2018 Credit Outlook for the Global Banking Industry

Transcription

1 Research Report on Credit Risks 2018 Credit Outlook for the Global Banking Industry Dagong Global Credit Rating Co., Ltd January 30 th,

2 Category Industry Studies Main Opinions Date Jan 30 th, 2018 The credit risk of global banking declines but the industry remains stable, while the risk differ among the main regions. The US banking sector will continue to improve its profitability and asset quality, boost its capital strength, and enhance its ability to resist risks, which would contribute to the decrease of credit risks. Credit risks of the European banking sector remain, with gradual improvement in banking profitability and outstanding NPL (non-performing loan) problems. Under the severe financial supervision in 2018, the asset quality of banking industry in China is expected to be stable. Although the profitability and capital adequacy might be slightly under pressure, the overall credit risk is controllable. In 2018, with the steady recovery of economy, the profitability of banking in emerging markets is expected to improve, but the credit quality still faces many challenges such as the high level of non-performing loans, the pressure of capital adequacy and the uncertainty in the external environment. Contact Financial Research Department Zhang Hanhan, Li Zhe, Han Xiliang Tel:(8610) Address:30th Floor, Eagle Run Plaza A, No.26 Xiaoyun Road, Chaoyang District, Beijing, China.

3 Dagong s 2018 Credit Outlook for the Global Banking Industry In 2018,credit risk of global banking industry is expected to be stable with slight decline, but credit risk characteristics of the banking industry differ across major regions. Benefiting from positive factors such as global economic recovery and increase in credit demand, profitability and assets quality of the banking industry in major regions have improved. After the 2008 financial crisis, increasingly stringent financial regulations enhanced the capital strength of global banking industry, improving its riskresisting ability. However, the banking industries of developed countries are polarizing in terms of credit risk, given the continuing low interest rate environment and the ineffective disposal of non-performing assets. While the credit risk of US banking industry has reduced significantly, the credit risk of European banking industry still remains high and the status quo is not improving. The profitability of European banking industry is still under pressure due to the low interest rate, the risks are still outstanding given the problem of asset quality problem and capital stress. In emerging markets, credit quality of banking industry is still fragile given that these countries are still at the stage of internal economic structural reform and accessing to international financial supervision standards. To be specific, in China, the compliance cost is expected to increase substantially, and the profitability, liquidity and asset quality are still under pressure, although the risk is controllable. In India and Russia, non-performing assets and capital-buffering pressure highlighted the frangibility of the banking industry. As to Brazil and South Africa, the credit quality of the banking industry is challenged by the political and economic uncertainties at home and abroad. I. The US banking sector will continue to improve its profitability and asset quality, capital strength and its ability to resist risks, which would contribute to the decrease of credit risk. The Federal Reserve's (Fed s) rate hike and financial deregulation trend will provide certain favorable operating environment for the US banking industry in The Financial Choice Bill embodying the Trump government s preference for financial freedom has passed in the House of Representatives in. Considering the distribution of members of the Senate and public opinion, the Bill passed in the Senate and eventually landing will face greater resistance. However, it is expected that the Republican Party may gradually promote financial liberalization by way of trade-offs or policy gambling, which could expand banks revenue channels and reduce their compliance costs. At the same time, the Fed s rate hike and the recovery of financing demand of real economy in led to a sustained increase in profitability of the banking sector, by the third quarter of, the sector s annualized ROA was 1.12% and its annualized ROE was 9.89%, creating a new high since the subprime crisis (Figure 1-1). In 2018, given the steady rise in inflation in the US, the Fed is expected to raise interest rates three times, leading to the federal funds rate ranging from 2% to 2.25%, and the size of the Fed's assets to be reduced to around 2.1 trillion dollars over the next five years (Table 1-1). The Fed s monetary policy of rate hike and shrinking 1

4 assets will accelerate to move up market interest rates and further expand the period spreads, resulting in an improvement in banks net interest margin (Figure 1-2). In summary, it is expected that the rise in banks net interest income will become more apparent in 2018 (Figure 1-3), boosting profitability further. Figure 1-1:Profitability of US banks(%) E 2018F -1-1 ROA ROE Source: FDIC, Dagong Table 1-1:The Fed s plan to shrink its balance sheet(billion USD) / / / / 7-9 Upper limit Treasuries Agencies & MBS Source: FED, Dagong Figure 1-2:Net interest margin of US banks(%) E 2018F Source: FDIC, Dagong 2

5 Figure 1-3:Revenue structure of US banks(billion USD) Net interest income Non-interest income E 2018F Source: FDIC, Dagong Sustained improvements in asset quality and capital strength have greatly increased the risk-resilience of US banks. With the effects of economic recovery, market financing needs and interest rates rising, banks ' willingness to supply credit continues to increase, as evidenced by banks loan balance to total assets increasing to 55.43% at the end of the third quarter of. Profitability continues to rise, which creates a good foundation for US banks to put more efforts into bad debts write-off for credit cards and other assets. By the third quarter of, the scale of non-performing loan (NPL) in US banks had fallen for 30 consecutive quarters, with the NPL ratio falling to 1.2% - the lowest level since the fourth quarter of 2007 (Figure 1-4). The number of banks and amount of total assets taken over by the Federal Deposit Insurance Corporation (FDIC) continued a double-down trend, accounting for only 1.81% of the total number of industry institutions and 0.09% of total assets (Figure 1-5). In 2018, although natural disasters may cause some uncertainties in the quality of agricultural credit in the southern region, there will still be room for improvement in the quality of banking assets, considering such factors as the continued increase in credit demand and the improvement of profitability. In the meantime, provision coverage of US banks reached % at the end of the third quarter of, which is the highest level since the fourth quarter of Capital adequacy will continue its steady upward trend since (Figure 1-6). Although the Fed s rate hike may increase the volatility of financial market in 2018, the US banking sector s credit risk level would remain stable given the substantial increase in the overall anti-risk capability of the sector. Figure 1-4:Asset quality of US banks(%) E 2018F NPL ratio Provision coverage ratio (right axis) Source: FDIC, Dagong 3

6 Figure 1-5:Health status of US banks(billion USD) Number of problem banks Assets of problem banks (right axis) Source: FDIC, Dagong Figure 1-6:Capital strength of US banks(%) Tier-one capital adequacy ratio Capital adequacy ratio E 2018F Source: FDIC, Dagong 2. Credit risk of the European banking sector will still exist, with gradual improvement in banking profitability and outstanding NPLs problem. The ultra-loose monetary policy will impede the improvement of profitability performance of the European banking sector in Banking sector will benefit from economic recovery in 2018, with an increase in credit demand and interest income, which will help to improve profitability. However, factors such as ultra-loose monetary policy and rising regulatory costs still severely constrain the profitability of European banking sector to stay at a low level. First, the ECB's monthly net purchases has reduced from 60 billion to a new monthly pace of 30 billion until the end of September 2018, and rate hike process was expected to start at the end of 2018 or 2019 because of some regions weak economic recovery. The ultra-low interest rate environment has limited the improvement in European banking sectors net interest margin. Second, regulation will remain at a stringent level, and the implementation of IFRS9 will cause a certain level of pressure on provisions as well as compliance cost. Finally, high NPL continue to negatively affect profitability, as some banks are still faced with cost pressure which include impairment cost, NPL disposing cost, restructuring payment and compensation cost. Thus, despite the fact that European banking sector s annualized ROA and 4

7 annualized ROE increased to 0.47% and 7.1% respectively in the first half of, and the improvements are expected to continue in 2018, the overall profitability performance remains at a low level when compared with global banking sector. Figure 2-1:Profitability of European banks(%) E 2018F ROE ROA(right axis) Source:EBA, Dagong The high NPL problem will continue to threaten the soundness of the European banking Sector. Benefiting from the recovery of European economy, the NPL ratio of European banking sector fell to 5.48% in the first half of (figure 2-2), but still ranked the highest among main regions globally. In addition, the credit risk among European countries banking sectors differs significantly, for example, the banks NPL ratio in Northern European and core European countries (UK, France, and Germany) are comparatively lower than that of other European countries; although Ireland, Spain and Portugal showed a high downward NPL ratio trend along with the domestic economic recovery, Italy and Greece still are faced with severe NPL problem (figure 2-3). In 2018, the problem of NPL remains the biggest threat to the European banking sector. First, reimbursement process is ineffective and expensive, which drag the clean-up process of NPL; second, the low interest rate constrains banks' NPL cleaning through earnings; third, with strong bank regulation and restrictions on banks been bail-out, it seems impossible to solve the problem of non-performing assets through government intervention; last, the real estate bubble might reoccur in some countries, with a high proportion of real estate claims, and normalization of monetary policies might burst the real estate bubble and threat the soundness of European banking sector. Figure 2-2: Loan quality and loss provision in the European banking sector (%) E 2018F NPL ratio Provision Coverage(right axis) Source:EBA, Dagong 5

8 Figure 2-3: Loan quality analysis of main European countries` banks (billion EUR, %) NPLs( ) NPLs( ) European Banking sector's NPL ratio (right axis) European Banking sector's NPL ratio (right axis) NPL ratio (right axis) NPL ratio (right axis) Source: World Bank, IMF, Dagong Weak risk mitigation capacity and regional financial complexity will push up the European banking sector s credit risk. Driven by strong regulation in Europe, banks are enhancing their capital by capital injection and issuing subordinate debts. European banking sector's capital adequacy ratios rose slightly to 17.99% in the first half of, whilst the capital adequacy ratios of banking sector in UK, Spain and Ireland showed some decline (Figure 2-4). In 2018, with the rate hike progress of the world's major developed countries, the volatility of financial market will directly increase the difficulty of capital enhancing, and some banks will face capital inadequacy pressure. By the end of June, the provision coverage ratio of the European banking sector was only 44.74%, far below the average level of major region s banks globally. With the slow improvement of non-performing assets and the risk of potential asset quality, the risk mitigation capacity of European banking sector is still deficient. In addition, Europe's main important banks businesses are spread all over the region, which have large external risk exposure. This makes the credit risk of one country s financial system easy to transmit to other countries' banking sector and to form the regional systemic financial risk. Figure 2-4: Capital adequacy ratio of major European countries banks(%) Source: World Bank, IMF, Dagong 6

9 Credit Outlook for the Global Banking Industry 3. Under the severe financial supervision in 2018, the asset quality of banking industry in China is expected to be stable. Although the profitability and capital adequacy might be slightly under pressure, the overall credit risk is controllable. In 2018, strong financial supervision will dominate China s banking industry and affects on its development. In, the banking supervision in China was significantly strengthened, and the People's Bank of China formally implemented Macro Prudential Assessment (MPA) to further control the market. The CBRC issued a series of regulatory measures to govern the market chaos (i.e. regulatory arbitrage), liquidity, and more supervision on the interbank business, entrusted loan business and finance products. At the same time, the establishment of the Financial Stability Development Committee will realize a unified regulator. In 2018, to ensure that supply-side reform in China continues and to prevent financial systemic risks, strong regulation will dominate China's financial regulation environment and the Financial Stability Development Commission will play a more prominent role, and more focus will be given to regulate shadow banking, internet finance, asset management and financial holding companies. Under this circumstance, the business structure of Chinese banks will be adjusted, the growth rate of banks wealth management products will continue to decrease significantly (Figure 3-1), the shadow banking system will continue to shrink (Figure 3-2), and the interbank business will continue to decline. Figure 3-1: Financial Products balance of China Banking Sector Balance of Financial Products (trillion CNY) YOY of Bank Financial Products Balances(%) Source: Chinawealth.com, Dagong Figure 3-2: Shadow banking in social financing incremental scale (billion CNY) Entrusted Loans Trusted Loans Undiscounted bank acceptance Source: People s Bank of China, Dagong 7

10 Rising regulatory costs will make a reduction on the bank's profitability. In 2018, monetary policy will remain stable and neutral, with interest rates on the financial markets moving up, therefore the banks net interest margin will stabilize and might upswing. However, the rising regulatory costs associated with the strengthening of financial regulation will continue to constrain the profitability of banks (Figures 3-3 and 3-4). First, since the regulatory authorities have strengthened the control over interbank business and financial products, banks fees and commission income have suffered certain pressure, and the proportion of non-interest income of banking industry have dropped significantly since the second quarter of (Figure 3-5), and the non-interest income is expected to under stress through the year of Second, with the strengthening of financial supervision as well as the increasing of bank costs and expenditures, operating efficiency is under slight pressure. Although the efficiency of China's banking sector is lower than that of the global banking sector, banks have begun to increase internal risk control and compliance management with corresponding increases in penalties since, hence the cost-to-income ratio presents an increasing trend (Figure 3-5), which negatively affects the profitability of banks. Finally, the sidesupply reform and shift of real economy growth will increase the downward pressure on credit quality; banks have to increase the impairment provisions, which further decrease the banks earnings. Overall, the profitability of China's banking industry still faces some downward pressure in Figure 3-3: Profitability of Chinese banks (%) E 2018F NIM ROA ROE(right axis) Source: CBRC, Dagong 8

11 Figure 3-4: ROA of all kinds of Chinese banks(%) State-owned banks City commercial banks Nation-wide Joint-stock commercial banks Rural commercial banks Source: CBRC, Dagong Figure 3-5: Non-interest income proportion and cost-to-income ratio of Chinese banks (%) Proportion of Non-interest income Cost-to-income Ratio Source: CBRC, Dagong In 2018, China's banking supervision will be conducted in a multi-pronged approach and the asset quality of banks will remain stable. With the adjustment of banking credit structure, the disposal of non-performing asset and the tightening of lending conditions, the asset quality of China's banking industry remained stable in, the nonperforming loan ratio of the banking industry maintained at around 1.74% (Figure 3-6). At the same time, the coverage ratio of banking industry increased slightly. In 2018, China will further take measures to eliminate the over-production capacity problem, reduce the real estate inventory, high leverage and production cost, which will not be conducive to improve the quality of banking assets, but the rural commercial banks might be under deteriorating pressures (Figure 3-7). Under the circumstances, banks are expected to further raise the standard of lending, and take varies measures to deal with the non-performing loans. Overall, the asset quality of China s banking industry is expected to remain stable and the credit risk is controllable. 9

12 Figure 3-6: Loan quality and loss provision in the Chinese banking sector(%) Special mention loans' propotion NPL ratio Provision Coverage ratio(right axis) Source: CBRC, Dagong 4 Figure 3-7: NPL ratio of all kinds of Chinese banks(%) State-owned banks City commercial banks Nation-wide Joint-stock commercial banks Rural commercial banks Source: CBRC, Dagong The capital strength and liquidity of China s banking sector might be under pressure but the risk is under control. In, the capital adequacy ratio of China s banking sector shows a slight decline during some seasons, but the overall tendency is stable. It should be noted that the overall capital adequacy ratio of China s banking sector is lower than that of other developed regions. Although the difference of calculation approaches might give some explanations, the high level of banking leverage is the main problem. In December, CBRC released a new rule about some newly added indictors about liquidity, in order to prevent financial systemic risks and curb the bubbles in financial assets, with the central bank s neutral monetary policy, it is expected that in 2018 the liquidity of Chinese financial market might be still under 10

13 some pressure, especially for small and medium-sized banks. However, considering that the central bank will adjust the market liquidity through various open market operations, it is expected that although there might be some liquidity pressure in the banking industry, the overall risk is still under control and the liquidity in the banking industry will remain stable (Figure 3-10) Figure 3-8: Capital adequacy of Chinese banking sector(%) CET 1 Tier 1 Captial adequacy ratio capital adequacy ratio 2013 Source: CBRC, Dagong Figure 3-9: Capital adequacy of all kinds of Chinese banks(%) State-owned banks City commercial banks Nation-wide Joint-stock commercial banks Rural commercial banks Source: CBRC, Dagong 11

14 Figure 3-10: Liquidity of Chinese banking sector(%) loan to deposit ratio liquidity ratio Source: CBRC, Dagong 4. In 2018, with the steady recovery of economy, the profitability of banking in emerging markets is expected to improve, but the credit quality still faces many challenges such as the high level of non-performing loans, the pressure of capital adequacy and the uncertainty of the external environment. In 2018, the recovery of economy and ease of monetary policies will support the profitability of banking in most emerging markets. However, due to the international factors such as the Fed s further interest rate hikes, the profitability is not expected to be improved largely. High non-performing loans, capital adequacy pressure are still the major threats to the banking sector in some emerging markets, and the credit quality improvement is still under pressure. Here we take BRICS as representatives of emerging markets, and the credit risk analysis are as follows: 4.1 The political and economic uncertainties in Brazil in 2018 will be detrimental to the continued improvement of banking s credit risk. The presidential election and external uncertainties will challenged Brazilian banks credit quality. In, as the pressure of inflation and devaluation relieved, the Central Bank of Brazil decreased interest rates continuously. In December, the central bank's policy rate drop to 7%, which is the lowest since 1986, together with the recovery of domestic economy, has boosted banks lending. Affected by this, as of the end of the third quarter of, all the key indicators of the Brazilian banking sector performed well. The capital adequacy ratio continued to rise to 17.97%. The annualized ROA and annualized ROE rose to 1.30% and 12.44% respectively, NPL ratio slightly decreased to 3.60% (Figure 4-1). In 2018, the presidential and parliamentary elections will cause some uncertainties on the continuity of policy and market confidence in Brazil and affect the process of economic stabilization and recovery, which might destabilize the sustainable development of banking sector, so the improvement of the credit risk in Brazilian banking sector still faces some challenges. 12

15 E 2018 F E 2018 F 2018 Credit Outlook for the Global Banking Industry Figure 4-1:Brazilian Banking Sector(%) Capital strength Profitability Capital/Total asset Capital adequacy ratio ROA ROE NPLs ratio E 2018 F Source:Banco Central do Brasil, IMF, Dagong 4.2 Russia's economic recovery, the continued cleaning-up of troubled banks and other positive factors will continue to support the development of the banking sector, but the problem of high NPL should be solved. Recovery of Russian economy, decreasing of interest rates, and the cleaning up of problem banks will continue to improve the credit of Russian banking sector, but the high level of non-performing loans continues to make the banking sector fragile. It is expected that the Russia's economic will continue to rebound in 2018 due to favorable factors such as oil price recovery. In, the Central Bank of Russia cut interest rates six times to 7.75% and trend of decreasing rate might continue in 2018, which is favorable to the credit environment of banking sector. In the meantime, the banking supervision in Russia has been stricter. The troubled banks have been continuously acquired and cleaned up, while some domestically important banks might be bailed out by the state (such as the nationalization of Russia's largest private bank Otkritie in August and B&N Bank in September ). It is expected that the number of Russian banks will continue to decline in the future (Figure 4-2). Continued cleaning up of troubled banks will be conducive to the regulation environment of banking industry and reduce the systemic risk. As of the end of the first quarter of, the capital adequacy ratio of Russia's banking industry rose to 13.43%, the annualized ROA and ROE increased to 1.53% and 12.32% respectively, both the capital and profitability showed a positive trend. However, in the first quarter of, the non-performing loan ratio 13

16 Credit Outlook for the Global Banking Industry has risen to a high level of 9.72%. The problem of non-performing assets has made the banking sector in Russia still fragile. Figure 4-2:Russian banking sector(%) 1000 Credit institutions with banking licences 1 1 Profitability E 2018F ROE ROA capital strength NPLs ratio Capital adequacy ratio Tier 1 capital adequacy ratio Source: Central Bank of Russia, IMF, Dagong 4.3 The NPL problem in India in 2018 still severe and the credit risk of banking sector still stays high. The asset quality of Indian banking assets continued to deteriorate, the size of nonperforming loans and the non-performing loan ratio continued to rise. Since the Indian banking sector has long been weak in dealing with the non-performing loans, and the asset quality of banks deteriorated significantly. Most banks have reduced or even stopped lending, resulting in long-term low profitability in banking industry. At the end of the second quarter of, annualized ROA and ROE were 0.40% and 5.46% respectively (Figure 4-3), much lower than other banking industry in most emerging countries. In the meantime, India will fully implement Basel III new capital rules in March 2019, but the long-term low profitability make the banking sector less able to replenish its own capital by themselves. Although the government announced a capital injection plan (2.11 trillion rupees) in October to alleviate some of the pressure, the capital adequacy ratio of the banking sector of India in is estimated at 13.2%. The pressure on capital replenishment will remain relatively urgent in the near future. What s more, risks such as capital outflows caused by Fed s increasing rates, the devaluation of local currency etc. will have a certain impact on financial liquidity in India, and therefore, the credit risk of India's banking sector in 2018 is still high. 14

17 E 2018 F 2018 Credit Outlook for the Global Banking Industry Figure 4-3:Indian banking sector(%) Capital strength Profitability Capital adequacy ratio Capital/Total asset ROE ROA NPLs ratio E 2018 F Source: IMF, Dagong 4.4 The instability of South Africa's political situation, insufficient foreign exchange reserves and rising pressure of domestic currency devaluation will continue to challenge the credit risk of South Africa s banking sector. Benefit from the rebound of commodity market, South Africa's economic performance in was better than expected, pushing the banking business to perform better. At the end of the third quarter of, South Africa's annualized ROA and ROE of banking industry were 1.34% and 16.56% respectively (Figure 4-4), the overall profitability was relatively stable. The capital adequacy ratio increased steadily to 13.84% and the non-performing loan ratio dropped to 2.76%, which indicates the improvement of capital and also the asset quality of banking sector. In 2018, the political stability in South Africa will face some challenges, insufficient foreign exchange reserves and domestic currency devaluation will be adverse to the steady development of the banking industry in South Africa, therefore the credit risk of South Africa s banking sector still face some challenges in

18 E 2018 F 2018 Credit Outlook for the Global Banking Industry Figure 4-4:South African banking sector(%) Capital strength Tier 1 caiptal adequacy ratio Capital adequacy ratio Profitability ROE ROA 2018 F 3.60 NPLs ratio E 2018 F Source:South African Reserve Bank, Dagong 16