Asia-Pacific Banks’ Rising Leverage Pose Rating Risks

High or rapidly increasing leverage, together with mounting exposure to China, will constrain upward rating momentum for banks in Asia-Pacific, according to Fitch Ratings. It could even lead to downgrades should China’s economy slow more sharply than expected and weaknesses in its banking system become more widespread.

Fitch estimates that private sector credit in Asia-Pacific will reach 148% of gross domestic product (GDP) by end-2012, approaching the peak of 150% in 1998-1999. The credit/GDP ratio is converging for Asian emerging markets (143%) and Asian developed markets (156%), marking a high for the former. Within emerging markets, leverage trends are mixed. Vietnam’s credit/GDP ratio has more than doubled since 1997, while Indonesia, Thailand, the Philippines and Malaysia have deleveraged substantially.

The credit ratings agency (CRA) expects leverage in China will continue to rise as credit is employed to underpin the economy. Strong credit growth in China, and to a lesser extent India and South Korea, has driven the region’s higher leverage. China-related growth also boosts Hong Kong’s credit/GDP ratio, which is the highest in the region, forecast at 229% by end-2012.

Relaxed underwriting standards, inadequate controls, property speculation and unproductive investments are likely to lead to a rise in bad debt, as Fitch has doubts over whether current credit and economic growth in Asia-Pacific can be sustained. Asia-Pacific countries in the highest MPI-3 category of Fitch’s macro prudential risk indicators (MPI) represent 43% of Fitch’s forecast 2012 GDP for the region, with China accounting for 38%.

The CRA expects economic growth in Asia-Pacific to moderate in 2013-2014 due to global uncertainty, which should lead to lower credit growth and, in turn, help to unwind risks built up from the post-2007 growth phase. Asian countries are also wealthier than in 1997 when the Asian crisis hit, placing the region in a stronger position to counter potential stresses.

Most banking systems across Asia remain funded abundantly by deposits. Banks in Greater China have been increasingly unable to match new lending with deposit growth, but they have been able to afford to expand while maintaining sound loan/deposit ratios (LDRs). South Korea, Australia and New Zealand have cut their reliance on wholesale funding, but their LDRs remain the highest in the region (above 120%).

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