Despite rebound in 2021, banks’ credits and profits will continue to be under pressure

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In this RadioFinance session, we will discuss the forecasts and the impact of the pandemic on the banking industry, rise in credit costs and declines in net interest margins as well as the overall profitability across APAC in the coming years.

In this RadioFinance session, Taimur Baig, chief economist of DBS Bank, highlighted that Asia now depends more than ever on China economic performance. If China grows by 11% in the first quarter of 2021, it will be a strong galvanising factor for production to recover and investments plans to be re-guided across Asia.

Alicia Garcia Herrero, chief economist of French investment bank Natixis, emphasised that China will not have a significant debt issue, however, there is still a need to keep interest rates low. If low rates were to persist in the midst of more dynamic growth, there will be substantial impact on the allocation and distribution of credit in the region.

Eugene Tarzimanov, senior credit officer at Moody's Investors Service, highlighted its negative outlook of APAC banking systems in 2021 with significant downside risks. Recovery of revenue and profits is expected to be highly uneven.

Gross domestic product (GDP) growth will rebound in the region given the low base effect of 2020, however the pace of recovery to pre-COVID-19 levels will vary across countries as well as sectors within economies.

Strength of recovery will be driven by how well the disease is brought under control and the mobility of labour, production and trade during the period. In this regard, China, Taiwan, and Vietnam are expected to recover faster than other economies in the region. However, banks continue to face significant pressures on asset quality and profits

Here are the key points discussed:

The following is the edited transcript of the session:

Foo Boon Ping (FBP): Good afternoon ladies and gentlemen, it is 4pm in Singapore and Hong Kong and Taiwan as well where one of our guests is currently located. Welcome to the Asian Banker RadioFinance session on the Asia Pacific banking industry outlook 2021. Today we'll be turning to our guest panel of chief economist and industry experts to look at the key issues and factors that will affect the global economy financial system, and specifically look at how banking system in Asia will perform over the next 12 months. We are happy to have as our guests today, Alicia Garcia Herrero, who is the chief economist for Asia Pacific at French investment bank, Natixis. We're also happy to have Taimur Baig who heads economics as well as macro strategy for interest rate, credit, currency and equities, at DBS Group Research. And finally, Eugene Tarzimanov, the senior credit officer responsible for financial institution group at Moody's Investor Service. In this greater finance session, we will discuss the outlook and the impact of the global pandemic on the banking industry, rising credit costs and declines in net interest margins, as well as the overall profitability of banks across Asia Pacific in the coming year. 

COVID-19 has plunged the global economy into its worst recession since the Second World War. Economies cannot start to recover until the disease is brought under control. The failure of leading economies to effectively control the spread of the contagion has caused unprecedented economic and social disruptions and set back decades of development that will have long term impact on future growth prospects. Although effective vaccines have been found and approved for usage, there are signs that the planned implementation of a universal vaccination programme will take much longer than anticipated that may further impinge on the lifting of social distancing measures and a wider restoration of economic activities. 

In its January global economic prospect report, the World Bank estimates that global growth in 2020 will contract by 4.3%, a drop of 6.8% from its pre COVID-19 forecasts in January of 2020. It envisioned a subdued recovery in global economic output in 2021 which will grow at 4% but still remains more than 5%. Below its pre-pandemic trend. The growth of emerging markets and developing economies in East Asia and Pacific in particular is projected to slow significantly in 2020 to 0.9%, a 4.8% contraction pre- COVID-19, the lowest since 1967. While the World Bank expects regional growth to rebound to 7.4% in 2021 as the pandemic subsides with more widespread COVID-19 vaccination. However, should there be a protraction of the health crisis, it may heighten financial stress and precipitate a sharper and longer than expected contraction in global trade compounded by re-escalating trade tensions. This may result in financial crisis that will cause a collapse in lending and a longer global recession as well as global recovery. 

While the World Bank has warned about the downside risk, it has also upgraded his January forecast from June of 2020. It is obviously more sanguine about recovery and growth, especially for Asia Pacific. I'd like to get our guests’ view on how they see the pace of economic recovery in Asia Pacific. How that pace will change with the start of COVID-19 vaccination. Let's start with Taimur to give us his take on growth this year. 

Worst performers in 2020 will be stars in 2021

Taimur Baig (TB): Thank you Boon Ping. Thanks for having us on this interesting topic which will remain topical for years to come. How do we deal with a pandemic? And where do things go from here? The worst performers of 2020 will be at least on paper, the best performers of 2021. So if you think of the outcome of 2020 in the context of our misery index, if you will change in economic growth rate and change in inflation, the three worst countries in Asia unambiguously would be India, Indonesia, and the Philippines. And thanks to the tyranny of the base effect, those are the three countries that will show a very strong rebound at least on an arithmetic number sequential growth. So it's not a hard task to come up with who had shiny examples of market leading numbers in the context of 2021. And you're already beginning to see the green shoots of that strong rebound. Now we should also be keen to make sure that we understand the difference between rebound and recovery. India, Indonesia, Philippines are rebounding very sharply. You see that in their trade numbers. You see them their government receipts of taxation but by the time they recover all the lost GDP from 2020, it will very easily be 2022. They're not going back to the pre-COVID level of GDP till next year. But this year they will rebound very sharply. Now, beyond that, what is the story in Asia? We have four very successful pandemic management cases. Well, let's say three of them are pandemic management cases of success. Fourth one, sort of winged it and got lucky. The three success cases would be Taiwan, where Alicia is connecting us from, then there is Vietnam, definitely China came back very strongly in the second half of last year. And then in South Asia, it's Bangladesh which will grow by all estimation over 2% in 2020 despite the fact that there was raging COVID infection and not much mitigation. A big contrast from their neighbouring India where activity contracted sharply because the authorities embraced lockdown. 

China will lead recovery in region

The China case is interesting because the momentum for China is a very big influence of both market and economic sentiment in the region. And you saw that in the third quarter of last year in the deep malaise of the COVID fallout China started reporting stronger export numbers. And then as a result, you could also see that the regional supply chain was humming. We were sending inputs to China. China was putting it together and sending to the rest of the world. Although reeling from the COVID crisis it was importing a lot of stuff buoyed by generous fiscal and monetary stimulus all over the Western world in particular. And you see this for example in the US trade numbers. Despite Mr. Trump's four-year effort, trade deficit vis-a-vis China actually expanded in the COVID year and in the last four months of 2020 the US ran on average about $90 billion of trade deficit with the whole world and substantial deficit vis-a-vis China. So as China began to hum in the third quarter, we got the first sort of push in terms of post-COVID recovery. Now what has happened in China since then is that the economy has gone strength to strength with the domestic demand engine of the economy is starting to fire quite convincingly from September, October onwards. As we sit here in the middle of January 2021, we see strong travel and tourism numbers strong retail sales, strong movement as far as credit growth is concerned. China is stepping into 2021 with a great deal of momentum. Unless the very recent news on some incipient COVID infection there in China creates a systemic risk, I think you can safely say that China will be growing very rapidly in the first quarter. Our DBS now casting model is flagging China to grow by between 11% and 12% on a year on year basis, which is of course, understandable given that in four quarters of what they contracted, but also there is strong sequential momentum. And on the back of that we will see regional economies pick up. Now this is a critical point that I need to stress because if this wasn’t happening 10 years ago, 15 years ago, a strong growth uptrend, China did not really matter that much for the region, China on growth accounting basis was a large source of global growth in 2008 and 2005. But in those days, the growth beta of Asia, if China grows by 1%, how much does Asia grow by? It was not very large. We are still dependent largely on Western demand particularly US and EU and also the global economic cycle. If you look at the econometric evidence over the last 15 years, you see an emerging increase in that beta, meaning Asia now depends more than ever on China's economic performance. If China grows by 11% in the first quarter of 2021, it'll be a very strong galvanising factor for factories to start humming, sentiments to start improving investment plans to get re-ignited all across Asia. To me, that is the key story, as you've noticed, I've talked to you about for 10 minutes without mentioning the outlook for the US or Europe whatsoever. I think that is very well understood that on the back of huge amount of policy support measures, they will grow. US probably will grow by 5% this year after contracting sharply last year. And by the end of this year, maybe if things go right, US may have recovered all the lost output of 2020. But in the case of Europe, it's more like a 2022 perhaps even 2023 story because the recovery there is far more muted. So as far as Asia's overlap, overall outlook is concerned, the big hope lies on China. And second big hope is their own domestic demand and own domestic success or failure as far as the pandemic management is concerned.

FBP: Thank you, Taimur. And with China's expected recovery this year, the impact on the region, as you mentioned, would be much more than 10, 15 years ago. And in the last global financial crisis, China was quite a significant engine of growth with the rest of the Western economies in recession. While their economies falter, we see that China continued to be the only large economy that has managed to maintain positive growth even through 2020 with its focus on domestic consumption. Now, Alicia, do you see China playing the same role this time around lifting the rest of Asia growth, as Taimur has kind of pointed out? How worried are you about the national debt in China especially not so much the national debt but corporate and SOE debts? 

Alicia Garcia Herrero (AGH): It's been fascinating the story of China's dominance in Asia is obvious in the data, but it takes us long to actually acknowledge it. And I think that's a good start of the conversation. We were relatively optimistic, maybe slightly less than consensus on Asia’s recovery in 2021. Because of the base effect is just smashing it all, hardly impossible, although not impossible, because we have Hong Kong. Hong Kong, 2019, and 2020. You can actually do even worse than 2019, if you really push it. But the whole point is that why did it happen because of lack of mobility? Meaning, if for whatever reason, and I think the main reason is a global wave, and I think we're not fully out of the woods on this global wave, we have Japan, we have Malaysia, we have some signs in China. And we have signs everywhere, because I was just looking at the data, Thailand, for example, cases of increase. The silver bullet, which was the vaccine, the magic rollout of vaccines, which can’t even happen in developed economies. How on earth can we still think is going to happen just like that before the end of second quarter? I think we need to review this idea. If you look at where we are with vaccines, we have major economies, China included, for which we don't even have the plan. We don't really even know when they plan to finish the rollout of the vaccines. And it's not a minor issue. Interestingly, India is ahead, started in January, with a big push but then it's already coming down. I mean it's impossible to keep that pace. So I think we all need to rethink. Are we sure we can do this by the end of the second quarter? And if we can't, and this wave, which of course is much more contagious, and how much it will come all the way to Asia. I think, frankly, and avoidable. The question is how can we restrain it is going to bring mobility down. So I dare say that, again, although we were slightly less optimistic than consensus, we probably pushed it too far, even ourselves. I'm talking about Natixis Research team. And I'm saying this aloud, as we speak, because we don't have new projections but I'm just fearing that the silver bullet is not as silver as we thought it would be certainly not as quick as we thought it would be. And we also probably didn't know that we would have a wave coming much more contagious than we thought it would be. So all of this brings me to the point of what about China? Because if China manages to avoid everything I just said, then the spill-over effects, even if we have less mobility in Malaysia, something will come out of imports from China. We'll have to note, just minor note, those imports haven't been there in the whole of 2020. I mean, on average, some countries have benefited more. We have agricultural products, a few things here and there. But overall, imports in China have fallen in 2020. We all appreciate the growth. It's lovely but it's not for us. I mean, as men in the rest of the world, not yet. The combination of the two is not as appealing. China is huge and great but it's not importing. And if the world falls down into less mobility, maybe not all the way to the first half of 2020, but something in between what we thought it would be and what it really will be.

And again, this is not Asia worse than the rest of the world, forget about the rest of the world, that's even worse, but it might not be as good as it looks. And these will come for your debt dynamics. And I will end here. I don't think we have a debt issue. There are many other places where we'll have that issues before Asia, or certainly before China. But we have to keep rates low, very low. And that in itself is creating protracted problems in terms of think about the actual rate of return. Think about the need for banks to cope with those low rates, think about, we'll move to banking with very soon, but it's just not what you want to have in a dynamic region. You don't want to have it anywhere. But if you are elderly and you're European, if you're in Japan, but if you are a dynamic region with those low rates, the degree of dislocation of credit can be humongous. In a way, it's a pity we can't get out of this sooner. 

FBP: Alicia, your view of growth this year is more cautious in terms of us getting over COVID-19. Back to Taimur, you paint quite an optimistic picture across the region and globally. So the US growth rate, and that is predicated on COVID being addressed or being resolved. What if there is a protracted another re-escalation of cases?

TB: I think the way to think about that is following in April and May last year, we were hit by a shock that we were completely unprepared for. And as a result, we have to shut down manufacturing and travel and meat processing and even to some extent agricultural got affected. But within a few months, we sort of started getting a sense of how to maintain social distance and be safe while carrying out economic activity. And hence, especially in the manufacturing hub of the world, which are Asia and East Asia, factories started operating pretty quickly. And regardless of the state of the pandemic, which remained fairly poor, in the fourth quarter of last year, we saw demand for Asia's products remain very strong. In Asia end of the year with extremely strong exports, we were on a PPP (purchasing power parity) weighted basis, Asia recorded about 15% growth in November 2019. So that momentum in my view remains in place independent of the trajectory of the pandemic, simply because people have cash in their hands. The supply of paycheck support, the supply of subsidies that is coming from the government in the West will continue unabated, regardless of how bad or how good the disease is. And therefore, people's ability to order something through online means remain absolutely independent of what is happening with respect to the crisis. I think this is where the big difference between the 2008, 2009 crisis and this crisis is. At that time, you had a spate of banking sector difficulties and a spate of corporate stress, which then spill over into huge distress in household balance sheets on people's income outlook, and so on. Now, for a few months last year, all of those things were happening. But since then, we've seen a very sharp recovery in the employment picture in the US in particular, but also in Europe. And same here in Asia, that we saw the worst, we left the worst behind us. And we start to recover not because we're back to traveling and hotels are full, but because we're just sort of countries that can rely on some degrees of domestic demand and are doing fine. And some countries that are based on exports engine are doing well. There's another very important, crucial difference between the past crisis and this crisis which will again proceed independent of the course of the COVID pandemic, which is the role of banks. Agustín Carstens who heads BIS (Bank for International Settlements) said very articulately and efficiently in April of last year, the banks which were the problem in 2008, 2009 have to be part of the solution this time. And you've seen that, if you look at bank balance sheets, delta of bank balance sheets over the quarters after the pandemic, they have been expanding in Europe, the US and in China, compare that with 2008, 2009 in the US bank balance sheet contracted in the quarters after the crisis, compared that with the European crisis in 2011, 2012 bank balance sheets contracted. If you have credit intermediation taking place, because banks have good balance sheet and they're being encouraged by the authorities, then cash on hand credit on hand will proceed independent of the trajectory of the pandemic. Of course, as Alicia pointed out, if the pandemic were to worsen, mobility will be affected, it may not be affected as badly as it was in April, May, but it will be affected nonetheless. And I think the country that is greatest at risk on that is China. They have been growing like gangbusters and they're doing very well by the second quarter comes along. Some degree of gravity will catch up with China in any case nobody can grow by 11% right? So it'll start coming down. And with the slowdown in growth, some of the normalisation measures that the authorities are pursuing in China right now combined, there will be some credit risk manifesting. 

FBP: Now we want to get Eugene into the discussion as well. How do you see banks impacted? In your earlier outlook, I think in December last year, or October, was quite a negative outcome for the banking industry. Could you explain?

Uneven economic recovery will have negative impact on banking sector

Eugene Tarzimanov (ET): Indeed, for banks in Asia Pacific for 2021 we have a negative view. What this means is that the risks are still tilted to the downside for the financial services industry. And there are a few reasons for that. Primarily, the economic recovery, we expect that to be uneven, highly uneven in Asia. Some economies will do much better in rebuilding their lost outputs. Among the winners, I would echo what my colleagues just mentioned - China, Vietnam, and Taiwan Those economies would do better and hence their banking system will do comparatively better. On the other side of the spectrum, we have economies like Thailand, for example, where there's a lot of reliance on tourism. Banks have large exposures to those affected industries. There's another round of infections in that country. My point is various sovereigns and sub sovereigns in Asia, the economy, the recovery will be highly uneven. That's going to have different impacts on the banks’ balance sheets. The second point is that when you have such a huge economic shock as we have seen last year, there has to be some pains on the banks’ balance sheets. But we haven't seen that last year. The NPLs (nonperforming loans) were pretty flat, just maybe a few defaults here and there, but overall, they were flat. And there was an obvious reason for that. This was a lot of government and policy support. A lot of forbearance, a lot of moratoriums. We expect that this year, we're going to see some mild impairment on the banks’ balance sheets. We don't expect a huge flood of NPLs. We expect a mild increase again. A lot of the support measures are still in place there. They're not terminated. And will continue, we will continue to see a lot of credit restructurings in Asia. So again, a bit of NPLs here and there. And third aspect of a negative view on banks is their profitability. I think what Alicia mentioned earlier, ultra-low interest rates will continue to weigh on bank margins. And again, banks in Asia make about 70% of their income from loans. If you have a low margin, it depresses your primary source of income. On top of that, credit costs will probably remain elevated. We actually expect credit costs and these are the provisions. We expect that provisions will probably be lower this year compared to last year. Because of what the banks have been doing last year is creating provisions ahead of the expected pain. If the banks were correct in their models and the provisions that they pre-emptively created are sufficient for new NPLs that we're going to see this year and next year, then I think credit cost would moderate. But if we're wrong and the banks are wrong, and there is a spike in credit costs, then it’s a different outcome for the P&L (profit and loss) side of the story. So again, there's a lot of moving parts. But the balance of risks is tilted to the downside. And then one quick comment to wrap up my overview. What could change our view? And in what circumstances could we see a more stable environment? We'll be watching how those loan moratoria, what are the exits from those loan moratoria? If the vast majority of clients pay back and come back to the original payment terms, that will be a very good sign. If banks are able to stabilise their margins, so there's not a lot of further decrease in margins, and credit costs normalise, then the profitability side of the story will gradually recover. I think those would be the key aspects for us to watch this year. And maybe we'll see indeed some normalisation of banking conditions in Asia.

FBP: Thank you, Eugene. Going back to Alicia. The view is that the growth this year will be uneven. So even in some sectors you will not see even growth. There are some parts of the economy that are doing better. There are some industries that will not come back for quite a while - airlines, tourism, and so on. And those will have profound impact on employment. And this outlook that most of you have is kind of coloured by how even or how uneven the growth will be. Alicia, what are your views in terms of the unevenness of the growth in 2021? And its impact especially on corporates and the impact on banks’ balance sheets? 

AGH: First of all, this very much depends on how far we are. The new wave in Asia and a delay beyond what we've already seen on the rollout of vaccines because we have already seen a rotation in December.  Great news. We are ending this horrible year and everybody's going to get vaccinated within the month. We already saw the old sectors doing better. And even energy. We're back. And again, the base effect. So that would mean hugely so. But I think that rethinking that is going to take longer than we thought it's already back in the market, although there is still a very positive vibe in the market especially in Asia. I wonder how long it's going to last? Because I think as we see this creeping in from Japan, Malaysia, to who’s next? I think Thailand has big chances of being next. That rotation. The bad sectors becoming the stars which is a little bit similar to the countries. The bad countries becoming the stars might no longer be there. The stars won't be the stars. And then you go back to the digital, the ICT of the world. So very much depends on that dual situation. Are we finally out of this or not? And if we aren't, there won't be any rotation in the sector.

FBP: How do you see US-China trade with the incoming Biden administration and the new trade pact   Regional Comprehensive Economic Partnership (RCEP)?

AGH: So I'm going to make an Italian comment here for in the sense that I'm going to look for a change because I tend to be, as a person, quite extreme. But this time around, I think we need to look at the centre of the thing. I don't think there will be a reset. That's the extreme Wang Yi-type (China’s foreign minister) approach to the issue - let's restart. I don't think there will be a reset. Also, because politically speaking, it's just very hard for Biden, no matter the choice. People focus on the choice of the administration, the names, Obama-type favours. But you just need to listen to Obama himself to realise that's not where he would have gone had he known. So, no reset but no Trump-ism. So it has to be in the middle. Now, what my impression is that what we've seen so far is that Biden has announced lots of things he will be doing, executive orders one after the other. Not on China. I thought he would start by saying, “Oh my God, this crazy web of sanctions that are distorting our own US investors and even the Wall Street-type favours his administration so far. Nope, nothing. But he said lots of things so far. So I think no reset, no Trump-ism. But if you ask me where in between, not as close to the reset as I thought, he would have been based on the choices he has made. I think the pressure to continue to push is clearly there.

FBP: Pressure to push for better relations with China and easing some of that trade tension. In terms of your view on the Regional Comprehensive Economic Partnership, how much of a lift do you think it will give our regional economies?

New regional and extra-regional trade pacts significant steps forward to facilitate cross-border trade, investment and payment flows

AGH: It is very interesting to see that RCEP which was announced as the deal of the history of Asia. The minute that it was done at the APEC meeting, President Xi already said, “We aim at CPTPP (Comprehensive and Progressive Agreement for Trans-Pacific Partnership)”, which basically means that this is just a step. This is not really in my opinion a path-breaking deal. It might be actually quite a good thing for us. And because at the end of the day, the loser here very obviously Taiwan. Three out of four largest investors in ASEAN are in the deal. It's going to facilitate obviously a global value chain and a more ASEAN-centric value chain which is a good thing for ASEAN. But it's not going to be the path-breaking theme that in principle was announced. If not, China would not pursue or at least say it is pursuing CPTPP. And I think the reason is that the deal is indeed of a different calibre. And much deeper in terms of the actual integration. And thus, RCEP will remain a purely trade deal with some gains for ASEAN but not massively. Not even with China, in my opinion. 

FBP: Thank you, Alicia. Taimur, what are your views on how regional trade will evolve in 2021? And especially between the US and China?

TB:The end of 2020 marked massive diplomatic gains for China, both with respect to RCEP, as well as CAI (Comprehensive Agreement on Investment), the deal that they signed with the European Union (EU). So just at a time when the narrative in the West is about de-globalisation, China is sort of saying, “Well, we like to create with our like-minded partners and if you want to improve market access, if you want to join our digital economy, which has huge potential for making money for the whole world's service and manufacturers, well, then you need to make us part of your deals”. And so for that perspective, RCEP works very well for China. The CAI is potentially very good because both Europe and China have a massive degree of interdependence both with respect to trade and investment. EU has about $140 billion worth of investments in China. China has about $120 billion of investments in Europe and all the machine tools that the Chinese used tend to be made in Europe and all the manufacturing parts that the Europeans used tend to be made in China. So from that perspective, the CAI is as important as development as the RCEP. The remarkable thing about RCEP is unlike the European Union deal, or the NAFTA deal where there were some degrees of convergence between Mexico, Canada and the US, or some degrees of convergence among the EU members before the deal was signed. This deal is very clear. The heterogeneity is stark. You have countries like Cambodia and Laos, and you have countries like Japan and Australia in this deal. It will be very unlikely that there'll be a quick fix, quick level playing field among all these varying degrees of development and market structures among these RCEP members. But at the same time, take on from the point that Alicia was making that for companies in ASEAN this is a massive step forward. Because now within the rules of origin that are set paths. Within the various chapters on technology transfer on services movement that are set paths, companies can start building even bigger factories in smaller countries in Asia and take full advantage of the RCEP-related free tariff or low tariff access. So this could be a shot in the arm for investment in the region for countries that are willing to absorb flows. And you have within Asia countries like China, Korea, and Japan that very eager to move some of their investment footprint into ASEAN. And I think RCEP is a very strong enabling factor. Overall, global trade has been stagnant or declining ever since the global financial crisis. But I think we focus so much on trade and goods that we forget that trade and services are actually the elixir of global growth these days and going forward., That would be it. And therein lies some degrees of advantage of Asia. Asia is very good at services not just IT outsourcing in India or Philippines or tourism in Indonesia and Thailand. But overall, whether it is financial services or health, tourism, education tourism, Asia is the place to be in my view going forward. Therefore, the stipulations like RCEP will improve cross border payments and that would be in my view a positive contribution to growth prospects in the coming decade.

FBP: RCEP is also notable in terms of the countries which are not involved like India, for example. Alicia mentioned Taiwan. How would that impact those countries? And how do you see trade multi-lateralisation in this region evolving in the years with rival partners being set up?

TB: This is the beauty of Asia. These agreements are not wedded to ideological stances and they're not set in stone. As you can see, in the case of very deep integration like the European Union, how difficult it is for the UK to get out of it. RCEP is not going to be that deep. And on the flip side, therefore, it will not be as stringent or as inflexible. It was very clearly stated by the RCEP members when the deal was signed that as we ratify it through the course of 2021 and beyond, the door remains open for any like-minded country to come back or join. So therefore, they're not closing the door on India. India had its own national security, domestic political consideration particularly with respect to agriculture and import substitution-based manufacturing policy that they're pursuing. And therefore, they were nervous about getting into a deal with China which they felt was going to be unfair to them. Things can change. Minds can be changed especially if you see this deal turning out to be very good for non-China participants in RCEP. India could very well come back. Many RCEP members will continue pursuing various levels of FTA (free trade agreement) with India. And therefore, you can still have some degree of participation in the supply chain by Indian manufacturers independent of RCEP. To me, the biggest gainer for ourselves is Japan because Japan did not have FTA. With Korea and China under RCEP, they get this entry into low tariffs or no tariff movement of manufacturing inputs. Japan would be the biggest winner. India is not the biggest loser because the door remains open. And RCEP remains what the members have said repeatedly - a living document. It could be augmented. It could be modified in light of reality of global trade and global geopolitical movements. 

FBP: We discussed that growth is enabled or precipitated by state and government relief or stimulus. How sustained do you see that in the year ahead, with stronger signs of recovery? What can you say about the impact of tapering of those stimulus and relief?

TB: We are still scarred by the policy mistakes of 2008, 2009. At the beginning, we were too sanguine. And then we got too confident about the recovery. We reacted to the crisis late, particularly Europe, but also us to some extent. China did not get that wrong. They actually saw the crisis coming by late 2007 and were easing policy when Europe was busy raising interest rates. So early detection was poor. And then the prescription, the stimulus measures were withdrawn prematurely. And that held back growth, both the EU and the US through the course of the 2010s. That mistake will not be repeated by policymakers in Europe and US and also Asian policymakers have learned from that. Enabled by the lesson of that crisis, I can think of many directions that the authorities will pursue this time like giving fiscal stimulus in place, like tolerating higher inflation than their target, like enabling banks to continue extending credit which will mark a strong contrast from the post GFC recovery and which is why you've seen the expectations, whether it is five cross five inflation expectations. Whether you see the shape of the yield curve around US dollar assets, everything is suggesting expectations of prolonged accommodation to stay in place. I don't think the policymakers are going to disappoint us this time.

FBP: Eugene, one impact of those policy is in terms of credit moratorium and keeping a low interest rate law. How is the tapering of those measures impact banks?

Banks leverage strong and stable balance sheets as well as government and policy support

ET: We talked to a few hundred banks in Asia. And some clearly said we don't know what is the exit. Some say it is going to be 30% of those loans under moratorium will require some additional help. Some say it is going to be a few percentage points. So you know that the gap is very large. So again, it could be pretty bad or it could be really good in terms of exits. What we've seen so far in the last few quarters are that exits are relatively smooth. And on top of that, banks are providing additional targeted assistance to clients. So I think what we're going to see is that a lot of those system-wide moratoria will be probably terminated this year. But banks would still actively restructure loans over the medium term. It could be two or three, four or even more years. We're going to see potential for a hidden NPL situation in Asia, and then not only in Asia, but also globally. Right. That remains a risk because banks would probably, might in some form or another, just kick the can down the road and try to avoid recognition of NPLs. 

FBP: There are markets where asset quality is already in terms of bad debt such as India and Indonesia. Which market do you think are more susceptible to a lifting of moratorium that will impact on the loan portfolios? 

ET: To answer this question, you have to look at the historical credit costs in many of those systems. And in Asia, credit costs are traditionally pretty high in countries like Indonesia, India, and Vietnam. But once you dig into those systems in more detail, you see that for Vietnam, for example, credit costs were pretty high because banks were cleaning up legacy problems. And a lot of the same explanation is for India. Banks have been cleaning up legacy corporate NPLs. Nevertheless, credit cycles can be more violent in these emerging markets. Hence, we'll be watching carefully what the banks report. On top of that, there is always the issue of transparency. Some regulators and banks would clearly say, “This is the restructured part. This is the loans in the moratorium. And this is the movement over the last few quarters”. So, you have a lot of clarity. But many banks don't give you that information. You have to use additional data points and less orthodox analysis to try to figure out where you might see more problems not only at the system level but also at an individual bank level. It's going to be an interesting year for us to try to figure out who are the winners and who are the losers here.

FBP: Taimur mentioned earlier as compared to the previous global financial crisis, in this crisis banks are in a stronger position. The longer this crisis were to go on, where do you see the weakness potentially? Obviously, as the asset quality comes down, then it will impact on reserve and profitability. Where do you see the vulnerability?

ET: Indeed, I fully agree. The banking systems in Asia are stronger than they were 10 years ago. And the banks have been building capital. So that's all good. Capital acts as a shock absorber. And that's very good. I think that the risk is whether we see again reinfections or renewed lockdowns and this whole economic recovery story does not materialise or even reverses. That's a clear downside risk. And in that situation, we're going to see probably more risks to the bank's balance sheets and NPL. But again, according to our simulations, the vast majority of banks in Asia have really good capital to withstand more stress and more stressed situation. Hence, we don't expect a lot of pain on the banks’ balance sheets but banks will be able to withstand those shocks.

FBP: Taimur, if we were to draw parallels between this particular crisis and the global financial crisis, where there is a lot of liquidity, low interest rates, from quantitative easing, in 2007, and 2008. A lot of that liquidity actually ended up in private equity investments and the formation or what was then the start of the gig economy and the fintech startup. Do you see the equivalent in this pandemic where a lot of that liquidity going into kind of new economic sectors? We see that bifurcation in the economy driven by technology, innovation, versus traditional sectors.

TB: It's inevitable. If you have cheap leverage available, and the yields are low, people will want to use that leverage to juice up their returns. This is the most basic structural approach towards money going to places that you don't expect and the unintended consequence of easy monetary policy. So the world is such that you have a lot of high net worth individuals. You have a lot of corporations all with access to cheap financing and comfortable cash cushion who are keen to juice up the returns that they ordinarily would have gotten from deposits or bonds. And they're not getting that. Therefore, they will go elsewhere. Now, this has coincided with some degrees of excitement about the world of financial technology and technology in general, that these are companies that in the past have been more about eliminating competition and maximising their hold on the market. I have the Amazon model in mind. And therefore, if you pick the Amazon stock, you make a lot of money. But the rest of the booksellers go out of business. What we're seeing in this wave is that the companies themselves are trying to come up with better innovation because the foundation of technology, the basic business model of trying to be very large and capturing gains is behind us. It's hard, unless you have some revolutionary new ideas, you can’t be the next Amazon you cannot be the next Alibaba. So once that happens, then companies have to become a little more creative. And that's where I see a lot of excitement in areas like wealth management and insurance where we haven't seen sufficient development with technology enabling and now that's happening. And also mind you when one sector is dysfunctional, some other sector will step up to pick up the slack. Classic example is India. India's beleaguered banking system was so shy of lending that you would have had basically an economic implosion in 2018, 2019 if non-banks did not step up. Of course, non-bank financial corporations in India had their own issue of governance and bad loans. But the fact of the matter is, there was a lot of investment going on their investors like the tech enabled model, and many non-banks were pursuing in terms of assessing credit risk. And as a result, people stopped investing in banks and they went to non-banks. And there were times in 2018, 2019 when on the marginal dollar basis, majority of the credit intermediation in India was driven by non-banks over banks. You will see investment in alternative areas at times like this, that's inevitable. And unless authorities worry about bubbles forming, or regulatory arbitrage taking place, or systemic risk building, they will let these things continue unabated for the time being. But there is a swinging of the pendulum from time to time, as you see, in the case of China. China has been a very big enabler of fintech and big tech for more than a decade. And as of 2020, they're not that enamoured anymore. And they are trying to tighten the belt around the wide latitude that tech companies enjoy. And I think this is the beginning of a global phenomenon. We'll see it in Europe, or we're seeing already in Europe, we'll definitely see it in the US. Therefore, investment in those areas would have to take into account that likelihood of regulatory oversight becoming tighter. And beyond that, just as a general note, we are seeing a lot of interest in alternative investment vehicles. SPAC (special purpose acquisition company) have become a big word these days where companies are listing themselves without going through the IPO route. We are seeing, the torrid pace of climb in the cryptocurrency world. So these are some of the times if you keep rates at zero stuff like this will happen.

FBP: And my final question. What do you see as the focus and priorities of banks and the sector as a whole in 2021?

Success in stabilising margins, moderating credit costs, and pursuing alternative growth such as green/sustainable finance will facilitate profit recovery

ET: I think the banks would be busy trying to relax their credit underwriting standards. So we've seen a lot of tightening last year. Banks didn't want to really expand too much. There was obviously credit growth, but a lot of it was slow. Well, they need to start growing again because they have a lot of excess liquidity on their balance sheets. And at some point, that becomes a structural challenge. It just kills your margin. If you just have a lot of cash and you just invest in garbage, you don't make any money. Banks will have to start growing again. And where exactly they're growing. I think it's going to be an interesting area. I also expect maybe a bit more M&A (mergers and acquisitions) activity in the banking space. Because if you're doing business in an advanced market, you probably want to go more in the EM (emerging market) path, particularly where some banks would be cheaper there. And margins are higher as well. And of course, credit costs, how do you control credit cost? And how do you ensure that moratoria exits are smooth and don't lead to a spike in NPLs? I think those would be the key areas for the banks to watch this year.

TB: To me, the banks will have to get closer to governments. The governments around the region want green financing and they will demand that banks become a very strong player in that. We're beginning to see that happen in China elsewhere, including in my bank. Second, is the issue of digital banking where banks will be facing competition whether it is in Indonesia, or Singapore, or elsewhere. More and more branchless internet based banking which will not only offer deposits and credit facilities. They might offer a wide range of products including travel services and insurance and estate planning, and wealth management and so on. Banks have to sort of pull up their sleeves and get to work. If they haven't already digitised themselves, they're actually behind and they might struggle. I think the banks who have sort of embraced digitalisation are ready to deal with these challenges. And going back to my earlier point, that green financing issue, it also has an overlay of digital banking because when you start lending in carbon neutral activities, when you start lending in areas like leaving forest untouched, and the carbon value of that sequestered value of that forest then gets traded in the carbon market, banks would have to become participants in all of these things. And without technology, these things are very hard to track and measure. You need satellite imagery. You need real-time assessment to get seriously into green financing. There's a massive amount of capital waiting on the wings whether it is from sovereign wealth funds or international multilateral organisations. They all are nudging at banks, “Help us issue green bonds, help us issue deposits that are green compliant, and help us get deeper into the activity related to greening of the economy”. And for a while, this was something that Europe was taking the lead in America was here and there. I think Asia is the next big frontier. So to me, that's the very exciting backdrop for banks going forward. 

ET: I totally agree it is becoming more mainstream those that used to be more niche activities. It's becoming more and more mainstream, I fully agree. 

FBP: And with regulatory push as well. In Europe, where there's regulatory requirements, especially in the asset management space to declare how sustainable investment portfolios are. And it’s being propagated across the whole financial services lending business into the capital markets. Among our economists on this panel and credit analyst, in 2021, a lot of the regional economies will start to rebound if not recover from the low base effect. China will be a key market to watch as it recovers faster than the rest of the region. And with the potential to lift the region as well and not forgetting globally, markets like the US will also start to recover. But on the banking side, the outlook continues to be more cautious and dimmer. The impact on asset quality is substantial and profitability may not come back until 2022. Banks have to keep the cost down in order to manage margins and as Taimur mentioned, watch out for new areas of growth like sustainable or green finance. 

And thank you very much, Eugene and Taimur for your inputs, as well as to Alicia. We thank you for your insights and analyses. We hope that our audience have also found this session insightful and useful. And if you have missed any part of this session and would like to listen to the playback of the session, you may visit the Asian Banker RadioFinance website where you can download a recording of our session including this one as well as sign up for our future sessions. And on that note, I wish everyone good day. Thank you. 

Keywords: Banks, Growth, Pandemic, Deal, Credit, Year, Recovery, Countries, World, Economy, Crisis, Remains, View, Session


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