Asia Pacific banks are expected to produce strong results in 2006, but increasing costs and credit risk need to be contained. Consolidations are changing the banking landscape as regulators strengthen domestic financial systems and competition increasingly becomes a game of survival of the fittest. By C. Kapfer
The outlook for the banking sector in Asia Pacific in 2006 is positive, with the region’s bankable population growing by an estimated 32 million people and increasing household wealth and income per capita translating to increased demand for banking services and lending. Banks’ profit and revenue growth are projected to be strong, despite rising global interest rates and high oil prices. According to the Asian Development Bank, the regional economy excluding China will grow 5.3 percent, compared to 4.3 percent in the previous year, but inflation is also rising.
In 2006, retail banking will no longer be the single major growth driver in the industry. Non-traditional types of lending are gaining prominence, such as syndicated lending, contract farming and micro-finance as banks seek to diversify income sources and spread risk. An important growth area is SME lending, fast becoming a focus in countries as diverse as Australia, China, Hong Kong, Indonesia and Singapore.
The new global interest rate cycle will impact banks that have been accumulating large portions of government securities. Banks now have to develop their disintermediation business by formulating a proper wealth management strategy, or innovating and differentiating their products rather than resorting to price wars. Strong credit growth and preparations to convert capital for Basel II compliance will put a premium on deposit mobilisation capabilities, both in volume and composition. Hence, liability management rather than asset generation will be paramount.
Despite producing healthy returns in the past two years, banks in the region still lag their European and US peers in cost efficiency and profitability. Costs are spiralling in India, Indonesia and the Philippines which have not been able to manage their headcount and resolve inefficient processes, but banks in Hong Kong and Singapore have been making investments such as training sales staff for future growth. To some extent, the resurgence in branch banking is feeding the cost problem. Modernisation programs to turn branches into sales platforms are moving up the agenda, as are expanding distribution channels to new territories.
The banking landscape is also changing, as regulators accelerate consolidation programs or as countries near WTO accession deadlines. In South Korea, the future of Korea Exchange Bank and LG Card will determine future competition, while foreign financial institutions are still desperately vying to get a foot in the door in China via acquiring stakes in domestic banks. The limited number of consolidations in Indonesia, Malaysia and Taiwan indicate that the market, not regulators, holds the key to success of banking sector reforms and not state drafted master plans. We expect that governments will become more active catalysts to spur consolidation, both directly in Indonesia or indirectly in Malaysia.
Consequently, concentration building will threaten small and mid-size banks. With the exception of Australia, smaller banks in most countries may struggle to stay alive or risk being taken over, such as smaller nationalised state banks in India, city commercial banks in China and mid-tier banks in Malaysia. Larger banks, however, are expected to accelerate efforts to integrate their regional operations into a seamless consolidated network.
While the outlook for the year ahead is favourable, better customer segmentation, debt collection and risk management are required in banks around the region. Credit risk is building up in several sectors in China, Taiwan and other emerging markets, while NPLs for motorcycle financing in Indonesia are growing to alarming levels. Prudential lending, an improvement in credit quality and efforts to tighten regulations and supervision may yet see 2006 as a profitable year for banks in Asia Pacific.