Global macroeconomic challenges are likely to increase pressure on the short-term earnings prospects of investment-grade banks in the Asia-Pacific, Fitch Ratings says in a new report. The report addresses the main questions asked by US and Canada-based investors during a recent tour by Fitch analysts to discuss mainly investment-grade rated banking systems, with particular focus on Australia, New Zealand, mainland China and Hong Kong, Japan, Korea and Singapore.
Banks in most markets face several challenges to operating performance, including increased costs related to regulation, slower trade and economic growth, subdued loan growth, low interest rates and acute competition. These factors are squeezing net interest margins and overall profitability. However, while many banks are likely to report weaker financial results (or less improvement) in 2020 than in 2019, we do not expect significant deterioration, and there is unlikely to be any immediate impact on ratings. Consequently, the majority of bank ratings remain on Stable Outlook. Nevertheless, some banks in Australia (in particular, the major banks and their New Zealand subsidiaries) and in Japan are more exposed to negative rating pressure. Where this is the case, ratings are on Negative Outlook.
To combat these pressures, banks are increasingly competing for fee income as part of less asset-intensive (or risk-weighted asset-intensive) growth strategies, including boosting total income from key relationships. However, many banks have resorted to taking additional risk, typically credit risk, in search of greater revenue and margin drivers.
Increased risk appetite is appearing in various channels. These include expansion into banking systems in overseas markets where Fitch regards the operating environment as weaker; moving down the credit curve to support loan-yields (through SME lending and unsecured personal lending, for example); holding higher-yielding investment securities; and higher loan concentrations in certain sectors such as property. The latter has been attractive to banks from a risk-adjusted return perspective, but higher concentrations increase the risk of faster deterioration in less-benign operating conditions.
We expect Australia’s major banks to face further earnings pressure in 2020. Falling interest rates and slow credit growth are putting pressure on net interest income, while the sale of parts of the banks’ wealth management operations and a reduction in fees and commissions will hit non-interest income. We expect a modest uptick in impairment charges in the weaker operating environment, with households remaining susceptible to shocks in light of their high leverage, while remediation programmes and system investments will weigh on costs. Furthermore, higher prudential standards in Australia and New Zealand will weigh on overall returns on capital, even though they will support the intrinsic strength of the banks. Australia’s economy is stable but growth is subdued, with downside risk stemming mainly from a weaker global economy and the US-China trade dispute.
Bank ratings in China, Hong Kong, Korea and Singapore remain stable, reflecting either external support (sovereign or institutional) or the banks’ intrinsic financial profiles having adequate buffers at current rating levels to weather expected deterioration in 2020. Nevertheless, downside risks exist, due to external challenges and, in Hong Kong’s case, an economy hit hard by social unrest. Increasing exposure to faster-growing emerging markets is likely to add to pressure, but this may only become more evident when the operating environment is less benign. This is also the case for Japanese banks, and comes on top of structural challenges to their domestic operations, which are likely to continue dragging on earnings and internal capital generation.
