After two years of Covid-19-induced economic slowdowns, escalating bad debt and meagre bottom lines, south-east Asian banks are primed for enhanced profitability and healthy credit growth in the coming months, riding the wave of higher interest rates region-wide.
As a rule, when central banks raise policy rates, in this case following the lead of the US Federal Reserve, which has hiked its policy rate from 0.13% in January to 4% in November, banks enjoy a period of higher net interest margins (NIM) as they hike lending rates quickly, while dragging their feet on the deposit rate.
South-east Asian banks are hardly exceptional in going for the bigger spread, but not all banking systems will benefit equally.
the Singaporean banks are one of the [Asia-Pacific] banking sectors that will gain the most benefits from the fed policy rate hikes
The Monetary Authority of Singapore (MAS) does not set policy rates for the local banking system. This means Singaporean banks can swiftly adjust their rates to whatever the Fed imposes in the US. “The Singaporean banks are one of the [Asia-Pacific] banking sectors that will gain the most benefits from the Fed policy rate hikes,” says Tania Gold, head of south and south-east Asia banks at Fitch Ratings. “The majority of the Fed rate rise has been flowing through in Singapore, so we are seeing large interest rate rises which are being reflected in the bank’s margins.”
Percentage jump
The swift pass-through from Fed hikes to the banks’ credits is assured by the lending practices in Singapore, where most loans are handed out on a fixed-plus basis, or a fixed rate of 0.5% plus the three-month interbank rate. Rates for most mortgage loans, for examples, have jumped from 1% in January to 4% in December, while current account and saving account (CASA) rates have remained relatively static.
DBS, the largest commercial bank in Singapore and in south-east Asia, stands to gain handsomely from the growing spread. “DBS has the strongest CASA franchise in Singapore at around 66%,” says Lim Rui Wen, group research analyst at DBS. “As a result, DBS has the lowest cost of deposits among peers and benefits from rising interest rates due to NIM expansion.” DBS saw its NIM widening to 1.9% in the third quarter of 2022 and expects it to reach 2.2% by mid-2023.
We expect double-digit percentage fee income growth next year, to be led by wealth management and cards
DBS and the other two Singaporean bank goliaths – United Overseas Bank and Oversea-Chinese Banking Corporation (OCBC) – should benefit from the higher interest environment across the region because only 50% of their lending is domestic. Besides the double-digit credit rise, the three big players have also been diversifying into more fee-based services. “We expect double-digit percentage fee income growth next year, to be led by wealth management and cards,” says Chng Sok Hui, chief financial officer at DBS. “Wealth management is stabilising and we will continue to benefit from capturing inflows from the region.”
But NIM remains the bread and butter for the Singaporean banks, as it is for all the south-east Asian banks. “Net interest income is about 65% of total income for Singapore banks, lower for OCBC due to its insurance subsidy,” says Ms Gold. “But I think 65% to 75% is run of the mill for Association of Southeast Asian Nations (Asean) banks. That’s normal.”
Indonesia’s comeback
Indonesian banks are likewise looking at greater profitability in 2023, but not necessarily due to higher policy rates enhancing their NIM. The policy rate has gone up, in line with inflation, but Indonesian banks have always had unusually high lending rates, compared with their peers. What is different about 2022/23 has more to do with market demand. “What we are seeing right now is for the first time in a long time the corporate loans are growing fast, and that is simply because the capital market is closed,” says Ivan Tan, banking analyst at S&P Global Ratings. In recent years, when global interest rates were low, Indonesia’s large corporations issued US dollar bonds, which enjoyed considerably lower interest rates than the Indonesian banks, which range between 8% and 12%.
That was before the Fed policy hikes. “If you fast-forward to now, the Federal Reserve has raised rates by so much that it no longer makes sense to raise dollar bonds,” says Mr Tan. The rupiah-denominated bond market remains undeveloped. “And the capital market is barely there, or frozen at this point. Which is why the corporate borrowers have come back to the banks, which is why the banks are experiencing a revival. They are looking at 8% to 10% loan growth. So that adds up to the volume-driven profitability we have seen,” says Mr Tan.
Around 50% to 55% of Indonesian bank loans are to large corporations, with 20% to households and the remainder to small and medium-sized enterprises (SMEs). This structure has not changed for the past decade. There is also tough competition for deposits among the Indonesian banks, for whom CASA deposits traditionally account for about 90% of funding.
One Indonesian commercial bank that is having no problem attracting new depositors is Bank Central Asia (BCA), part of the Djarum Group. BCA is the largest private sector commercial bank in Indonesia with the fastest-growing deposit base. “This is a bank with a strength in meeting the daily transaction needs of Indonesians that gives it a large pool of sticky, granular deposits, for which it faces less pressure to raise rates to maintain retention,” says Willie Tanoto, director, financial institutions at Fitch Ratings. “Many of the middle- to upper-income consumers in Indonesia have a BCA account, because it has long had a good distribution network and ancillary services like internet banking and credit cards that work well, so everyone keeps some money with them for their daily needs.”
S&P estimates the level of non-performing loans (NPL) in the Indonesian banking system at 5%, one of the highest in the region (where the average is between 2% and 3%), but these will not appear on the banks’ balance sheets until March 2024, when the final forbearance deadline falls due, after it was initially scheduled for March 2023.
GDP growth elsewhere
Both Malaysia and the Philippines are expecting above 6% gross domestic product (GDP) growth in 2022, and can anticipate 5% to 6% growth over the next three years, according to S&P Global. This sets a solid foundation for banking credit growth, with higher interest rates improving banks’ profitability, at least in the short term. In the higher interest rate environment, S&P foresees a 1.3% to 1.4% rise in return on assets (ROA) for Malaysian banks in 2023, compared with between 1.1% and 1.2% in 2022, and a 1.4% ROA for Philippine banks in 2023, compared with 1.3% in 2022. “This is on the back of higher margins from policy rate hikes, we expect, and lower credit costs,” predicted S&P Global of the Philippine banking sector. Loan growth of both Malaysian and Philippines banks should be in the 5% to 6% range for 2023.
Malaysia has greater immunity to the Fed’s direction than some of its Asean neighbours, analysts note. “For Malaysia, the starting point is that their inflation isn’t as bad as elsewhere,” says Fitch’s Mr Tanoto. “Administered prices and subsidies keep inflation better in check, and you don’t have as large a need to move the policy rate. The overnight policy rate has been stable, moving within only a two-percentage-point range over the past 18 years.”
Vietnam growth constraints
Vietnam remains one of the fastest-growing emerging markets in the world, despite Covid-19. The World Bank forecasts 7.5% GDP growth in 2022, with a slight slowdown at 6.7% in 2023, as the global recession cuts into the country’s export earnings and tourism receipts. Even during the worst days of the pandemic, the banks were still doing healthy business. “The reason was that during the Covid-19 period, the central bank cut rates, and a lot of the rate cuts were passed on to the funding costs of the banks and they did not pass all the benefits to the borrowers, especially the private sector ones,” says Amit Pandey, financial institutions ratings, south and south-east Asia, at S&P Global. Loan growth was 14% to 15% in 2020-21, while GDP growth was 2.9% and 2.6%, respectively.
While the State Bank of Vietnam (SBV) has raised its policy rate 250 basis points since October, it is not necessarily the policy rate that determines lending trends in Vietnam. “Traditionally the policy rate is not the primary policy lever for the SBV. The annual credit quota is what has the largest impact on near-term monetary conditions,” says Fitch’s Mr Tanoto. Individual banks are granted their credit quotas based on their compliance with SBV regulations and goals. This year the SBV has put in place a 14% ceiling on credit growth.
The banks also face some internal barriers to the rapid credit growth that they have grown used to. For a start, many of the banks are operating at a 100% loan-to-deposit ratio, and they have witnessed a switch from CASA to fixed deposits in the higher-interest-rate environment. “It is correct that the NIM of the banks has been better because of the higher rates, but now going forward we don’t expect the NIM will expand and there is a chance it could decrease,” says S&P’s Mr Pandey.
Thailand’s new opportunities
The Thai economy has been a regional laggard in shaking off the impact of Covid-19, partly because tourism accounts for 18% of GDP and tourism-related companies were hard hit by the pandemic. But the country appears to be heading for a modest 3.2% GDP growth in 2022, which could hit 4% in 2023 as the tourists return. In the longer term, the economy faces structural challenges including a rapidly ageing population, rising wages, high household debt and a subpar education system that is not pumping out the highly skilled labour force the country needs to move up the value chain.
Thailand’s banking system reflects the country’s economic doldrums. A recent McKinsey report pointed out that the price-to-book ratio of the top five Thai banks was 0.7, compared with 1.8 for overall stocks listed on the Stock Exchange of Thailand. Furthermore, Thailand’s share of the total south-east Asian banking market capitalisation has declined from 16% in 2009 to 9% in 2021, McKinsey noted. The report’s recommendations for the banks were to focus on ‘new economy’ corporate lending, sustainable finance and enhancing credit to SMEs.
While exports and tourism, Thailand’s traditional engines of economic growth, sputter on, there is a search among the banks for new avenues of growth. “The growth will come from two areas,” says Payong Srivanich, president of the Thai Bankers’ Association (TBA) and CEO of Krung Thai Bank. “On the one hand, there will be a big shake-up with the recovery. The tourism industry is one example. Second, there will be the transformation, the re-engineering of all segments to move towards more digitalisation, and a move towards more ESG-related activities. All these things require transformation and change, and that definitely requires capital.”
The banking system is also working on ‘common utilities’, to cut common costs for the system. “Bank of Thailand [BOT] and TBA have a roadmap for critical growth enablers. We are talking about common utilities, about open infrastructure, open data, which will lead to open competition,” says Mr Srivanich. “And the second thing is we are pushing very hard to address financial inclusion.” BOT will start issuing licences for virtual banks in January, with the aim of increasing financial inclusion.
The push to expand financial inclusion to SMEs and the unbanked or underbanked is in part driven by necessity. Unlike their Indonesian counterparts, Thai banks can no longer depend on corporate banking for credit growth. The banks are competing with the robust capital market, including a vibrant Thai baht-denominated bond market. SME and retail loans now account for 60% of Thai banks’ loan portfolios, a proportion likely to rise in the future.
Kasikornbank (KBank), the most profitable Thai bank in the third quarter of 2022, with a strong SME base, provides a good example of the lending trends. “For the third quarter of 2022, net profit increased 22.5% year on year due to an increase of net income, mainly from loans to retail and SME business customers with a focus on lending via digital channels along with using data for lending analysis,” says KBank CEO Kattiya Indaravijaya. “As part of its endeavours to advance Thai society, the bank has lent to more than 500,000 new small-pocket customers as of September 2022, for their improved access to funding sources, and expects to offer small-ticket financing to around two million customers by 2025.”
