BackBanking stress in emerging economies
Banks in emerging countries need more capital infusion to meet Basel III norms and to continue supporting growth
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Emerging economy countries—Brazil, Russia, India, China, Mexico, and Turkey (BRICMT)—face a number of problems today. Chief among them being deteriorating asset quality, a shortage of capital and slowing credit growth. These could undermine the asset quality of the largest banks in these countries. The reason is the economic slowdown following years of strong credit growth. To add to all this, there is a growing concern about their rising household debt burden.
The ratio of household debt burden to gross domestic product (GDP) for these countries rose faster than the growth in GDP per capita. India is the exception. Consumer lending in its case has been growing at a slower pace. That’s because Indian banks have been cautious due to their previous large credit losses among unsecured consumer loans and because high real estate prices have led to a slower rise in the volume of residential mortgages. Given the cyclical nature of BRICMT economies and their still-low GDP per capita, it is safe to expect rising household debt to create stresses in the asset quality of banks in all these countries except India. In particular, the concerns in Russia relate to rapid increase in high risk unsecured lending, while in Mexico, large home builders and deteriorating consumer demand are causing concern. In Turkey, it is a rapid surge in credit card debt and consumer lending.
One ameliorating factor in favour of these economies is that liquidity outflow and weaker local currencies is likely to have a moderate effect on the Brazilian, Chinese, Indian, Mexican, and Russian banking sectors. This is due to the modest external financing needs of these countries and their low exposure to foreign currency denominated loans and deposits. If this is one saving grace, they are troubled by a series of macroeconomic imbalances: higher interest rates, inflationary pressures, or currency mismatches at the borrower level can weaken the asset quality of their banking sectors. From this vantage, Turkey looks particularly vulnerable to capital outflows due to its large and recurrent current account deficit (about 6.2% of GDP in 2013), dependency on short-term debt financing, sensitivity to high energy import prices, and a sluggish monetary response to exchange-rate pressures. Given these problems, the banking sector in these countries requires strengthening. These countries will require large amounts of capital not only to support double-digit lending growth but also comply, in certain cases, with the forthcoming implementation of new Basel III global rules.
According to S&P’s risk-adjusted capital (RAC) measure, the capital adequacy ratios of Russian, Brazilian, Indian and Chinese banks have continued to drop, as lending growth has outpaced their ability to generate earnings. Indian banks began implementing the new Basel III capital requirements on 1 April. The regulatory requirements in India are more stringent than the guidelines of the Basel committee on banking supervision. While large Indian banks hold sufficient capital, according to regulatory requirements, this quantum is moderate when it’s adjusted for risk. Indian banks will require, at a minimum, an estimated additional capital of ₹ 69,100 crore in the next five years for growth after Basel III. This amount could rise to ₹ 2.6 trillion, given the domestic banks’ tendency to hold higher-than-minimum capital and the limited market for hybrid instruments in India. Chinese banks too need large capital of $84 billion by 2019 to attain 9.5% tier 1 ratio.
Despite the expectation that credit growth will slow in BRICMT countries, the pace will still likely be higher than the global average for the next two years. As a result of this high growth and the expected implementation of new Basel III rules, BRICMT banks will require additional capital.
This will impact profitability of BRICMT banks. The banking systems of BRICMT have remained profitable for the past three years, with an average return on assets (ROA) of about 1.5%. Turkish and Russian banking sectors have been the most profitable of the peer group, with an average ROA of 2.0% and 1.8%, respectively, while the banking sectors in India and China generated an average ROA of 1.1%.
India’s sluggish economic growth, rising interest rates and currency volatility are hurting the country’s highly leveraged corporate sector. One can expect continued weakness in infrastructure-related loans, metals and mining, and construction-related sectors. Consumer loans, in contrast, have low non-performing loan (NPL) levels, reflecting low (and declining) household debt, steady unemployment rates, and rising wages amid high inflation. We expect the banking sector’s NPL ratio to surge to 4.4% of total loans by 31 March 2015, from 3.4% as of 31 March 2013, due to increased defaults among corporations, particularly small-to-midsize enterprises. Stressed loans in India will exceed 10%, as the reported NPLs exclude restructured loans. Chinese banks too are facing stress on corporate credit quality emanating from lacklustre export growth, debt-laden local governments, and an oversupply in many manufacturing industries. Indian banks’ earnings should remain stressed through fiscal years 2014 and 2015, given high credit costs. The banks’ earnings in fiscal year 2014 are also likely to suffer from trading losses due to sharply higher interest rates. However, banks will report lower trading because the central bank has allowed banks to shift part of their government securities to held-to-maturity category at the market value as of 15 July 2013. We expect the ROA to be below 1% for the next two years.
Geeta Chugh is senior director, South and Southeast Asia Financial Institutions Ratings, Standard & Poor’s Ratings Services. Comments are welcome at theirview@livemint.com
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