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After getting clobbered in the Crisis, Asia's 500 biggest banks are over the hump. Now comes the challenge of consolidation.

This is the story of Asia's biggest financial institution. In 1996, Japan's Bank of Tokyo and Mitsubishi Bank finalized a merger of equals that created the Bank of Tokyo-Mitsubishi. The new entity had assets of $719 billion, nearly twice as big as those of its then closest rival Sumitomo Bank. Because of the cost of the union, Bank of Tokyo-Mitsubishi's fiscal 1996 profit of $287.7 million was nothing to crow about. But the future looked bright. Until, that is, the 1997 currency crisis that felled the economies of Thailand, Indonesia and South Korea and badly dented almost everyone else's. When that horrible year ended, the Bank of Tokyo-Mitsubishi had lost $5.9 billion. In fiscal year 1998, it bled another $3 billion

Look at the behemoth now. In the year to March 2000, the biggest bank in the Asiaweek Financial 500 made $1.2 billion. Fifty-nine of the 144 other Japanese banks in this year's listing also swung back to profitability. So have some institutions in South Korea, including H & CB and the Industrial Bank of Korea. And lenders in Singapore, Hong Kong and Malaysia, which saw sharp reductions in earnings in 1997 and 1998, notched three-digit percentage increases in 1999. Their first-half interim results, especially those of Hong Kong Bank, are even more spectacular (see story page 58). In all, Asia's 500 biggest banks made $19.5 billion last year (see table page 54), compared with $17.1 billion in 1998. That is still smaller than their combined pre-Crisis earnings of $28.2 billion in 1996.

It seems the overlay of rust on the chrome plates of Asia's banks is finally being polished away. Some hard-to-remove stains remain, it is true, particularly in Indonesia. But in many countries, market regulations have been tightened, banks restructured and recapitalized, and provisions for bad debts tucked away. "In some markets, banks have made a substantial overhaul of the credit-approval process and put in place better risk-management," says John Hobson, a regional bank analyst with CS First Boston in Hong Kong, who deems Japan's banking system already "in decent shape." Fewer loans are turning bad, which has emboldened many institutions to claw back loan-loss provisions, one reason why so many reported profits last year and in the first half of 2000.

The challenge now is to maintain profitability and meet the demands of globalization and new technology. "Asia hasn't had the sort of banking consolidation that everybody expected two years ago," says Rana Talwar, CEO of London-based Standard Chartered Bank, which last week won a bidding for the Hong Kong retail assets of Chase Manhattan Bank. "There are nationalistic reasons and, in some cases, some family-owned banks are just not ready to change. Size is everything in banking these days. You need to have a regional or global brand and economies of scale. You need resources to invest in new technology." Since 1998, foreign financial institutions have acquired all or part of 18 Asian banks, making them formidable competitors (see story page 72).

Other observers fret about governance. "There are still a number of countries where the same managers are running the banks," says Raymond Lee, head of regional bank research at Salomon Smith Barney in Hong Kong. But even institutions that have undertaken real change could remain in danger. Ironically, the improvements in risk assessment and other systems are holding back loan growth. "Banks no longer operate as banks in Thailand," grouses a foreign businessman who is having trouble getting loans. "The lending must be credible," counters Bangkok Bank president Chartsiri Sophonpanich. "The fact that we don't have much lending at the moment is a function of the current state of the economy." Anemic loan growth is a problem not only in Thailand. It is also an issue in Indonesia, Hong Kong, Japan, Malaysia, the Philippines and South Korea (see banking capsules, page 75).

For all the worries, Asia's banking systems are looking in better shape today than in the past three years. The Bank of Japan says the country's 136 banks have disposed of 60% of their aggregate non-performing loans of $440 billion accumulated from 1991 to 1999. Four merger agreements have been signed. The Mizuho Group, comprising Fuji Bank (No. 2 in the 500), Dai-ichi Kangyo Bank (No. 4) and the Industrial Bank of Japan (No. 8), will become the world's largest financial concern later this year. Third-ranked Sumitomo Bank will merge with No. 5 Sakura Bank by April 2002. Sanwa (No. 6) and two other lenders plan to consolidate operations under a holding company in April next year. Even current No. 1 Bank of Tokyo-Mitsubishi will grow bigger next year after its merger with No. 16 Mitsubishi Trust & Banking.

The problem of failed banks is also being resolved. Ripplewood Holdings of the U.S. has taken over the former Long-Term Credit Bank of Japan, which it has named Shinsei ("Rebirth") Bank. Another bankrupt lender, Nippon Credit Bank, was reborn as Aozora ("Blue Sky") Bank Sept. 4 after it was sold to a consortium led by Japanese Internet giant Softbank. A third insolvent institution, Tokyo Sowa Bank, will be taken over by U.S.-based Asia Recovery Fund. Japan's business community is in for more shocks. Shinsei Bank's American owners have refused to forgive $1.9 billion in loans to major department store Sogo. The government decided to take on these obligations, but a public uproar forced it to back down. Sogo has declared bankruptcy.

South Korea, which was forced to go cap in hand to the International Monetary Fund in 1997, is no longer in begging mode. The country's Financial Supervisory Commission (FSC) says domestic banks are now ready to emerge as "clean banks" after making adequate provisioning for all doubtful loans. The conclusion was reached after the FSC re-audited the reports of individual banks using what it calls forward-looking criteria. Previously, institutions were allowed to classify debt to restructuring companies as performing loans and to make only partial provisioning on loans to companies under court receivership. Notes guaranteed by the ailing chaebol Daewoo were treated similarly. Under the stricter guidelines, new "potential losses" of $3.5 billion have been recognized.

The Ministry of Finance and Economy now estimates peak non-performing loans (NPL) at $142.8 billion, 14.5% of loans outstanding. But D.S. Shin, chief market strategist at Samsung Securities, expects the NPL ratio to reach 17.3% or $171 billion, on expectations of more soured loans from troubled units of chaebol like Hyundai. Taking the government's number, 70% of the total forecast non-performing loans have been taken care of, leaving $43.3 billion to be tackled. But if Shin is right, the actual proportion would be a much lower 58%, meaning the bad loans yet to be restructured total $71 billion. "To restructure the remaining [$71 billion] in bad assets, we estimate that $50.6 billion in public funds will be needed, including $20.3 billion for the purchase of NPLs," says Shin.

Much depends on the finances of Hyundai and the LG Group. Some bankers are not as pessimistic as Shin. "Hyundai is definitely a concern, but except for Hyundai Engineering and Construction, Hyundai companies are not in bad financial shape," says Kim Jin Man, CEO and president of Hanvit Bank, the 33rd largest lender in the Asiaweek 500. "LG's debt-equity ratio has exceeded 200%, but if they can earn enough to pay interest, I will not be concerned." Hyundai Construction chairman Kin Yun Kyu has briefed Kim about the company's grand projects in North Korea. "I told him I would like to see Hyundai funding them from internal capital," says the bank president.

While they too have made progress, Thailand and Indonesia, the other two Crisis countries, are in a more precarious state. The Swiss-based Bank for International Settlements estimates the cost of recapitalizing the banking system at 40% of GDP for Thailand and up to 60% for Indonesia (Korea: 15%). Thailand's NPLs are estimated at 38.6% of loans outstanding as of the end of 1999, slightly higher than Indonesia's 37%. Thailand's banking system, though, is better capitalized with a capital-adequacy ratio of 12.4% Indonesia has a negative 18.2%. And while Korean banks notched a 3.3% return on assets last year, their Thai counterparts had a negative ROA of 2.5%.

Indonesian lenders performed far worse: They had a minus 17.4% return on assets. But they are surviving. "There has been no need for further recapitalization," says Ferry Yosia Hartoyo, head of research at Vickers Ballas in Jakarta. Soebowo Musa, director of bank restructuring at government agency IBRA, says about 80% of the banking sector has recapitalized: "As of May 31, the average NPL as a percentage of outstanding credit stands at 29.8% for these recapitalized banks." The government has injected a total of $51.7 billion into 16 institutions, including seven lenders in private hands. Ailing Bank Bali, whose sale to Standard Chartered Bank was aborted over legal problems, is due to be recapitalized in October. Three smaller banks have been liquidated since Jan. 1999.

Mergers are in progress. Four government banks have formed Bank Mandiri, No. 73 in the Asiaweek 500 and the biggest bank in Indonesia. IBRA has taken over Bank Danamon (No. 296) and is merging it with eight other troubled banks it has had to acquire. IBRA hopes to sell Danamon next year, although analysts are skeptical about the prospects of a union of such weaklings. Much depends on political stability. "If the political situation deteriorates, there will be no demand for credit," says Liny Halim, a banking analyst at Barings. Few corporate loans are being made even now. Most banks focus on consumer loans and low-yield government bonds.

Loan growth is negative in Malaysia too, even though the GDP there is forecast to expand by more than 8% this year. Officially, the NPL ratio is 6.5% as of June. But the relatively low figure is based on a definition of a non-performing loan as one that is in default for six months, not three months as is the international norm. "The Malaysian recovery is in many senses artificial and only lays the ground for the next banking crisis down the road," says CS First Boston's Hobson. "Banks there are being run by the same people who got them into the mess during the Crisis." Property values remain high despite the pre-Crisis glut in Kuala Lumpur and elsewhere. Says Hobson: "I don't see how you can clear worthless loans without seeing asset-price adjustments."

Some 44% of those loans have been transferred to asset-management agency Danaharta, which has been slowly selling them. "It is important for Danaharta to find the real value of the loans and assets it has acquired," says Franklin Tan, head of research at OCBC Research in Kuala Lumpur. But he reckons that the NPL problem has stabilized. Indeed, banks have slowed down on loan-loss provisioning, which explains their hefty earnings. "But this is a one-off thing," warns Tony Chan of Thomson Financial Bankwatch. Spreads are tightening as the government pressures banks to raise deposit rates even as loan growth remains sluggish because many manufacturers still have excess capacity and therefore see no need for big loans.

The government is also forcing the country's 38 banks and other financial entities to merge into 10 groups. The last six sale-and-purchase agreements were signed last week, reportedly after the central bank arm-twisted at least one senior banker. The shotgun marriages will need a lot of work. "For instance, the merger between Bank Bumiputra and Commerce Asset Bank to form Bank Bumi Commerce has been completed," says Tan. "But it will take a long time for optimum levels [to be reached] because the cultures are very different. Bank Bumi was a government-owned bank which did not have profit as primary objective. It collapsed twice and had to be rescued by the government. Commerce Asset was well-run and consistently made profits. Unfortunately, the better bank is the smaller partner in terms of branches and staff." But the consolidation, says Tan, "is making us [among the] stronger in the region with the possible exception of Singapore."

The Singaporeans are indeed emerging as kings of the East Asian hill. Market leader DBS Bank (No. 34) has acquired the government postal savings bank, POSBank, and has bought institutions in Hong Kong and Thailand. DBS Thai Danu Bank (No. 324) seems poised for a leadership position in Thailand after an aggressive sale of its non-performing loans (see story page 60). DBS has also bought a significant stake in the Bank of the Philippine Islands (No. 244), which has merged with Far East Bank. Like Malaysia and Singapore, Philippine banks are consolidating. But charges of cronyism are tainting the process. Lucio Tan, who is close to President Joseph Estrada, has been attacked for his controversial acquisition of No. 264 Philippine National Bank (see story page 69).

All these leave Hong Kong and Taiwan looking like laggards, despite their banks' generally strong balance sheets. While tiny Union Bank has been sold to Beijing's Industrial and Commercial Bank of China (No. 7), Hong Kong's other institutions seem determined to stay independent and small. That is also true of most Taiwan lenders, which are choosing to remain parochial. No. 108 Chinatrust Commercial Bank has decided against acquiring other Asian institutions (see story left). As for China, don't count on any consolidation soon. Unlike the rest of Asia, it is only starting to tackle its frightening bad-loan problems. India, Asia's other giant, is on a better financial footing, but three of its 27 state-owned banks are bleeding profusely and the country's powerful unions will not let them close.

But a shakeout will come. "In Asia, owning a bank still has glamour, even though small banks have lousy returns and the competition is getting tougher," says Salomon's Lee. "Still, we are going to see more consolidation in the next three years than we have seen in the last three." That is inevitable because of the huge investment needed for Internet banking, web-enabled 3G mobile-phone transactions, smart cards and other 21st century technology. It will happen because Asian corporations are moving from just bank borrowings to equity funding and bond-raising, a suite of services that large institutions are best placed to offer. "There is a lot of cash in Asian societies, which means a lot of transactions for sophisticated payment systems involving smart cards, the Internet and so on," says Hobson.

The winners will be those Asian banks that have cleaned up their books, recapitalized, brought in new management, expanded beyond their borders and embraced technology. They include the obvious ones like Singapore's DBS Bank and Hongkong Bank, which were relatively unscathed by the Crisis. But the one-time losers could still spring a surprise. In South Korea, Shinhan Bank, Kookmin Bank and H & CB have transformed themselves into lean and mean operations with razor-sharp credit and risk-management systems. No. 74 Bangkok Bank lost $1.6 billion last year after bleeding $1.4 billion in 1998. It has now completely overhauled its systems and hired experienced bankers from Australia's Commonwealth Bank. Predicts Hobson: "Bangkok Bank can go through the next economic cycle knowing that things won't go as awry as they did in the last downturn." There is life after the Crisis.

Reported by Assif Shameen/Singapore, Laxmi Nakarmi/Seoul, Arjuna Ranawana/Kuala Lumpur, Julian Gearing/Bangkok and Amy Chew/Jakarta
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