merchant and payments services represent a large source of fee income, and the potential to cross-sell products on these platforms is enormous. With the lack of complete platforms for online transacting, banks have thus far merely scratched the surface of the potential of this business line.

Barquin says more than 50% of bank customers are willing to switch their deposit and investment holdings to banks that offer comprehensive digital solutions.

Customers want the ability to pay bills and make transfers, check their balances, buy and sell investment products, and report problems and give feedback anytime, anywhere, according to EY’s recent study on digital banking.

Institutions that adapt quickly to offer well-made platforms may see faster deposit growth and increased transaction velocity due to the additional convenience it affords to its customers. Banks are actually at a strategic advantage, due to their large existing customer base and the greater trust of clients in these institutions versus smaller third party payment providers. E&Y believes that mobile payments will constitute the majority

of online activity and infrastructure investment. “The recent advances in mobile payments mean more customers expect to be able to transmit funds instantaneously,” adds EY. The increase in the prevalence of online banking has far-reaching implications.

Online transacting does not exist in a vacuum, and does not happen for its own sake, but rather as part of an e-commerce ‘ecosystem’. For e-commerce to flourish, industry professionals and analysts note that three things must be in place: logistics; trust in the system; and convenience of payments. The second and third factors are almost automatically solved by digital platforms offered by reputable and trusted banks.

The potential synergy is still largely untapped, and banks that move quickly have the opportunity to be first to capitalize on a potentially huge market segment. Thus far, the disruptors like Paypal and Google Wallet have been first to market, taking the lion’s share of these online transactions.

Clicks and mortar As internet access proliferates along with the usage of smartphones, penetration of mobile banking is bound to continue on its upward trajectory. “The trend toward digital banking is unlikely to stop, even as factors such as regulatory obstacles and, for some consumers, a personal preference for physical branches works against it. In one indication, across developed Asia, more than 80% of the survey respondents have purchased goods or services online, yet only 58 to 75% have bought banking products online, depending on the country,” says Barquin.

That being said, online banking will not completely replace physical banking, and will actually serve as a complement that improves the overall customer experience.

Having both a strong physical and digital presence affords customers the option to move seamlessly between channels, because clients now want to be able to interact with their bank wherever and whenever they want.

Barquin also notes that clients still prefer to transact in person for more personal and complex products such as financial advisory, mortgages, and insurance. Digital banking and physical banking will eventually exist side-by-side as banks move from ‘brick-and-mortar’ to ‘click-and-mortar’.

FIRST The Analysts’ call

What’s dragging HSBC down?

HSBC braces for another hammering in 2015 as profit pains persist

T

is anticipating more uncertainties in 2015.

Given this scenario, Antos anticipates an 8% decline in pre-tax earnings this year and has lowered his 2015 earnings estimate by 26%. “Core earnings performance is the key challenge for this bank. We do not foresee a turnaround in 2015,” says Antos.

Sharnie Wong, analyst at Barclays, also foresees subdued dividends growth. “We now expect limited growth in earnings and dividends in the near to medium term, as HSBC tackles increased structural challenges and seeks to build capital,” says Wong, who downgraded her We see little chance at this point earnings expectations for HSBC by 12-16%. that the bank will reach its ROE target It is expected that restructuring in 2015-17. plans will focus on the US, Mexico, Brazil and Turkey markets, which have been underperforming. Should the financial results for these markets fail to the year. improve, they could be the target of drastic While HSBC has revised its return on management action, according to Antos. equity target down to 10% from 12-15%, “We believe HSBC is at the start of this is still too optimistic and will not likely another process of going back to the drawing be achieved in the next few years, according board to think about what the shape of the to James Antos, analyst at Mizuho Securities business should look like for the next three Asia, based on the bank’s track record. to five years,” concurs Chintan Joshi, analyst “HSBC has not consistently generated at Nomura. double-digit ROEs since 2007. ROE averaged He adds that while the scale of HSBC’s 9.1% and CET1 (transitional basis) averaged expected restructuring will not be as large as 11.2% over the past five years. We see little the one Standard Chartered is facing, it will chance at this point that the bank will reach likely involve a 10% cut in costs, and another its ROE target in 2015-17,” says Antos.

10% capital reallocated to more profitable Management has also scrapped its costbusinesses. These moves should help kickincome target, which, combined with the start earnings momentum for the bank. lowered ROE target, suggests that the bank he banking giant ended 2014 licking its wounds as pre-tax profits plummeted, and there’s no respite in sight. The last quarter of 2014 was rough for HSBC, with falling earnings contributing to its lowest performance in five years, but analysts warn that the worst may not be over and that the profit pain could continue in 2015. The HSBC profit horizon is murky at best, and more pessimistic analysts expect the bank to miss key performance targets for

16 ASIAN BANKING AND FINANCE | JUNE 2015

James Antos – Mizuho Securities While the controversy surrounding alleged money laundering and tax evasion through its Swiss private bank has made recent headlines, a major revenue setback in Global Banking and Markets (GBM) is the main reason for HSBC’s negative earnings surprise in 4Q. GBM revenues fell US$1.37 billion quarteron-quarter, largely due to mark-tomarket losses in derivatives and nonqualifying hedges. GBM accounted for 42% of group pre-tax profit in 2013, but this fell to 32% in 2014.

Sharnie Wong – Barclays That GBM is the division that drags down the overall group return does not come as a particular surprise, and is not something that is specific to HSBC. However, this is a significant issue, as it consumes 45% of the group’s capital while the commercial banking business is slightly smaller and the higher returning retail division is now a relatively minor part of the group.

Taking all divisions into account, profitability in the Americas still remains weak, but the rest of Asia Pacific looks close to adequate, while Europe is low.

Chintan Joshi – Nomura What are the problem areas for HSBC? GBM in Europe and North America. In North America, commercial banking (CMB) needs to make material strides in profitability, otherwise [their] presence in North America will be in question. Latin America appears to be struggling across the board.

Europe’s strong retail and wealth management and CMB returns are mainly due to the UK. This hides the lack of profitability in France and Turkey, particularly in retail.

2015

CORPORATE PERFORMANCE AWARDS JULY 8, 2015 SHANGRI-LA HOTEL SINGAPORE

FINANCIAL INSIGHT: mergers & acquisitions

AsiaPac’s P/E ratio rose 12% over the last year

Asian appetite for M&A deals to be stronger in 2015 Hong Kong M&a will ride on corporate restructuring while Singapore is the only country in Southeast Asia to see waning appetite.

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sia has spent the past few years cutting back on mergers and acquisitions (M&A) deals, but 2015 will be the year when it forgets the diet and feasts on more transactions – with one exception: Singapore. The country has been singled out for its weak appetite, caused by fears over rising interest rates and the slow growth of major economies.

Vishal Sharma, Asia Pacific head of M&A at KPMG, points out that the region’s forward price/earnings (P/E) ratios – an indicator of corporate appetite – rose 12% over the last year, higher than the global increase of 7%, according to the latest KPMG Global M&A Predictor, a forwardlooking tool that helps to forecast worldwide trends in M&A deals.

Asia Pacific ex-Japan’s capacity to transact is predicted to rise by 18 ASIAN BANKING AND FINANCE | JUNE 2015

Asia Pacific ex-Japan’s capacity to transact is predicted to rise by 15%, indicating that corporates in this region will have the funds to satisfy this stronger appetite.

15%, indicating that corporates in this region will have the funds to satisfy this stronger appetite.

Thomson Reuters data show that the value of announced M&A deals involving Asia Pacific companies, excluding Japan, witnessed a record start and totaled US$243 billion so far this year, a 67.5% increase in deal value compared to the first quarter of 2014 (US$145.0 billion). The average M&A deal value for disclosed deals grew to US$149.9 million compared to US$84.9 million in the first quarter of 2014.

Completed M&A activity involving Asia Pacific companies amounted to US$99.6 billion thus far, an 8.3% increase in deal value compared to the first quarter of 2014 (US$92.0 billion) despite a 13.7% decline in number of

completed transactions, according to Thomson Reuters.

Skipping the M&A buffet Singapore, however, is bucking the upward trend in appetite.

Although the country’s capacity to transact is expected to increase by 11%, its forward P/E ratio dropped 3%, making it the only country in Southeast Asia to see waning appetite. Malaysia’s forward P/E ratio rose 5%, Indonesia’s by 19%, Thailand’s by 22% and the Philippines’ by 23%.

“The drop in Singapore’s forward P/E ratio is a reflection in some ways of the global concerns around rising interest rates and weak growth expectations from the large economies of China and Japan. Singapore, being an open economy, feels the effects of these likely headwinds faster than some of the other economies such as Thailand, Malaysia and Philippines,” says Sharma.

In line with these predictions of limited appetite, Singapore’s first quarter M&A activity has been relatively slow, compared with the same period in 2014.

Overall Singapore M&A has

FINANCIAL INSIGHT: mergers & acquisitions dropped to US$10.2 billion so far this year, a 67% decline from a year ago, says Elaine Tan, senior analyst, deals intelligence at Reuters. She adds that only three deals valued US$1-billion-andabove were announced so far this year compared with at least seven deals with a combined total of US$18.5 billion during the first quarter of 2014.

On the other hand, the dip in deal-making activity may be partly due to the high base in 2014, which set a new annual record. Tan also notes that the forecasted dearth of M&A deals could turn around, especially when factoring in a government bid to boost inbound M&A and the declining appeal of equity markets.

Hong Kong takes the lead Meanwhile, in Hong Kong, M&A levels are predicted to skyrocket this year as more conglomerates consider multi-billion dollar restructuring deals. More companies have jumped on the band wagon, probably with the urge to follow in the footsteps of Li Ka-shing and his bold reorganization of his massive diversified conglomerate into two new listed companies. The recordbreaking deal is likely to cause a domino effect in the territory, say analysts, with corporate restructuring poised to become a defining M&A theme this year.

“In Hong Kong, we expect more restructuring among family-held conglomerates similar to the Hutchison-Cheung Kong deal,” says Samson Lo, head of M&A, Asia at UBS Investment Bank.

Helping to convince other conglomerates is the sound rationale behind the reorganization: The Hong Kong tycoon expects the two new listed companies will create shareholder value as well as provide investors the option to choose between investing in property or nonproperty assets, says Thomson Reuters’ Tan. The deal will see Cheung Kong (Holdings) Ltd acquire the remaining interest in

Hutchison Whampoa Ltd, to form CK Hutchison Holdings Ltd, in a stock swap transaction valued at US$47.7 billion, including net debt.

Tan notes that the deal surpassed the biggest-ever M&A transaction involving Asia Pacific – CITIC Pacific’s US$42.2 billion acquisition of CITIC Group’s main asset in 2014 – and pushed the region’s M&A activity to witness the best annual start to any year since records began with US$211.0 billion. “It’s a hectic start this year for deal making in Hong Kong, with Li Ka-shing’s main companies leading the deal flurry,” says Tan. “They also stepped up the pace of M&A activities overseas, focusing on European and other foreign markets. This included Hutchison Whampoa Ltd’s US$15.4 billion pending acquisition of O2 PLC from Telefonica SA,” she adds.

This brought overall M&A activity in Hong Kong to US$83.9 billion so far as of early March, which Tan says is a more than twice the level of the previous year, making it the highest first quarter level on record in terms of deal value.

Stronger Asian appetite The rest of the year promises to sustain the blistering M&A momentum in Hong Kong in the face of a stronger Asian appetite for deals. “Hong Kong and Singapore are regional financial hubs, and as a result, a lot of the M&A activity there is driven by companies operating in other countries in the region that have based themselves there; when you look at the deals announced in 2015 to date that’s again clear, particularly for China-related deals in Hong Kong,” says David Cogman, partner at McKinsey & Company.

Cogman expects Chinese acquirers to lead the M&A charge this year, both through outbound deals and in the domestic market with state-owned enterprise restructuring and an increasingly

Vishal Sharma

Elaine Tan

David Cogman

healthy private company deal market. Major companies in other countries may also step up their activity in intra-regional M&A due to their healthy cash positions and expansion mode aspirations.

KPMG data suggest large companies are paying down debt and stockpiling cash, putting them in a prime position to fuel their M&A deal-making sprees.

“We are seeing an upswing after almost three years of decline.

This confidence will drive M&A transactions activity, with both deal volumes and deal values moving in a positive direction during the second half of 2014,” says Sharma.

Asia looks outside the region UBS’ Lo notes that an expected increase in more lucrative targets in Western regions could lure away attention from Singapore and other ASEAN companies.

“We expect an increase in outbound activity from Asia Pacific driven, in part, by a plethora of high-quality assets and real estate in the US and Europe coming on to the market and, in part, by Asian investors seeking growth opportunities,” says Lo. But looking at the broader region, Cogman reckons the deal activity in Asia tends to be mostly intra-country and intra-regional with 77% of deals by value being domestic wherein the acquirer and target are from the same country.

Meanwhile, cross-border deals within Asia Pacific were 13% of the total, or roughly the same as it has been in past years.

Source: Thomson Reuters

ASIAN BANKING AND FINANCE | JUNE 2015 19

Country report: china

A greater profitability pressure looms

Chinese banks to suffer from thinner NIM as the central bank’s rate cuts take effect Most analysts predict lower earnings for China banks this year due to rate cuts and deposit rate liberalization, but a possible improvement in asset quality may more than compensate for this.

I

f China banks are unhappy at the prospect of leaner bottom lines in 2015 as the central bank snips borrowing rates, they can find some comfort in the fact that this could be a catalyst for better asset quality and higher share prices. Still, analysts are divided on whether this comforting side effect is even on the cards, with more pessimistic observers forecasting a slower China economy and a rise in problem loans.

China banks face a challenging earnings horizon in 2015, says May Yan, analyst at Barclays, as net interest margin (NIM) and deposit growth pressures persist. “On a static basis, large banks estimate the November 2014 rate cut and 10% liberalization could reduce 2015 NIM by 9 to 12bp.

2015 profit should grow in the low single digits for large banks,” she says.

Data released in the People’s Bank of China’s (PBOC) latest monetary 20 ASIAN BANKING AND FINANCE | JUNE 2015

On a static basis, large banks estimate the November 2014 rate cut and 10% liberalization could reduce 2015 NIM by 9 to 12bp.

policy report confirm that efforts by the central bank to lower borrowing rates are taking effect, according to Fitch Ratings.

While borrowers will benefit from the short-term relief that lower borrowing rates bring, banks will have to swallow thinner net interest margins, especially as deposit competition remains stiff. Fitch Ratings expects NIM pressures will likely continue through 2015 as loans are gradually repriced.

“The resulting NIM squeeze for Chinese banks could be significant, and may encourage banks to shift their balance sheets to higher yielding, riskier assets. This is also the case as Chinese authorities have been encouraging banks to increase lending to micro and small enterprises. It remains to be seen whether banks will be adequately compensated for this shift,” says Fitch.

Banks will see greater profitability pressure, concurs Christine Kuo, analyst at Moody’s Investors Service.

“While deregulation of deposit rates will allow banks to better defend their deposit funding against competing wealth management products, it will come at the expense of narrower net interest margins (NIMs),” she says.

Growth in fee income is also under pressure from the tightening supervision of banks’ wealth management products business and regulatory limits on fee charges on bank services. If there is a silver lining, says Kuo, it is that the deposit rate liberalization will likely be staged over two to three years, lessening the intensity of immediate impact on profits.

Net profit and NIM could fall by an average of 4.9% and 8bp respectively, according to Wilson Li, analyst at CCB International, taking into

Country report: china consideration the rising deposit rates, in response to the latest rate cut that lowered benchmark rate for loans and deposits by 25bp.

While banks grapple with lower NIMs, analysts are debating whether there will be a corresponding asset quality improvement and whether this will offset the near-term profitability decline.

Asset quality improvement?

Rate cuts might be negative to earnings, but will be positive to, and stabilize the asset quality of, China banks in the medium term, says Li. This, in turn, will likely boost stock market prices. “Easing in asset quality will be a catalyst to bank share prices, as asset quality at the moment is a much bigger concern than declining earnings growth caused by narrowing NIM. Recall that the November and December 2014 rallies in bank share prices were triggered by the rate cut in November 2014,” Li adds.

“We expect much the same to occur in the wake of the recent rate cut. Share prices of the smaller banks like CITIC Bank and Minsheng are likely to fare better, as they will benefit more from marginal improvements in asset quality.”

But Kuo predicts that asset quality will continue to deteriorate, particularly in the face of a continued slowdown in overall economic growth. “Problem loans will continue to originate from mostly private sector borrowers in cyclical industries such as manufacturing and trading, and medium-sized and small borrowers, to which banks may not pass on the full benefit of the recent lending rate reduction. In addition, problem loans from the real estate sector may start to rise from a low base if the market downturn continues,” she says.

Yan also foresees an asset quality deterioration among China banks, but believes it will be manageable.

While China’s gross domestic product growth is likely to trend down in the first half of 2015, it should bottom out by the third quarter, she says.

Having met with a cross-section of financial regulators, government officials, banks, and local companies, Yan reports expectations that 6-7%

real GDP growth is achievable in the near to medium term. She expects GDP growth in 2014 to continue to be supported by improved exports with the stabilizing of overseas economies, resilient consumption growth, and an onrush of infrastructure investment projects.

A flurry of financial reforms Much of the near-term uncertainty in the banking industry stems from the flurry of financial reforms shaking up the sector, but analysts believe China banks will come out stronger after the dust settles. Kuo argues that these policy developments should help stabilize the operating environment for Chinese banks, albeit at the price of greater profitability pressure.

She says recent shifts towards more accommodating monetary and credit policies will help arrest the decelerating trend in the credit cycle and maintain broad credit growth at a 15%-20% pace, while bank credit growth sits at a 10%-15% rate.

The interest-rate deregulation should not deter banks from courting smaller borrowers, which adds to their overall asset risks. According to Kuo, the government’s latest measures to tighten supervision on local government financing vehicles (LGFVs) and state-owned enterprises should address some of the structural issues and risks banks face in financing these borrowers.

China banks might have to deal with a slower pace of internal capital generation on the back of lower lending profitability and higher credit costs, but Kuo says the net impact on their capitalization will be subdued if credit growth steadies at the current pace. She says several banks will likely raise common equity and Basel IIIcompliant capital in the next year or so, which should further help stabilize the industry’s capital position.

The changing regulatory regime should also allow for greater funding and liquidity for China banks, according to Kuo. “The current policy mix will lessen pressures on banks’ liquidity positions. Banks will take relief from the central bank’s more relaxed stance on liquidity provision, which contrasts with the more vigilant

Recent shifts towards more accommodating monetary and credit policies will help arrest the decelerating trend in the credit cycle and maintain broad credit growth at a 15%-20% pace.

stance it assumed in 2013 in an effort to forestall credit bubbles,” she says. Kuo adds that from a liquidity perspective, banks will also benefit from further interest rate liberalization, which should give them more flexibility to improve their pricing of liabilities to stabilize their funding base.

Yan warns, though, that China banks remain cautious in certain areas where policy support remains unclear, such as how new debt raised by local governments and LGFVs since 2015 will be treated.

China has been rolling out a number of regulations aimed at curbing local government debt problems, but execution has been tricky, especially in the classification of existing local government debt. For this reason, banks were hesitant to extend more loans to LGFVs earlier this year, which could hurt loan growth.

As China banks move away from the current LGFV financing model, Yan reveals that most industry insiders believe that financing for local government-led investment projects will take the form of publicprivate partnerships.

Entrusted loans as percentage of total loans and their compound annual growth rate

Source: Banks’ annual and interim reports

Chinese banks’ net interest margin

Source: CBRC

ASIAN BANKING AND FINANCE | JUNE 2015 21

PEOPLE PROFILE

National Australia Bank’s Christy Tan dead set on enhancing the bank’s Asia-focused research Tan aims to boost NAB’s brand as a bank that is regionally and globally respected for its Asian research and insights. gether with the existing formidable research and strategy teams based in Sydney and Melbourne to help the bank to expand our support of customers in Asia as well as Asiaactive customers from Australia and New Zealand. I personally enjoy the daily challenge and fulfilment that come with bringing Asian insights and value to NAB’s research platforms and bridging NAB’s Australia and China franchises.

Christy Tan Head of Markets Strategy and Research for Asia, NAB

C

hristy Tan joined National Australia Bank in July 2014 as Head of Markets Strategy and Research for Asia. Her role in NAB focuses on Macro strategy and research on Asia (excluding Japan) financial markets. Christy also assists in NAB’s expansion into China and the region. She reports to Peter Jolly, Global Head of Research - FICC in Sydney and Jessica Tilton, Head of Markets Asia in Hong Kong.

Almost one year into the role, Christy Tan talks to the Asian Banking and Finance team about her goals, philosophies, and future plans.

ABF: What makes you excited about your position?

I joined NAB in July 2014 and my excitement certainly built up after taking on the role. I am especially thrilled by the opportunity to create and build a research platform for Asia, based in Asia and more specifically, at the heart of all the action - Hong Kong.

Being the first Asia-based research role in NAB, I work to22 ASIAN BANKING AND FINANCE | JUNE 2015

ABF: What three goals are you focused on?

I would like to create, build and enhance quality Asia research to grow NAB’s presence and brand, particularly in Asia and our core markets of Australia and New Zealand. It is critical to build a strong foundation for Asia research that is sustainable for the team going forward.

It is also my long-term goal to enhance NAB’s existing brand as a leading Australian bank with strong Australia and New Zealand research and expertise to one that is regionally and globally respected for its Asian research and insights as well. Most recently, our forecasts for Asian currencies were ranked in the top two in the world by Bloomberg for two consecutive quarters and we are doing our best to build on this excellent momentum to do even better in the coming months.

ABF: What changes are you planning for?

I would prefer to call them personal innovations rather than changes.

These would entail constantly asking myself: My present belief system has brought me to where I am, now what can I do better? What are some corporate and personal

brand-strengthening initiatives I can embark on?

ABF: What are your key business philosophies?

I believe that the key to have strong and sustainable business success is being governed by the right values and having people in the organisation who live out those values.

Businesses have to be clear about what is most important, especially when facing conflicting options. As one of Australia’s top banks, I am glad that NAB shares my personal philosophy of delivering business returns with integrity and a positive impact on our clients and communities.

I would like to create, build and enhance quality Asia research to grow NAB’s presence and brand, particularly in Asia and our core markets of Australia and New Zealand.

ABF: What previous positions prepared you for this one and how?

I joined Bank of America in 2005 which was later merged with Merrill Lynch in late 2008. With the merger, the research department and its clientele expanded greatly and systems were put in place immediately to ensure business continuity both regionally and globally.

Because things were changing so quickly, I was exposed to the organisation’s efficient efforts to transition and bring together two starkly different cultures, working styles and processes. That experience was indeed invaluable to me.

ABF: Anything else you’d like to add?

I am personally very committed to advancing causes supporting fair practices for women in the workplace as well as women in leadership.

I am also currently pursuing a part-time MBA course with Manchester Business School. Knowledge is after all the new currency.

Analysis: hong kong banks

Loan growth will slow further in 2015

Hong Kong banks at an inflection point

After six years of strong credit growth and near-zero credit costs, Barclays believes things are about to change in 2015 as economic growth slows, US interest rates rise, and China interest rates fall.

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e expect loan growth for the Hong Kong banks to moderate in 2015, after six years of rapid growth, due to slower economic growth and monetary easing in China as well as lower commodity prices which especially affects trade finance. Over the past five years, system loans have grown by a 17% CAGR (2009-2014) and we forecast this to slow to ~7% in FY1516E. Hong Kong’s loan growth has been historically inversely correlated with China’s loan growth. Hong Kong has been a source of cheap funding for China-related corporates since the Global Financial Crisis in 2008. System loans for use outside of Hong Kong and trade finance have respectively grown by 29% and 25% CAGRs over the past five years (20092014).

With more monetary easing in China to come in 2015, we believe loan growth in Hong Kong could slow further. Hong Kong system loan growth has already moderated 24 ASIAN BANKING AND FINANCE | JUNE 2015

in 2H14, rising by only 3% h/h, the slowest pace in five years.

The PBOC cut benchmark interest rates on 22 November 2014 and cut the reserve requirement ratio (RRR) on 4 February 2015. Our China economist, Jian Chang, expects twomore interest rate cuts and two more RRR cuts to come this year.

She forecasts China real GDP growth to slow to 7.0% in 2015, down from 7.3% in 2014.

Moreover, borrowing offshore for Chinese-related corporates is now more expensive as Barclays expects the RMB to depreciate against the USD/HKD. We think this is evident already from the sharp slowdown of system trade finance in Hong Kong, which declined by 10% m/m in December 2014. Forward exchange rates currently imply a 2% expected depreciation of the RMB relative to the USD over the next 12 months.

We currently forecast a 10% contraction in trade finance loans in 2015. In the event of liquidity tightness caused

“A key risk for the banking system is if expectations for higher US interest rates lead to large and sudden liquidity outflows.”

by potential interest rate hikes in 2H15, we see further downside risk to growth as banks manage liquidity by allowing these short-term trade loans to roll off the books.

Sudden liquidity outflow a key risk Over the past six years, the Hong Kong banking system has benefited from significant fund inflows since QE. Rapid growth in system deposits (9% CAGR) supported an even faster rise in loan growth (14% CAGR).

The system loan-to-deposit ratio rose from 50% in 2009 to 72% in 2014. A key risk for the banking system is if expectations for higher US interest rates lead to large and sudden liquidity outflows (i.e. contraction of system deposit base).

In Arthur Yuen’s (the deputy chief executive of the HKMA) speech in January 2015, he said this is one of the areas that the HKMA is monitoring closely because “as rates rise, there will be an impact on global capital flow and this can influence

Analysis: hong kong banks “Hong Kong banks have benefited from near-zero credit costs for the past six years in the low interest rate environment.”

First US rate hike expected in June 2015

liquidity at banks quite quickly”.

Loan balances could contract quite sharply, especially trade finance loans which are shorter in duration (three to six months’ trade cycle), as banks manage liquidity risk. Funding cost could rise quickly as deposit competition intensifies. After the initial squeeze on liquidity and margins, we expect banks to reprice up loans to protect margins, while deposit and loan demand and supply would rebalance over time.

Asset quality to deteriorate Hong Kong banks have benefited from near-zero credit costs for the past six years in the low interest rate environment. The system NPL ratio is at a record low. However, greater exposure to China-related loans combined with slowing economic growth in China could result in asset quality deterioration for the Hong Kong banks going forward. System-wide,

loans for use outside of Hong Kong (which we believe is predominantly China-related lending) rose by a 26% CAGR between 2008 and 2014 and now accounts for more than 30% of total loans.

The Hong Kong banks are exposed to China-related loans via lending to China-related corporates, mainland banking subsidiaries and also indirectly via investment in Chinese banks. All four of the local Hong Kong banks in our coverage universe showed a deterioration in asset quality in their China portfolios, with NPL ratios rising h/h in 1H14. Arthur Yuen, the deputy chief executive of the HKMA, also recently warned that that there were some instances of defaults in 4Q14, a sign that asset quality is coming under pressure, in his speech in January 2015.

While the asset quality of the Hong Kong loan portfolios remains solid so far, we see a rising risk of

Loan growth – entering a period of slower growth

Source: Company data, Barclays Research estimates

deterioration if US interest rates rise, as borrowing costs will increase for corporates and households. The HKMA is increasingly concerned about the rapid rise in consumer debt fuelled by low interest rates and abundant liquidity. Going forward, we remain cautious on asset quality, reflecting a potential slowdown in Hong Kong and China’s economy, and the eventual rise in benchmark interest rates in the medium term. We have factored in a gradual increase in credit cost and NPL ratio for the Hong Kong banks in FY14E-16E. Margin to improve in 2H15 Hong Kong interest rates have historically tracked the US closely due to the HKD/USD peg although variances may occur at times due to local factors and stresses. Our Barclays Research economics team expects the first US rate hike to occur in June 2015, with the Fed funds rate gradually rising to 0.75-1% by end-2015 and 2.5-2.75% by end-2016.

The Hong Kong banking system benefited from significant fund inflows after the Global Financial Crisis and quantitative easing. Abundant liquidity in the system combined with low interest rates resulted in Hong Kong banks’ average net interest margin declining from 2% in 1Q08 to 1.4% currently. We expect margins to improve in 2H15 assuming our economists’ expectations for US interest rates rise plays out. A rising rate environment is typically positive for banks, albeit with a short time lag (usually about three months) as the loan-to-deposit spread expands and as excess funds generatehigher returns for banks with surplus liquidity.

By Sharnie Wong, analyst at Barclays

China interest rates: 7-day repo and 3-month SHIBOR

Source: Bloomberg, Barclays Research

ASIAN BANKING AND FINANCE | JUNE 2015 25

SECTOR REPORT 1: CASH MANAGEMENT

Asian corporates demand specific services

In Asian cash management, customisation is now king

Offering customised solutions has become the critical success factor for banks that want to grow their cash management business.

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hen banks approach Asian corporates, presenting a shiny pre-built cash management system is no longer enough to make the client sign on the dotted line. Banks must instead assemble a highly customised solution that responds to the cornucopia of challenges and confusion that confronts clients in this industry.

Corporates have every reason to be this demanding – they are under heavy pressure to keep up with the fast-changing operating environment, according to analysts. There are new modes of transactions, information and leapfrog of legacy models in key areas such as e-commerce, mobile commerce, collections, reconciliation, payment services and real-time settlements, says Balaji Natarajan, global head of payments and collections, global transaction banking at ANZ. In addition, corporates face a mine26 ASIAN BANKING AND FINANCE | JUNE 2015

“Banks could advise corporates – many of whom are expanding overseas as part of their ambitious growth strategies – on region-wide integration.”

field of regulations that force them to provide a large amount of data regarding transactions and counterparty. These regulations, which are aimed to strengthen the banking sector, can prove onerous to Asian corporates especially since these had not been required in many other established markets, says Natarajan.

As a result, Asian corporates are often overwhelmed and require banks to act as creative guides. Banks are expected to provide clarity and then propose customised solutions that will meet a corporate client’s increasingly complex needs. “The regulatory considerations in most markets could be fairly daunting to corporate treasury,” says Natarajan. “Banks can assist on establishing an appropriate operating model and share practices for better efficiency.”

Banks could advise corporates – many of whom are expanding

overseas as part of their ambitious growth strategies – on region-wide integration, while providing real time transactional and reporting capability for each of the geographies, he adds.

Given the mounting needs of Asian corporates for specific services, there is even an opportunity for banks to act as aggregators in partnership with non-bank operators such as telecommunications firms and payment gateway companies to provide a “safe and compliant access to services through a single point,” says Natarajan.

Integrated end-to-end solutions Realising that Asian corporates are looking for fully integrated end-toend cash management solutions, Maybank is one of the banks that has embraced customisation as a source of competitive advantage.

As an example, Maybank recently developed a customised solution for a multinational that faced challenges due to its decentralised cash balances held in various accounts across several banks, according to Maybank.

Maybank created an innovative liquidity management solution which used in-country pooling and cross-border aggregation. This gave the bank’s multinational client higher

SECTOR REPORT 1: CASH MANAGEMENT

More regional treasury centres arise in Asia

investment yields and greater control of their cash flow.

Offering such a customised solution begins with banks asking the right questions. Then the banks should draw on their industry knowledge and local expertise to come up with answers. “The process starts with the right engagement and communication between the bank and corporate in order to identify key needs of the client and there on develop effective solutions to meet those needs,” says a Maybank spokesperson.

“As the needs of corporates may vary according to industry, sector and even geography, often solutions are highly customised. Therefore, banks need to have both local as well as regional expertise in order to implement comprehensive solutions that help corporates optimise not just their cash management but the entire working capital cycle,” he adds.

Regulatory headaches When corporate clients approach banks, not only do they expect banks to have their troubleshooting hats firmly on, but also offer a prescription for their regulatory headaches.

The largest issue by far in regulations is withholding tax and the potential tax leakage on gross interest flows due to its potential material impact on the economics of global cash pooling arrangements, says James Badenach, financial services tax partner for Asia Pacific at EY. These headaches stem from the patchy development of tax laws and practice in and among Asian countries.

“Asia still has a long way to go

with respect to making its tax rules more efficient for cross border cash management, compared to Europe,” says Badenach. “The locations in Asia have varying levels of development in tax laws and practice, nevertheless, it is fair to say that there is a significant incidence of cross border withholding tax on interest payments which impacts cross border cash management in Asia. However, the bigger issue in Asia are the regulatory restrictions associated with currencies as opposed to tax,” he adds.

Badenach notes that in respect to withholding tax, Hong Kong is the exception rather than the norm by not levying withholding tax. Even Singapore levies withholding tax on cross border payments of interest, except in certain circumstances under specific incentives.

Rise of Asian RTCs In their role as creative problemsolves and local regulatory experts, banks often end up with clients asking a conundrum: Which country to host their treasury function? Badenach argues that the aforementioned tax implications have a significant weight on this decision. “Tax is an important location selection criteria for both the location of treasury functions and where transactions are booked. The tax implications generally have a greater impact on the location of where transactions are booked,” says Badenach.

While European countries have been preferred, there is an increasing presence of regional treasury centres (RTCs) in Asia. Badenach attributes this to a list of advantages such as enhanced transparency, operational

Balaji Natarajan

James Badenach

Benny Koh

efficiency, risk management process as well as cost reduction. He says there are four key location considerations for RTCs mainly include sophistication of the banking and financial system; political, legal and regulatory environment; tax and cost considerations; and proximity to the underlying business of the corporate group or the corporate and regional headquarters.

Given these considerations, Singapore and Hong Kong are considered as the most preferred locations in the region, although Badenach says there are also evolving centres like Shanghai, Malaysia and Thailand.

Singapore and Hong Kong stand out from the rest of their counterparts because of their well-developed banking system, efficient capital markets, deep talent pool of experienced treasury and banking staff, and the common law legal system, says Badenach.

For his part, Benny Koh, managing director, treasury advisory, Deloitte Southeast Asia, says companies looking to set up RTCs in Asia should consider factors like a city’s connectivity to broader financial markets, availability of skilled employees, quality of public and IT infrastructure, political stability and availability of incentives.

He says Singapore scores high on all these decision points, making it an attractive destination for RTCs. Moreover, challenges to set up RTCs in Singapore ought to be minimal since process is well documented and the requirements to available incentives are clearly articulated.

“The rise in the numbers of RTCs in Asia is encouraging as it reflects Asia’s growth and importance in the global trade arena,” says Koh. “The increasing middle income population in Asia will continue to drive demand for goods and services and multinational companies that want to reach Asian customers faster will continue to optimise their supply chain and go-to-market strategy.” As more corporates look set up their treasury functions in Asia and considering the upheavals in technology and regulation, skill rather than size may determine the winner in Asia’s lucrative cash management competition.

ASIAN BANKING AND FINANCE | JUNE 2015 27

SECTOR REPORT 2: banking technology

It’s high-time for banking products on-the-go

Banks urged to make digital services accessible as non-bank entrants step up Generation Y & Z’s spending is ramping up, and so is the need for instant access to banking products.

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ith Generation Y and Z steadily moving into the wealthier phases of their economic lifecycle, these “digital natives” are becoming an increasingly larger part of the total spending pie. Mohit Mehrotra, a consultant at Deloitte, estimates Generation X, Y and Z’s spending to be about 75% of the total spending in Australia, Hong Kong, Malaysia and Singapore by 2025. As these native netizens become increasingly significant economically, the dominant consumer preference will eventually shift towards access to banking products on-the-go, and in real-time. As a result, this will drive the growth of demand in end-client digital services over time, which is a theme that banks will have to address.

The incumbent banks’ lack of speed in reacting to the growing trend of digital banking has afforded disruptors a very clear opportunity to take advantage of an underserved need.

28 ASIAN BANKING AND FINANCE | JUNE 2015

“Generation X, Y and Z’s spending will be about 75% of the total spending in Australia, Hong Kong, Malaysia and Singapore by 2025.”

Due to the lack of online transaction banking products, non-bank players often referred to as ‘FinTechs’ have emerged as disruptors, notes Mehrotra. With the non-bank challengers having seized the chance to establish themselves as early adopters in this space, banks will inevitably have to step up their investment in the digital transaction processing space lest they lose out to the disruptors in this highly lucrative new sector.

Iswaraan Suppiah, group chief information & operations officer at CIMB, notes that for banks, “the next challenge will be to make these digital services as simple and easy to use as like the smartphone apps from technology firms.” According to Suppiah, the digital needs of the customers will definitely have to be met in the coming years, as “banks that don’t gear up will be replaced by non-bank entrants.” Banks are actually very well positioned to be the leaders in this

space due to the advantage that they have in terms of client relationships.

Incumbent banks already have the large client databases, relationships, and the privilege of access to larger, institutional clients. Mehrotra notes that banks now have two broad strategic choices: Seek to gain a first mover advantage, or remain on the sidelines and be forced to play catchup eventually.

Tech investment remains with core systems As much as there is a need to invest in the infrastructure to offer new products and services, the bulk of IT investment for banks in the region is still dedicated to those that focus on existing clients and products or to production and maintenance.

According to Jan Bellens, global emerging markets leader for banking and capital markets at Ernst & Young, “Banks are very big spenders on IT –

SECTOR REPORT 2: banking technology the larger Asia-Pacific banks have IT budgets running over 1 billion USD. Unfortunately only about 30% of total IT spend in Asia-Pacific banks is going to investment.”

These “greenfield” investments into offering new product lines and service offerings still take a back seat to the requirements of banks to continuously upgrade their core banking systems in order to meet regulatory and existing customer needs. Even in banks that are making digitalization a strategic priority, we still do not see large amounts of CapEx devoted to this.

For example, Alfian Sharifuddin, DBS Bank’s managing director and group head of consumer banking channels technology, reveals that with digital banking becoming a key priority, they spend over SGD600 million on technology every year. In 2014, DBS committed another SGD200 million over three years to digitalize the bank. The real priority for spending is still for enterprise platforms that serve the overall bank.

Strategic alternatives for banks Mehrotra presents two strategic directions for banks to address the shift in digital adoption of transaction banking. The first is a Digital Inside-Out and it is defined by internally driven initiatives that improve existing transaction banking solutions and steadily bring them online. The next is a Digital Outside-In strategy, centered on exploring capabilities that the bank does not currently have, in an attempt to bring new digital products and services to its clients.

The first strategy is something that many banks are currently employing

Banks break through social media

already. As mentioned earlier, one of the key focuses is the improvement of current systems and slowly bringing more products online, but with an emphasis on Enterprisewide capabilities. In the case of ANZ for example, they have laid out a roadmap for significant investment in technology for the foreseeable future.

“As a Super Regional bank over the last 3 – 5 years we have been investing in the construction of Enterprise Capabilities that are required to support our 33 countries – those platforms that are enterprise in nature such as Payments, Mobility/Digital, Data, Security and also corporate functions such as Risk, Finance and Human Resources,” says ANZ’s chief technology officer Patrick Maes.

Banks are looking towards an “omni-channel” customer experience rather than preferring one channel over another. Consumer banking units are becoming more strategically focused on allowing the customer to transact anytime, anywhere, and in whatever way that they like. CIMB’s online & mobile platform Clicks, for example, is focused on functioning as a “branch in your pocket” according to Suppiah.

Alfian Sharifuddin

Patrick Maes

Jan Bellens

Social media key to connecting with customers The significant amount of total time spent on the web that is allocated to social media presents a great opportunity for banks to engage their customers through these channels.

DBS noted that they have more than 2 million internet banking users, and that at least 1 million transactions are done via their mobile platform.

Sharifuddin notes that since the “The significant amount of total time spent on the web that is allocated to social media presents a great opportunity for banks to engage their customers through these channels.“

launch of DBS PayLah! Last year, their mobile wallet that can also be used for peer-to-peer payments, they have already garnered 200,000 users which makes them one of the most popular mobile wallets in Singapore.

For SME owners, they launched DBS BusinessClass, which allows entrepreneurs to participate in discussions, access news, articles and register for exclusive networking events or seminars anywhere they are. “We also encourage our staff to become mentors to SME owners, maintain an active presence and share insights through the DBS BusinessClass app, which now has more than 7,000 members,” says Sharifuddin.

Not only does this allow banks to draw customers towards their products through promotional activities, but it also to provide real-time, seamless customer service through the platforms’ built-in messenger services. According to EY’s Bellens, “One of the biggest challenges for banks in the digital world is to drive consumer engagement. Consumers are engaged with timely news snippets, they are engaged by games and they are certainly engaged with social media.”

The customer-in-charge theme This is a key area that banks must be able to capitalize on, but very often in the past, they have struggled to maximize the potential from social media. “Banks that can capitalize on the ability of Social Media to connect our customers to each other and to services ecosystems that support this notion of the customer in charge will extract the most from this potential,” says ANZ’s Maes. He notes that the theme of “customer in charge” will continue in the future as social media continues to influence and shape industries.

According to Maes, this is not just something found in trendy areas such as social media, mobile apps, and big data. In the area of mobility, we see an increasing demand for convenience; in intelligence and advisory, customer trust is more difficult to garner; also, arguably most important, the need for a information security for online platforms has become almost essential. “This is a key proposition of banking into the future,” he adds.

ASIAN BANKING AND FINANCE | JUNE 2015 29

ANALYSIS: apac banks’ shape shifters

The impact of a domestic slowdown is potentially high for India

APAC banking sector outlook: Six shape shifters that may reset the region’s course Government support and regulation are potential high-impact negative factors, according to S&P.

R

egulation is the name of the game for Asia-Pacific’s banking sectors in 2015. It’s now Asia-Pacific’s turn to consider introducing certain regulatory developments that are being implemented in the U.S. and Europe, and it is a process that Standard & Poor’s Ratings Services projects might be challenging for many of the region’s banking systems.

Some systems, such as Japan, Australia, and Hong Kong, have begun preparing themselves for the new phase of global regulation. And they are the ones whom we can see as being most likely to remain ahead of the others as the changes take hold. However, in such a large and disparate region such as Asia-Pacific, we see a range of potential intermediate or high-impact negative factors that could cause a change in our overall current view that the region’s system is overall stable. Front and center are considerations of government support and regulation – including matters integral to stable outlooks and ratings rigidity at current levels – in particular including whether local banking sectors follow the lead of the U.S. and Europe concerning a likely reduction of direct government support and implementation of senior creditor bail-in or whether they choose an alternative path.

Other factors include high private sector debt, rising and/or already high property prices in some countries, 30 ASIAN BANKING AND FINANCE | JUNE 2015

A potential major disorderly property adjustment in China as having a high or intermediate negative impact on many AsiaPacific banking sectors.

and a potential disorderly market response to U.S. monetary policy tightening. Further, we continue to contend that a potential major disorderly property adjustment in China – even if we believe it to be a low-probability occurrence – as having a high or intermediate negative impact on many Asia-Pacific banking sectors.

So what will influence the outlook for Asia-Pacific’s banking sectors in this new epoch of global regulation, amidst the continuing confluence of economic and industry risks? We believe there are six key factors poised to determine the way things go for the region’s financial systems.

Shape Shifter 1: 2015 Will See A Focus On Government Support As is occurring in Europe, 2015 is shaping up as a watershed year for regulation in Asia-Pacific’s banking systems. On Feb. 3, 2015, Standard & Poor’s took various rating actions on certain U.K., German, Austrian, and Swiss banks following a review of those banks’ government support. These rating actions reflected our view that extraordinary government support is now unlikely in the case of U.K. and Swiss nonoperating holding companies (NOHCs), and is likely to become less predictable for operating companies in the U.K., Germany,

ANALYSIS: apac banks’ shape shifters and Austria under newly enacted legislation that fully implemented the bail-in rules enshrined in the EU’s Bank Recovery and Resolution Directive (BRRD), effective Jan. 1, 2015.

Whether banking systems in Asia-Pacific ultimately embrace trends emerging from the U.S. and Europe concerning alternative solutions to the traditional government support model (such as via the implementation of senior creditor bail-in) will likely be a key rating factor impacting ratings or outlooks in 2015.

The potential removal of government support – while currently perceived by us as a low-probability scenario in many Asia-Pacific banking sectors – is likely to have a negative rating impact, should it occur. This is because Asia-Pacific has a high proportion of banking systems (14 of 19 rated banking systems) whereby we view a government as “highly supportive” toward its country’s banking sector.

By contrast, we currently assess none of the 19 Western European systems for which we rate banks as “highly supportive” (all are currently considered “supportive”), while in the U.S. and Canada we also currently believe the respective governments are “supportive” but not “highly supportive” toward their banking sectors.

We note that higher rating uplift above a private sector commercial bank’s stand-alone credit profile (SACP) is available for highly systemically important banks in jurisdictions in which we view the government as “highly supportive” rather than “supportive” (or where government support is believed to be “uncertain”, in which case we attribute no ratings uplift). In our opinion, Asia-Pacific bank ratings have potentially greater scope

A downside scenario for economic growth across Asia-Pacific banking sectors could include weaker-thanexpected domestic demand and a global economic slowdown.

Rating outlooks and credit watches for Asia Pacific financial institutions (February 28, 2015)

Source: Standard & Poor’s

Gross nonperforming loan ratios

Fiscal 2014 figures are annual figures for Australia, Singapore, Hong Kong, New Zealand, Thailand, Indonesia, Vietnam.

Figures through second quarter for Japan, Taiwan, Korea, Malaysia, Srilanka.

Figures through third quarter for China, India and figures through second and third quarter for Philippines. Data is for selected banks.

Source: Standard & Poor’s, banks, and other sources

for deterioration from current rating levels should we ever believe that there was a diminution in government support, compared with banks in some other regions.

Shape Shifter 2: Slowdown In Domestic Economies We continue to believe that there is a relatively low probability in most of the region’s banking systems of an economic slowdown during 2015 that is significantly worse than our current downside scenario. Moreso, recent, positive external developments in the form of stronger consumer spending in the U.S. and lower global oil prices mean things are looking up for the Asia-Pacific region overall, noting that the economic data is yet to reflect these tailwinds.

In our view, the impact of a domestic slowdown is intermediate for most of the banking systems but potentially high for India and Vietnam. This is because the stressed asset cycle is already weighing on the performance of these banking systems. We see anticipated brighter economic prospects during 2015 for both of these countries, although we believe respite from asset-quality problems is still some time away. Concerning India, our opinion is that the economic trend as it influences banking sector creditworthiness remains negative. Aside from New Zealand and India, the other two banking sectors in Asia-Pacific for which we view the economic trend as negative are Malaysia and Mongolia. Looking forward, and consistent with our overall stable outlook across Asia-Pacific, we would expect some rigidity in non-performing loan levels across the region in 2015.

In our view, a downside scenario for economic growth across Asia-Pacific banking sectors could include weaker-than-expected domestic demand and a global economic slowdown. Intensified risks in the eurozone, a major disorderly property adjustment in China, and an adverse market reaction to the U.S. Federal Reserve’s monetary policy normalization could potentially trigger this downside scenario.

We also continue to monitor political developments, where relevant. For example, in Thailand, a downside scenario for economic growth may also be triggered by heightened political problems.

Shape Shifter 3: Eurozone Risks Our view is that eurozone risks could have an intermediate impact across most Asia-Pacific banking sectors. In our view, an intensification of risks in the eurozone and Russia could hurt banking sector creditworthiness, as the region remains dependent on global trade. We further note that eurozone stress could likely result in higher wholesale funding costs for some Asia-Pacific banks that depend on borrowing from Europe, or in a significant period of disruption that access to markets could be a problem, not just cost.

We note that banks in Australia, New Zealand, and to a lesser extent Korea depend more than others in the region on wholesale funding, noting that most banks in these countries contended satisfactorily at prevailing rating levels with the significant period of market dislocaASIAN BANKING AND FINANCE | JUNE 2015 31

ANALYSIS: apac banks’ shape shifters asset-quality ratios for many banks in these countries are sound by international standards, with some scope to absorb higher problem loans associated with property lending in the context of current ratings and outlooks.

In China, and elsewhere in Asia-Pacific, our opinion is that while a price decrease of 20%-30% would inevitably hurt banks’ asset quality, we currently view this factor as having an intermediate but not high impact on banking sector creditworthiness. For China, however, a confluence of negative developments above and beyond our current scenario could easily see us revise this risk factor to “high” from “intermediate”.

These factors could include, but are not be limited, to a: Potential price plunge materially in excess of our current 20%-30% scenario; and/or relaxation of bank loanto-value from current levels; and/or greater dependency by real estate developers on bank funding rather than other sources of capital.

On the topic of China, we continue to view risks associated with the increasing shadow banking sector as having the potential to spread to the banking sector, which inevitably could negatively affect certain banks’ credit standing.

Thailand cut rates recently

tion in the wake of the global financial crisis beginning in 2009; in recent years they have generally strengthened funding capabilities.

Shape Shifter 6: Rising Interest Rates We view a short-term interest rate hike as having an “intermediate” impact on some Asia-Pacific banking sectors, whereas in some others we expect the impact to be “limited”.

We envisage that tighter monetary policy in the U.S. and subsequent run-up of market rates could trigger interest rate hikes in global and local markets. We see this scenario as more likely impacting some countries, including Singapore, the Philippines and Hong Kong. By contrast, some other countries (China, Korea, Thailand, India, and Australia) have cut rates recently, with the likelihood of a U-turn less likely in the short term.

In our opinion, Indonesia is the Asia-Pacific banking sector that may be the most likely to experience a negative impact on banks’ credit quality from higher interest rates. We note that interest rates in Indonesia have risen by 175 basis points already in recent times, as the government has sought to defend the rupiah.

Shape Shifter 4: A Major Disorderly Property Adjustment In China Even considering we believe it to be a low-probability outcome, our scenario for a major disorderly property adjustment in China would have a high impact. This scenario would, in our opinion, likely lead to significant negative spillover effects for the economies and banking sectors in China, Taiwan, Hong Kong, Japan, Korea, and Singapore. We note that China is an important trading partner for those countries, and that a major disorderly property adjustment in China could lead to recessionary conditions in these countries that in turn could severely hit the asset quality of their banks.

Further, Hong Kong banks have relatively high direct exposure to China, and could likely suffer material credit losses on those loans. Some other countries, including Australia, New Zealand, and Indonesia, would likely be adversely affected by collapsing commodity prices in a hard-landing scenario. By contrast, the banking sectors in some other Asia-Pacific countries, such as the Philippines, India, and Sri Lanka, would likely be less affected because of these countries’ lower dependence on exports to China.

Shape Shifter 5: Plunge In Property Prices In our view, sensitivities concerning the property sector are an intermediate risk factor for many Asia-Pacific banking markets. For banks in Australia, New Zealand, Singapore, Malaysia, China, and Hong Kong, a plunge in real estate prices is a key risk factor because home loans and real estate-related loans account for a significant percentage of bank lending.

Furthermore, private sector indebtedness in these countries is relatively high by international standards, and – to varying degrees – property prices are rising and/ or already high. These factors are even considering that 32 ASIAN BANKING AND FINANCE | JUNE 2015

For banks in Australia, New Zealand, Singapore, Malaysia, China, and Hong Kong, a plunge in real estate prices is a key risk factor.

Resetting The Course?

The world is demanding changes to banking practices and expectations, so as to hopefully better manage a repeat of the global financial crisis experienced in the second half of the 2000s.

The challenges of embracing a globally uniform set of banking standards are highlighted by the differing economic and industry risk factors characterizing Asia-Pacific banking. Some countries – Japan, Australia, Hong Kong – are further progressed in making this assessment, while other countries within the region have a ways to go in considering trends taking hold in Europe and the U.S. The direction that individual countries take could have shape-shifting implications for bank credit quality in Asia-Pacific. By Gavin J Gunning, credit analyst at Standard & Poor’s Ratings Services

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