Tougher times ahead for APAC banks as their risk appetite grows

Conditions make it hard for banks to boost earnings without taking more risk.

Four of the region’s developed-market banking systems and three of the emerging-market banking systems face a negative outlook amidst operating conditions that give them no choice but to take extra risk in order to boost earnings, according to a report by Fitch Ratings.

An earlier report by Fitch noted that banks are relying on various credit channels such as overseas expansions and higher-yielding investment securities to weather headwinds that affect profits, such as high prudential standards, weak growth prospects and the rise of digital technology.

Amongst developed market systems, Japan’s banking sector stand out amongst their regional peers in terms of taking on more risk. It has become hard for Japanese banks to boost earnings without taking extra risk given challenges to their business models and tougher overseas conditions, previous reports by Fitch Ratings revealed.

The banking systems of Australia, Hong Kong, and Singapore also face increased downside risk to financial performance due to weaker economic growth, lower interest rates, and strong competition.

“The most striking trend in recent years is banks increasing their risk appetite incrementally to support profitability in the face of lower interest rates, compression in net interest margins, softer growth prospects, strong competition and higher costs, especially in development markets. We expect this trend to continue in 2020,” the report noted.

Additional risk-taking actions include expansion into riskier markets, higher loan concentrations in certain sectors, M&A, and holding higher-yielding investments, noted Fitch Ratings. Banks supported asset growth by selectively relaxing underwriting standards with cheaper loan pricing or lower collateral coverage. Banks are also raising their exposure to property by lending to non-bank financial entities.

Asset-quality challenges also plague select emerging market systems in the region, notably China, India, and Indonesia. All three have negative outlooks for their banking sectors, whilst China and India are also under pressure to boost earnings and capital to support growth.

In particular, China’s banking sector is plagued by its high non-performing loan (NPL) ratio, which rose further to 1.86% in Q3 from 1.81% in Q2. This is also 3 bps higher compared with end-2018. The country’s rural and city commercial banks drove NPL ratio to deteriorate further, with troubled banks most numerous in Northern China, a report by BBVA Research said.

Conversely, Sri Lanka's banking sector’s outlook is now stable, reflecting brighter prospects for loan growth, according to Fitch Ratings. But the environment remains challenging following a cyclical trough.