Inflation, weak economies to erode Asia Pacific banks’ buffers in 2023

The falling valuation of assets worldwide and supply disruptions weigh on banks’ profits.

Financial industries should brace for tough times as analysts forecast a difficult year ahead.

Banks’ buffers, built over the past decade, are expected to come into test amidst a period of rising interest rates, inflation, and weakening economies, S&P Global Ratings noted in its annual banking outlook.

“Higher inflation and weakening economies may eventually catch up with banks. Inflation is at 40-year highs in some banking jurisdictions, and this is feeding into higher. Inflation is also putting the brakes on the outlook for economic growth,” the ratings agency warned.

Quintuple whammy

In a banking review, McKinsey & Co. listed five shocks affecting banks globally, including those in APAC, as a result of the longtail effects of the COVID-19 pandemic and ongoing geopolitical tensions in Europe and East Asia: macroeconomic shock; asset value shock; energy and food supply shock; supply chain shock; and talent shock.

“Soaring inflation and the likelihood of recession are sorely testing central banks, even as they seek to rein in their quantitativeeasing policies,” McKinsey wrote.

Another notable issue that banks face is falling valuations of assets worldwide. In China, the decline is felt especially from its property market, which in turn will contribute to its expected slowing loan growth. In a separate report, S&P Global Ratings Senior Director & Sector Lead Analyst Harry Hu said that the country’s overall loan growth will likely come at below 10% in 2023, worsening from the 10.6% expected for the full year of 2022.

“A moderately easing monetary environment, fierce deposit competition, and concessional loan rates to policy-preferred sectors continue to erode the sector’s profitability. Property development stress lingers despite initiatives to contain the risk,” Hu noted.

China is not the only market with property woes. Property sector refinancing risk has also risen in Vietnam, S&P analysts noted. In contrast, Australia, New Zealand, Hong Kong, and South Korea are experiencing house price declines after years of sustained increases.

“A sudden drop in market confidence could heighten systemic risks,” the analysts said. “Nevertheless, healthy loan-to-value ratios in Hong Kong, South Korea, and Singapore; healthy mortgage insurance in Australia; and debt serviceability limits and tests in all four markets should partly mitigate asset quality risks.”

Fintechs and cryptocurrencies are noted to also be losing their values. The crypto industry in particular is in tough times, with notable high-profile bankruptcies of cryptocurrency organisations, most recently that of cryptocurrency exchange FTX.

Banks will also be affected by disruptions to the energy and food supply related to the war in Ukraine. The ongoing conflict reportedly contributes to inflation and puts millions of livelihoods at risk, McKinsey warned. Supply chain disruptions that began during the pandemic persist, and continue to affect global markets.

The fifth shock is related to employment. COVID-19 has reshaped and shrunk the talent pool as more people began to work remotely or left the workforce altogether to join what McKinsey calls “the great attrition.”

Some rise, some fall

In Asia Pacific, a gap will exist between the performance of banks in emerging markets (EM) and those in developing markets (DM).

“We expect most APAC EM banking systems to report steady financial performance in 2023 or only mild variance versus 2022. This partly reflects our forecasts for continued robust economic growth in India and Southeast Asia, and stronger growth in China, despite the weaker external environment. This should support loan expansion, with benefits to net revenue, which will largely offset weakening asset quality,” S&P said in a recent report.

In contrast, banking systems in APAC DMs–Australia, Singapore, Japan, South Korea, New Zealand, Taiwan, and Hong Kong–will post a more mixed financial performance. Loss absorption buffers in these markets should remain similar to 2022 levels, S&P said, adding that in general APAC DM banking systems should be able to weather the deteriorating global economic landscape in 2023 better than other regions globally.

The exceptional and the egregious Two markets will buck the trend: Sri Lanka and Singapore.

Singapore banks’ profitability metrics are expected to strengthen further to above pre-pandemic levels in 2023, even taking into account credit costs and their loan growth being hit by the ill effects of the external environment.

“Singapore banks are well placed for margin upside over 2022 and 2023 as rate hikes gain momentum. Balance sheets of large Singapore banks are rate-sensitive and benefit from an extensive buffer of low-cost customer deposits,” said Ivan Tan, Primary Credit Analyst for Singapore, S&P.

Tan added that a NIM (net interest margin) expansion of 10 bps-15 bps in 2023 is possible. However, the nonperforming loan ratio could weaken over the next 18 months.

“We have become more circumspect on mainland China and some regional economies to which Singapore banks are exposed. China’s economy faces downside risks from its property downturn and strict COVID curbs,” Tan warned. “[However] we believe general provision buffers built up during the pandemic offset downside risks to asset quality, and the overall financial impact should be manageable.”

On the other end of the spectrum, Sri Lanka’s banks face a tough 2023. S&P named banks in Sri Lanka as having the highest financial profile vulnerability in its metrics.

“The operating environment remains challenging for the lenders following the sovereign’s default on its foreign currency obligations in May 2022,” S&P reported.