China, US Rates Pressures Build for APAC Banks in 2016

Dec 16, 2015 (LBO) – Banking sectors within the Asia-Pacific (APAC) region are likely to face a more challenging year ahead as financial systems adjust to slowing growth in China and the prospect of higher US interest rates, says Fitch Ratings in the agency's 2016 Outlook Report for the region.

Earnings and capital buffers built up in recent years mean that most banking systems start from a position of strength going into this weaker economic backdrop. The exceptions are the large markets of China and India, and the frontier markets of Mongolia and Vietnam, although the outlook for banks in India and Vietnam is balanced by a more favourable economic environment.

We have a higher proportion of banking systems on negative sector outlooks for 2016 than was the case in 2015. This is driven by the prospect of deteriorating asset quality, a more cautious risk appetite from most banks contributing to weaker credit growth, and margin pressures - all of which is likely to lead to slower profit growth.





Fitch views lower credit growth as a positive development from the perspective of financial sector stability. With respect to the outlook on ratings, we have a stable outlook on the overwhelming majority except Mongolia and the Philippines (negative and positive, respectively). The predominantly stable outlook reflects two factors: first, that there is some tolerance in the ratings to slowing growth, given the buffers; and second, the rating outlooks reflect sovereign support in the cases where the Viability Ratings are lower than Issuer Default Ratings.



Support from the authorities still matters in APAC. Key downside risks are Chinese growth and US interest rates, as rapid credit growth and the accumulation of high private-sector debt since 2008 has made some countries across the region sensitive to a major change in economic conditions. Fitch expects Chinese GDP growth to slow to 6.



3% in 2016 and 6% in 2017, and for US interest rates to rise gradually in 2016. However, a more severe China slowdown and/or a sharper-than-expected increase in US rates could lead to greater economic headwinds, weaker APAC currencies, and possibly higher domestic interest rates - raising the cost of debt servicing. For the Chinese banks, this would compound asset-quality and earnings pressures which are already mounting. For the rest of APAC, the more open economies such as Japan, Singapore, Hong Kong, Korea and Taiwan would be affected, especially those financial systems with the largest direct exposure to China (Singapore, Hong Kong, and Taiwan), while further weakness in commodity prices would also be likely - exposing Indonesia, Malaysia and Australia. Unhedged lending in hard currency that has been built up in some markets may also be tested, which would in turn have a knock-on impact for sectors in the supply chain - affecting asset quality more broadly in the local domestic banking system.

That said, currency risks appear to be less than for other emerging market regions.

On a positive note, Fitch sees capital levels improving as global regulatory pressures begin to influence capital trends across the region, with the Australian banks continuing to lead the market.

With the Total Loss Absorbing Capacity (TLAC) rules having been finalised, we could see this beginning to influence regulatory capital and TLAC-qualifying instruments issuance trends - as local regulators clarify their thinking in response to the measures announced by the Financial Stability Board in November 2015.