Bank atlas 2006 - The world's largest banks: Two stories across the globe
High borrowing levels and possible interest rate rises could threaten profitability in the US and Europe, while Asian and Latin American banking systems become increasingly sophisticated, say analysts from Moody’s Investors Service.
The 2008 bank atlas is now available: The world's largest banks
Guide to the leading banks across the globe by market capitalization
The world's largest banks
The global landscape for banks remains a two-tier story. Banks in the US and Europe are still posting strong results but there are challenges ahead. In the US, the economy is vulnerable to shocks because of high borrowing levels, and Europe could suffer from further interest rate rises and a growing appetite for risk, although some European countries have different dynamics. Although the performance of Latin American banks is beginning to converge with that of banks in more developed markets, there are concerns about the high lending activity. Asian banks, however, look set to benefit from the growing financial sophistication of the region’s consumers.
Banks in the Asia Pacific region enjoy a stable rating outlook since stronger banks are becoming more diversified and productive, offsetting the risks associated with factors such as concerns about the sustainability of the current pace of economic expansion and potential asset bubbles.
Risk management and supervision, unified as a result of Basle II standards, have become more robust, in parallel with a trend in Asian economies towards greater openness and competition. Although government support remains evident, regional authorities appear to have learned the lessons of the Asian financial crisis and are now focusing on strengthening banks by promoting market discipline and strong supervision rather than by direct intervention.
However, most banking systems continue to exhibit strong liquidity and excess capacity, and mergers have been slow to create any meaningful reduction in capacity. Competition has intensified. Nevertheless, Asian banks have shown a cautious approach to risk, which has resulted in an overall reduction in non-performing loans and improvements in loan-loss reserves coverage. Throughout the Asia Pacific region, capital has been gradually restored through improved earnings and fund raising, with hybrid securities constituting a new trend. Overall, the healthier state of the region’s banking systems should enable banks to handle a moderate weakening in their operating environments, should such a trend emerge.
Looking ahead, Asia’s under-penetrated consumer sector is an important driver of growth, even against the background of the rapid build-up in consumer debt in Korea and Taiwan. In many Asian countries, individuals are just beginning to move from being savers to investors and consumers, and such a change will drive demand for financial services and bank profits for many years to come. Moreover, the Asian public is adopting an increasingly sophisticated approach to savings, partly because of the appearance of wealth management/funds products and the recent bull run in Asian equities.
Another development to watch is the emergence of financial holding companies (FHCs) in Asia. FHCs have been forming in Korea, Japan and Taiwan, while China and Thailand have adopted a wait-and-see attitude. The promise of FHCs is that they can provide a multitude of financial services – via cross-selling – to a captive client market. So far, though, performances have been mixed.
Large US banks have enjoyed a benign credit environment over the past few years and have benefited from extremely high levels of global liquidity and expanding outlets for mitigating credit risk. Despite this favourable backdrop, there are concerns about the growing macroeconomic imbalances that characterize the US economy and the possible impact of a downturn in asset quality. Given significant levels of borrowings, the US economy is undoubtedly relatively vulnerable to a shock, whereby a sharp correction in demand for US Treasury debt would imply a potentially significant increase in interest rates and a corresponding decline in the value of US dollar assets. This would have significant implications for the housing market and, with it, consumer asset quality.
Asset quality remained robust in 2005; however, a modest deterioration in 2006 is expected. In particular, the consumer sector is vulnerable because of the high consumer debt service burden, which stems from rising interest rates, the knock-on effects of a prolonged correction of the residential real estate market and the drag of elevated energy costs on disposable income. In terms of commercial asset quality, it is likely that the major US banks will be protected against significant problems since they have solid reserves and enjoy strong earnings. Furthermore, US banks have significantly reduced credit concentrations over the past decade.
US bank profitability has been hampered by their holdings of mortgage-backed securities. Although, until recently, US banks struggled with a relatively flat yield curve that put pressure on margins in a period of increasing rates, banks are not faced with transformational challenges in their basic profitability model. The aggressiveness of US banks to bolster their deposit franchises is clear evidence that the profitability supported by banks’ exclusive access to the payments system is fully recognized.
Improving macroeconomic conditions in Latin America over the past few years have led to robust loan and deposit growth and a healthier profit performance from banks across the region. Financial fundamentals have been improving as a result of stronger credit demand and revenue diversification, coupled with much lower funding and credit costs. The Latin American banks have also been benefiting from a deepening penetration of under-served customer segments, This should continue, given the very low lending penetration in the region.
Latin American banks’ own initiatives to redefine their franchises have also enhanced their earnings potential. Managements are focusing on diversifying revenues and building fees, as well as on developing alternative distribution channels and customer segmentation tools in order to compete with foreign banks and non-banks in efficiency and service quality.
The banks’ performance metrics have been converging with those of banks from more developed markets, partly influenced by those foreign banks’ important presence in the region.
As interest rates fall and competition increases, profit margins are being squeezed, which is compelling the banks to push for volume growth and yield. A major concern is the possible effect on asset quality and hence future profitability of high lending activity in the higher-risk consumer and middle-market segments.
Another strong year for banks in Europe is expected, after they recorded strong revenue generation, low loan-loss provisioning needs, strong capitalization and good expense control in 2005. So far in 2006 risk-weighted earnings among European banks have been strong and asset quality continues to be underpinned by strong underwriting standards. Moreover, capitalization remains sound.
Indeed, these strong fundamentals have outweighed the significance of various headline-grabbing events in the European banking sector over the past 12 months – such as a few bank failures and the volatility of trading spreads in Iceland. Moreover, isolated events of stress are not likely to affect the European banking sector as a whole.
Cross-border M&A activities are picking up in Europe, as evidenced by the acquisition of Italy’s Banca Nazionale del Lavoro (BNL) by BNP Paribas earlier this year, and last year’s acquisition of Germany’s HVB by UniCredit. While domestic mergers typically create synergies, cross-border mergers – especially when part of the franchise is retail based – will typically focus mainly on revenue upside as retail activities continue to be country specific.
However, it is possible that the peak of the cycle might have been reached – although the outlook for the remainder of 2006 is positive, 2007 will be a challenging year.
Although upgrades are continuing to outnumber downgrades in the EMEA region, margins for banks remain under pressure. Moreover, over the past 12 months, there has been a weakening in risk controls and a growth in the appetite for risk at some banks. The impact of further increases in interest rates and the potentially detrimental impact they may have on asset quality will also need to be tracked. Other factors to monitor include provisioning levels as the corporate credit cycle turns and defaults increase; the net impact on margins from interest rate rises and increased competition; overheating property prices in several European countries such as Spain, the UK, Ireland, the Netherlands and Nordic countries; and breaches in corporate governance in general, and in risk management governance in particular.