Dec. 04 2018 — 2019 is shaping up as a more difficult year for the region's banks. The majority of our outlooks on Asia-Pacific banks are currently stable (see graphic on page 2), and our base case is that the banks will most likely weather the more difficult credit conditions at their current rating levels. We see little rating upside during 2019 but some notable downside risks that potentially could affect ratings. While we expect that most banks can contend with a moderate and gradual negative turn in the credit cycle at current rating levels, a significant and abrupt credit cycle downturn would likely result in negative ratings momentum for some Asia-Pacific banks.
For High Debt And High Asset Prices Set The Scene For A Cyclical Downturn
Many Asia-Pacific banking jurisdictions are at, or slightly past the peak, of what has been an extraordinarily long credit cycle. China has been on a very strong credit growth path since the Global Financial Crisis when it put together a Chinese renminbi (RMB) 4 trillion stimulation package to support its economy; and Australia has, rather astonishingly, not had an economic recession for 27 years. More generally, the effects of the global financial crisis beginning in 2008 were more muted in the Asia-Pacific region than in the U.S. or Western Europe.
A combination of high debt and high asset prices that has evolved over much of the Asia-Pacific region during a protracted period of low interest rates is a natural red flag for the future credit standing of Asia-Pacific banks. Strong growth in debt across the region has manifested in many forms. Household debt is high in some jurisdictions, including Australia, New Zealand, Korea, Malaysia, Singapore, and Thailand, while growth in corporate sector debt has been strong in China.
Property is a continuing key risk factor across numerous jurisdictions in Asia-Pacific - including China, Hong Kong, Australia and New Zealand – even if concerns have ameliorated, to some extent recently, in some markets.
A key factor that could undermine ratings is if there were a sharper or more significant or prolonged correction in asset prices than we currently envisage--in particular if accompanied by other negative developments such as a meaningful pullback in market liquidity.
Heightened Market Risks
Exacerbating risks leading into 2019 is that markets have become more volatile during the fourth quarter of 2018; and that we expect this trend will continue. The existing environment of depreciating domestic currencies--most notably affecting India and Indonesia in Asia-Pacific--and skittish bond markets, as well as expectations for higher interest rates and more difficult financing conditions in 2019, are likely to pose additional risks and further challenges for Asia-Pacific banks.
Pre-Positioning Ahead of Potential Financial System Stress
The Asia-Pacific region reflects a diverse range of banking risks across the 20 jurisdictions where we assess banks (see chart 1). Unless a significant and abrupt negative step change in credit should occur--which is plausible but currently outside our base case--we retain our view that most Asia-Pacific bank ratings are likely to remain stable during 2019. In part, this is due to our prepositioning of ratings that has already occurred for the negative turn in the credit cycle that we believe will ultimately be inevitable. Over the past two years, we have progressively made numerous negative adjustments to our banking industry country risk assessments and ratings in major markets, mainly reflecting our view that the relentless buildup of economic imbalances or impending future higher credit risks in the economy will eventually take their toll on bank credit quality. These negative adjustments include those in New Zealand (August 2016), India (November 2016), Australia (May 2017), and China (September 2017).
Meanwhile, we retain our negative view of industry risk in the highly competitive and low profitability Japanese banking sector; and harbor lingering concerns regarding the potential for very high house prices in Hong Kong to hurt banking sector credit quality notwithstanding that these risks have eased, to some extent, in recent months.
Asia-Pacific Banks In Reasonable Shape, By International Standards
Heading into stronger headwinds, asset quality in the Asia-Pacific region compares more favorably than other regions on some metrics and as indicated by the ratio of nonperforming assets (NPA) to gross loans for banks in the global top 200 (see chart 2). Differences across regions primarily reflect variability in the stage of the credit cycle--Western European NPA metrics experiencing a long, slow recovery from the aftermath of the global financial crisis that began in 2008 and that crystalized in peak NPAs in 2013. Also noted is that slower charge-off practices in some Western European markets lead to an optically higher structural NPA ratio, even in good economic times. We believe that Asia-Pacific NPA metrics have some prospects for deterioration from their current strong levels as the credit cycle turns.
Cold Wind Blowing – Downside Risks Not To Be Underestimated
While our base case is for relative ratings stability in 2019, downside risks cannot be discounted or underestimated. A number of worrisome regional risks are at the centerpiece of our forward view and any meaningful escalation concerning these risks will likely contribute to negative ratings momentum for banks. In addition to banks having to contend with heightened market risks leading into 2019 - including more volatile commodity, currency, equity and property prices - we are concerned with worsening corporate refinancing risks and the spillover effect on banks from the U.S.-China strategic confrontation. Risks associated with China’s leverage, as well as technology disruption and cyber security, remain elevated but are relatively unchanged over recent months leading into 2019.
Asset Quality Should Remain Broadly Intact In Most Jurisdictions Throughout 2019
Our base case for 2019 is that nonperforming asset (NPA) ratios should remain relatively stable, by international standards, in particular across many of the developed markets in Asia-Pacific, including Singapore, Hong Kong, Japan, South Korea, Australia, New Zealand and Taiwan (see chart 4).
In some other jurisdictions, NPAs will remain much higher--notably India (see chart 5). Meanwhile, the asset quality outlook for 2019 for most countries in Southeast Asia is relatively stable.
While most Asia-Pacific banks can withstand some diminution in asset quality ratios during 2019 with no negative adjustment to ratings, a negative step change in credit because of an escalation on downside risks will contribute to negative rating changes.
Asset quality in India compares much less favorably than regional averages, and we see no meaningful change in this regard as likely during 2019. In India, we believe that banking reforms initiated by the government will eventually strengthen the banks but there will be significant challenges for banks along this pathway. We note that higher resolution of NPLs is expected in 2019 under the new Indian bankruptcy law, and while we expect the banking sector’s performance to gradually recover from about 2020 this could be delayed if currency depreciation or finance company liquidity issues impact the banking sector.
In China, we expect asset quality to slightly worsen over the next two years due to tighter lending conditions under financial and corporate sector deleveraging policies, corporates refinancing at higher interest rates, and more stringent rules on nonperforming loan recognition. Our outlook for problem loans in China takes into account special mention loans as well as nonperforming loans (see chart 6).
Relatively Stable Outlook For Capital and Earnings
Our earnings and capital outlook for banks in many Asia-Pacific jurisdictions remains broadly supportive of ratings at current levels. Generally mirroring our expectations for global banking trends ex-Asia Pacific, we expect risk-adjusted capital ratios of systemically important Asia-Pacific Banks to remain relatively stable in 2019 (see table 2, Issuer Credit Ratings And Component Scores; and chart 7, first published in our commentary "Top 100 Banks: Banks Are On Track To Withstand A Credit Cycle Turn," Oct. 2, 2018). We currently expect rigidity in our assessments of most banks' capital and earnings prospects during 2019, underpinned mainly by banks’ reasonably sound internal capital generation prospects.
Government Support Likely To Continue
We retain our view that systemically important private-sector banks should continue to benefit from government support in most jurisdictions during 2019. We note that government support remains high in AsiaPacific compared with banks in other regions in particular North America and Western Europe (see chart 8). We fully anticipate, however, that rating adjustments for Asia-Pacific banks will occur--as has already occurred in Western Europe and the U.S.--should banks transition to alternate resolution and crisis management frameworks that offer less support than government support.