Asian banks' efficiency gains may start to erode when interest rates fall

An expected turn in the interest rate cycle in 2024 will likely dent a trend of efficiency improvements for banks in several Asia-Pacific geographies.

Increasing interest rates improved net interest margins and boosted incomes for most Asia-Pacific banks, helping some lenders to lower their cost-to-income ratios in 2023. Now, as the region's central banks may be near the peak of their tightening cycles and may cut rates in 2024, the room for driving efficiency higher may become limited.

The average cost-to-income ratio, which measures a bank's operating expenses as a percentage of income, of lenders in Singapore fell to 40.47% in the 12 months ended Sept. 30, from 49.36% in 2022, according to data from S&P Global Market Intelligence. Banks in Taiwan logged a marginal improvement in their average cost-to-income ratio, the data showed.

Margin squeeze

"Obviously, profit margins at Asian banks will shrink," putting upward pressure on their cost-income ratios, if the US central bank cuts its rates next year, said Koichi Niwa, an analyst at Citigroup Global Markets Japan.

Still, banks in India saw their average cost-to-income ratio rise despite lower interest rates as lenders in the South Asian economy remain on an expansion spree, adding branches and customers as the economy grows.

Japanese banks, among the least efficient in Asia-Pacific, may gain as the central bank is widely expected to drop its policy of negative interest rates. "Banks in Japan could improve cost-to-income ratio as interest rates of the country are expected to rise next," Niwa said.

Taking cues from the US Federal Reserve, most major central banks in the region have raised rates since 2022 to tamp inflationary pressures. The tightening cycle is widely expected to be near its end and global central banks may start easing in 2024.

*Click here to download a spreadsheet with data featured in this story. *Click here to read our recent story on loan-to-deposit ratios of the 20 largest Asia-Pacific banks in the period ended Sept. 30, 2023.

Notable exceptions

The exceptions were the central banks of China and Japan. The People's Bank of China has maintained an easing bias through 2023 as it seeks to support the sagging economy. The Bank of Japan is evaluating data to decide if and when it may abandon its negative rates policy that's been in place since 2016. The Japanese central bank, in effect, tightened monetary policy by allowing long-term government bond yields to rise in a series of moves since December 2022, though it has yet to decide on raising short-term interest rates.

Banks in mainland China, among the most efficient in the region by cost-to-income ratios, improved further, mainly as they kept tighter control on costs. The average cost-to-income ratio of banks in mainland China declined to 37.50% in the 12 months to Sept. 30, from 40.30% in full year 2022, Market Intelligence data showed.

Mainland Chinese banks enjoy lower cost-to-income ratios "thanks to low labor costs, larger scale, advanced tech adoption and corporate banking focus," said Iris Tan, senior equity analyst at Morningstar.

China Zheshang Bank Co. Ltd. reported the lowest cost-to-income ratio of 25.67% among major individual banks in Asia in the July-to-September quarter, down from 28.20% in the prior year period. Several other mainland Chinese lenders, including Bank of Jiangsu Co. Ltd. and Bank of Shanghai Co. Ltd., saw their efficiency slide in the third quarter.

"If the US cuts its rates next year, that would make it earlier for China to cut its rates further," preventing the Chinese currency alone from depreciating against the dollar, said Koichi Mio, a senior economist at NLI Research, who covers the Chinese economy. Given that, cost-to-income ratios at Chinese banks could face upward pressure, Mio said.