Moody’s Investors Service says Asian banks are showing a “certain overconfidence”.
In its Asia banking outlook report released last week, the global credit rating agency cautions against the Asian banking sector’s “exuberance” and says a potential problem could come from the fact that the Asian economic cycle may be peaking in the next one or two years. It admits that banks’ asset quality has not yet been affected, but at the same time hints at the “possibility of an asset bubble” as too much money is chasing too few assets.
“While the boom and industrialization in China and India will continue for the next few decades, some downturns, possibly sharp, will be unavoidable,” it says.
PricewaterhouseCoopers, an audit and advisory firm, too, released a banking report this month. The thrust of the report is the growth of banking in the E7 emerging economies—China, India, Brazil, Russia, Mexico, Indonesia and Turkey. According to the report, the banking sector will grow significantly faster than the gross domestic product (GDP) of these emerging economies. The total domestic credit in China is likely to overtake the UK and Germany by 2010, Japan by 2020 and the US by 2045. It also says that India is likely to emerge as the third largest domestic banking market in the world by 2040 after China and the US. The report also suggests that, in the long run, India is likely to be the fastest growing banking market among the E7 economies. Going by the PricewaterhouseCoopers model, China will continue to grow faster than India over the next five to 10 years but, after that, India will catch up with and overtake China.
What differentiates India from other markets is an agile and cautious banking regulator. Concerned over an overheating economy, the Reserve Bank of India (RBI) has raised interest rates and tightened liquidity by jacking up the cash reserve that commercial banks need to keep with the central bank to slow down the growth in loan advances. The loan growth, in fact, has come down to around 26% now from around 30% for three years in a row.
Moody’s expects the overall loan growth to start subsiding with a more sustainable level of 20-25%. This is also in line with RBI expectations. Even a 25% credit growth is quite huge, but one needs to view this in the Indian context, where credit penetration rate is very low and just about 50% of the country’s GDP, much behind some of the developing Asian economies. Mortgages and personal loans will continue to grow as long as the economy is growing at over 8%, adding to the purchasing power of the salaried population. Moody’s is bullish on retail loan growth in India as even after growing at a scorching pace over the last three years, retail loans still account for only 8% of India’s GDP. In contrast, in some other Asian economies, such as Malaysia and Taiwan, retail loans are above 50% of GDP.
Retail loans, including mortgages, had grown by 41% in 2005-06 against the 31% growth of the banking system’s overall loan portfolio. Mortgages, in fact, have been growing at around 45%. As a result, the share of retail loans in the overall credit portfolio of the banking sector rose from 22% in March 2005 to 27% in December 2006.
The rating agency says that delinquency rates of unsecured retail loans are on the rise as some individual customers are finding it difficult to service their debt because of rise in interest rates and inflated asset prices. However, overall, retail loans carry significantly lower credit risk, compared with big-ticket corporate loans. In an economic downturn, one bad corporate account does more harm to a bank than a thousand consumer loans. Moreover, RBI has already waived the red flag and raised the risk weight and provision requirement for some segments of retail loans over the past year.
While Moody’s gives credit to the Indian central bank for reining in credit growth, Credit Suisse’s latest report on Asia Banks Sector, released in the last week of June, blames the regulator for coming in the way of banks’ growth.
Indian banks, according to Credit Suisse, are the worst affected in Asia by regulations. The rise in risk weight and provisioning requirements in certain loans has significantly affected Indian banks’ return on equity (RoE), it says.
Another contributing factor that dents Indian banks’ bottom line is the 1.5 percentage point rise in Indian banks’ cash reserve ratio in the recent past—from 5% to 6.5%. As prudential norms, most banking regulators across the world require commercial banks to maintain a certain cash level with them—ranging from 1% of deposits in Thailand to 11% in China.
The Chinese banks keep 11.5% of deposits with the central bank and earn 1.89% interest on the reserve. Indian banks keep 6.5% of their deposits with RBI in the form of cash reserve on which they do not earn any interest. They also need to invest 25% of their deposits in government bonds, which fetch them between 7% and 8% interest. As a fallout of such requirements, Indian banks’ RoE has gone down by 1.9%. The average RoE of top-listed Indian banks is around 17%. The ideal level of cash reserve ratio in India, according to Credit Suisse, is 3%, while investments in bonds should not be more than 10% of deposits.
The RBI can bring down both, but it is not doing so as the regulator is caught in a bind. Once the cash reserve ratio as well as the limit in banks’ investment in government bonds is brought down, banks will use the released cash to aggressively chase new assets, adding to the already overheated economy.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai Bureau Chief of Mint. Send comments to firstname.lastname@example.org