Weekend Comment Dec 9: Challenges ahead for Asian banks

A RECENT BLOOMBERG report pointing out that Hong Kong “may need to stand behind some banks and deposits” should Europe’s debt crisis worsen put the spotlight on Asian banks.

Nigel Chalk, the International Monetary Fund’s China mission chief, is reported to have said that in a very bad scenario the government may have to “perhaps guarantee some of the deposits in the banking system as they did in 2008 in the wake of Lehman Brothers”.

After the Lehman collapse in 2008, the Hong Kong Monetary Authority used its foreign exchange reserves to guarantee bank deposits and the government announced a fund from which banks could access additional capital if needed, shoring up confidence in lenders after the run on Bank of East Asia.

 

This time round, the Euro-crisis continues to buffet the markets and Asian banks may remain under pressure. According to a Dec 8 report by Citigroup, Asian banks are currently trading at 1.34 times (trailing) price to book. Going by past cycles, these banks should have 28% upside. However, because of the de-rating of Europe’s banks, US$ liquidity “risk-off” events, and a near-term soft patch for China's economy, Asian banks are unlikely to recover so soon.

 

“We are only six months into bank net earnings downgrades; the 12-14 months of past cycles may prove a better ‘buy banks’ signal,” the report states. Citi economists believe that Asian GDP should hit the trough by March 2012. On a historical basis, banks tend to recover after such an event.

 

Of some concern are the banking systems in Hong Kong, Singapore and Malaysia. Citi cites reports from the Bank of International Settlements data showing that the banking systems of these three economies have large exposures to European banks. Clearly there would be a negative impact when Eurozone banks have to “deleverage” their balance sheets. Citi points out that the large banks in Asia such as HSBC, Standard Chartered and the US and Japanese banks will remain present in the region as they are less affected.

 

At any rate, Asian banking systems in local currency terms are nowhere near as liquid in 2011 as they were in 2008 pre-Lehman. Loan to deposit ratios or LDRs and loans to lendable deposits in many Asian currencies are at a multi-year high. “That leave Asia's banks relatively more vulnerable to a liquidity crunch, should it occur, and at the very least we sense that many banks have increasingly relied upon more expensive time or wholesale deposits to underwrite loan growth in the past year as funding tightened,” the Citi report states.

 

Another potential concern for investors in Asian banks is how much and how widespread US$ lending growth has become in Asia's banks in the past 1-2 years. “Such banks’ US$ lending will come under scrutiny given that the price of US$ funds has tightened sharply in recent months,” Citi says.

 

Asian banks’ capital levels are one of the best globally. “Generally we do not foresee direct material adverse impact upon Asian banks, and hence we have not considered this as a major concern in 2012,” Citi says, adding that Asia could be impacted indirectly given European banks’ forced balance sheet deleveraging.

 

As for the most recent set of results, in Singapore, 3Q11 results disappointed. DBS Group Holdings delivered the best performance with earnings rising 4% qoq on robust core banking results. Net interest income edged up 1% qoq as strong loan growth helped offset margin compression. Non-interest income was supported by steady fee income growth while trading gains held up well.

 

“The best line of defense would be to stick with the most liquid, strongest deposit franchises in each country,” Citi says. In Singapore its top pick is DBS. In China, Citi likes Industrial and Commercial Banking Corporation (ICBC) while in Hong Kong, Bank of China (Hong Kong) is its top pick. Citi has a sell on Bank of East Asia.