By Wei Yen, Celina Vansetti-Hutchins,
Cécile Bidet,
Sam Theodore
Methodology | Top 250 emerging market banks
CONSOLIDATION, ACQUISITION BY western financial institutions, stronger regulations and supervision, and increasing pressure for market discipline should in time steer many layers of emerging market banks towards lower risk, sustainable profits, and sounder management.
Latin America Chile and Mexico have on average the strongest banking systems, Brazil, Colombia and Peru are adequate; and Argentina, Bolivia, the Dominican Republic, Uruguay and Venezuela are poor to very poor.
The banking system that is improving fastest is Mexico’s, where there is rapid convergence with the developed world. The recently announced agreement on the Fobaproa (bank fund for savings protection) issues lifts the uncertainty that was clouding the system, without impacts on banks’ financial fundamentals.
Chile’s relatively mature system is in the best shape. Its bank’s good financial strength ratings are based on generally strong management of credit and market risks, and on ample liquidity and capital, as well as a drive for fee growth and operating efficiency.
In Brazil, structural vulnerabilities constrain ratings, despite strong banking franchises. Improving domestic financial architecture and signs of economic recovery should boost lending. In the meantime, banks are focusing on fee growth and cost controls. Colombia and Peru are also moving forward; this is the second year of solid net income for Colombian banks, aided by a lower cost of credit. Peru’s system is well managed, comparatively liquid, and has relatively little government debt.
Argentina remains mired in a banking crisis that is exacerbated by the sovereign default and major restructuring is needed.
Asia At last, Asia is experiencing a general economic recovery. In general, banks’ asset quality has improved across the region. However, excess liquidity and rock-bottom interest rates mean that margins will be constrained in the near future. Furthermore, excess industrial capacity means that loan growth will lag GDP growth. Many systems in the region are overbanked, with indistinguishable products and services on offer. Competition is fierce and market share is crucial to survival. Banking consolidation is expected to continue. The entry of major international banks in local markets is notable but had been expected, increasing competition. At the same time, continual liberalization – driven by market-savvy regulators and enhanced risk management, thanks in no small part to Basle II initiatives – suggests creditors can no longer expect that banks will get state support. Increasingly they have to fend for themselves.
Regulators are determined to avoid a recurrence of the Asian financial crisis. Although there will always be some banks that are “too-big-to-fail”, the smaller institutions in many systems might not be able to count on state protection. The desire of regulators to avoid future massive bail-outs has prompted the accelerated introduction of both regulatory reforms and market discipline.
New regulations to gradually remove barriers to competition and establish deposit insurance schemes are among policy tools being deployed. At the same time, regulators’ requirements of better transparency and disclosure, improved risk management and corporate governance are designed to instil market discipline. In the light of these efforts, government support to banks should become more divergent, and a wider range of bank ratings can be expected in each system. However, this could take a long time to evolve.
Bank M&A activities will continue apace. The need to achieve critical mass in markets with limited growth is driving domestic mergers in Korea, Taiwan and Hong Kong. At the same time, local banks have leveraged foreign strategic partners as a competitive weapon. Also, foreign banks’ desire to enter fast-growing but under-served financial markets has meant that such alliances have regularly been forged. Both types of mergers are positive developments.
Citibank’s acquisition of KorAm Bank of Korea is a case in point. Citi will challenge local banks and reinvigorate their need to upgrade. Elsewhere, a recent trend of cross-border acquisitions is likely to continue. These include the merger of Thai Military Bank, IFCT and DBS Thai Danu Bank of Thailand (a subsidiary of DBS Bank in Singapore); the acquisition of shares in China’s Industrial Bank by Hong Kong’s Hang Seng Bank; the acquisition by Taiwan’s Fubon Holding of Hong Kong’s International Bank of Asia; and Citibank’s acquisition of a stake in Shanghai PuDong Development Bank as well as HSBC’s disclosed negotiations to purchase up to 20% of China’s Bank of Communications.
Specific situations include the weak capitalization of Thai banks, the aftermath of the credit card debacle in Korea, and the continuing stressed credit environment in the Philippines. China is another special case. Its rapid economic development has become the envy of many of its neighbours. The policymakers have been quite successful in managing the economic transition by encouraging competition while strengthening discipline and supervision. Recent debate as to whether China will have a hard or soft landing still continues. However, given that so much of the excess demand of late was driven by fixed-asset investments, these powerful administrative measures have resulted in a drastic slowdown of investments in some key industries that are overheating. As a result, banks’ growth and profits will slow and non-performing loans will rise. Shareholding banks, which have been growing by an average 50% a year over the past few years will be affected most. The big-four state-owned commercial banks will be less hard hit because they have become more cautious in business expansion.
Emerging Europe In general, banks in central and eastern Europe are, thanks in good part to foreign ownership, achieving marked progress, particularly in converging with western standards. However, more structural improvements are still required.
For the western banks, the key benefits range from immediate financial targets to more long-term strategic goals. Indeed, many have found that their acquisitions are becoming valuable assets. However, a few players, either for domestic reasons or in the light of growing competition, might choose to exit the market later.
Banks have made big advances over the past few years in most countries, following widespread privatization. As a result, banking sector development is likely to be slower in the future in the light of the large amount of financial strengthening achieved thus far. Nonetheless, for certain banks, there remains significant scope for improvement in risk management as well as image and reputation.
Despite notable discrepancies between individual countries, all the markets have been improving in the past few years. The most advanced banking systems are those in the Czech Republic, Estonia and Hungary and, to a lesser extent, Poland. In Slovenia, despite the banks being majority government-controlled, the system is highly creditworthy. Less advanced systems, such as those in Bulgaria, Croatia, Romania and Slovakia, have been improving steadily.
With privatization close to completion in most markets, foreign ownership is now at its highest at about 75% overall. The only countries where major players still await privatization are Poland, Romania and Slovenia, while some small and less advanced systems, notably in the Balkans, have yet to embark fully on privatization.
Strategic ownership has the benefit of providing stability and also expertise in risk management and retail banking. However, such ownership does not ensure perfect control and some risks remain, as illustrated by the K&H fraud case in Hungary and Kredyt Bank’s problems in Poland (both institutions being owned by KBC Bank). Nonetheless, overall, foreign owners tend to have a positive impact by enhancing risk management and the IT infrastructure, improving the quality of services and expanding the range of products.
With the restructuring of the major banks nearing completion, we expect competition to intensify in Croatia, the Czech Republic, Hungary, Poland Slovakia and Slovenia. Furthermore, there are too many lightweight financial institutions, and we expect competition to speed up consolidation.
Russia
The Russian banking system is far more precarious than those in central and eastern Europe. Most personal and business savings are not deposited in domestic banks, and among those that are a large share go to state owned savings bank Sberbank. Many privately owned banks appear to be in business to satisfy the needs of a few individuals or businesses. There are too many banks (some 1,300) and total banking assets are only a small fraction of GDP. Rumours can destabilize the industry, as witnessed by the recent banking crisis during which Alfa Bank lost a significant share of retail deposits. Russia’s central bank is taking steps to enhance market confidence in the system and the legislature has finally, in the midst of the recent crisis, approved a deposit insurance scheme. However, more steps will be needed to strengthen a fragile banking system.
Methodology | Top 250 emerging market banks: making progress on a broad front
