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Asia’s banks not investors' financial utopia

Investment in Asian banks could seem the correct course of action at a time when Western banks are struggling to stay profitable, but investors in Asia might be trading one set of problems for another

There is little doubt that third-quarter results for the large US and European banks have been disappointing, something partly attributed to the unfavourable financial climate. However, while Asian institutions might not be reeling from the 2008 crisis in quite the same way, they have their own issues. The quarter has seen banks rely on debt valuation adjustment (DVA) to bolster uninspiring results. Bank of America, Morgan Stanley and Citigroup – to name a few – relied on DVA to boost their profits for the quarter. Morgan Stanley, for example, relied on a DVA gain of $1.7 billion to reach its reported income of $2.2 billion.

Banks have been forced to respond to their lacklustre performances, with several – including Barclays and BNP Paribas – slashing exposure to the eurozone periphery, and Credit Suisse announcing further layoffs after a similar downsizing in July.

The quarter also saw an uncharacteristically poor performance from Goldman Sachs, which posted a loss of $393 million. This is only the second time in its history as a publicly listed company that the investment bank has turned a quarterly loss.

“CEO and investor confidence, as well as asset prices across markets were lower in the third quarter, given the uncertain macro-economic and market conditions,” says Lloyd Blankfein, chairman and CEO at Goldman Sachs.

The outlook for Asian banks is comparatively strong, what with poor performances from the major American and European institutions. Even Japan, often used as an example of a perennially underperforming financial sector, has a more positive outlook than in recent memory. Profitability has been strong, with the three largest banks reporting annualised return on equity at around 15%.

While this might seem to be a positive turn for the country’s struggling banking sector, a report from CreditSights’ analyst David Marshall suggests this good news might not mark a significant long-term change for Japan.

“[High profitability is] due to [continued] strong gains from its investment bond portfolios, which have pushed up revenues, while loan impairment charges have been low or even negative,” says Marshall. "This is nice while it happens but [it] isn’t sustainable."

No matter how strong a performance, Japan’s banking sector manages to turn out, it does little to calm fears over a country that has seen little to no growth for the past 20 years and has a net debt of around 130% of its GDP.

“Japanese banks are currently doing relatively well, but given concerns over their future growth, earnings and capital, it is hard to see them as an attractive equity story," says Marshall.

China’s primary concern is that credit has grown at a rate that outstrips even the impressive GDP growth that the country has shown. Credit growth at this level can be problematic in any country, but Marshall feels that China’s unique features might make it particularly vulnerable.

“China also has some distinctive features of its own that seem likely to cause trouble: distortions in resource allocation arising from low or negative real interest rates, government ownership of the banks and much of the economy, the heavy involvement of local governments in ... investment projects,” says Marshall." Taking these into account, it is hard to see Chinese banks getting out of this credit boom without some material credit losses."

South Korea might possess the most promising target for investment. The Korean banking sector has historically been – and remains – more profitable than the Japanese sector. Korean banks have managed to shake off worries regarding their leverage, something that has been one of the biggest concerns expressed about the country’s financial sector.

“The bank’s capital ratios have also strengthened,” says Marshall. "High leverage was for years viewed as a weakness of Korean banks but this has changed in recent years."

Korea moved to Basel II in 2009 and the entry into force of the regulation has served to increase the capital adequacy ratios of the Korean banks. According to the Financial Supervisory Service, the Korean financial regulator, the level of tier 1 capital held by the banking sector is currently over 11% – it barely scraped over 8% in 2008.

It seems that while investors might want to see Asian banks as an attractive alternative to their Western counterparts, the East is not the financial utopia they are looking for.

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