Thai banks’ asset quality feared to remain under pressure in 2016

The deterioration in asset quality can be seen as Thai commercial banks’ non-performing loans surge.

If Thai banks plan to reach the end of 2016 unscathed, then shifting gears to a more cautious pace may be optimal given the potholes that dot the operating environment, led by a limping domestic economy and mounting household debt. Thai banks will be tested this year on the asset quality and regulatory fronts, according to analysts, but those with sufficient buffers should swerve past these obstacles and even post modest profits.

Fitch expects asset quality to remain under pressure for most of 2016, with the small and medium enterprise (SME) segment being particularly at risk of rising non-performing loans (NPL). The deterioration in asset quality can be seen among Thai commercial banks whose non-performing loan (NPL) ratio rose to 3.3% in mid-September, with Fitch forecasting a further increase in 2016.

The incoming year offers little reprieve as Thailand’s domestic economy faces a difficult recovery. Not only have exports been hurt by slow global trading conditions, but also domestic investment has been inadequate in propping up the economy.

“The operating environment for the Thai banking sector remains weak, with limited prospects for economic growth and muted consumer sentiment,” says Fitch Ratings.
The problem of a flailing economy is compounded by the credit build-up in the Thai private sector and households in the past five years. Relative to regional peers, the leverage seen in Thailand is higher than average. “This indebtedness limits the potential for further credit-led growth, and also raises downside risks for lenders in the event of a sharper-than-expected or very prolonged economic recession,” says Fitch Ratings.

“Thailand’s continued weak operating environment, and the lingering effects of high credit growth prior to 2014, are combining to increase downside risks to banks’ asset quality.”

Among the banking segments, the most at risk from deteriorating asset quality are loans to SMEs, which make up around 39% of total bank loans, adds Fitch.

Unsecured personal lending, which makes up a smaller portion, around 8%, of loans is also vulnerable given an economic downturn.

“Both SME lending and unsecured consumer lending have risen more rapidly than other segments since 2013, which raises their vulnerabilities as loans season,” says Fitch Ratings.

As a reaction to this tougher operating environment, loan growth will likely fall among most Thai banks, says Maria Lapiz, analyst at Maybank Kim Eng. “When banks envisage a dimmer economic outlook, they will tighten their credit standard, resulting in lower credit supply. Worsening credit conditions may amplify and propagate the economic weakness, resulting in slower economic growth than it should have been. We foresee a rising probability of this scenario next year,” says Lapiz.

But even as the sector outlook remained negative, Fitch Ratings kept its ratings outlooks for most banks at stable, reflecting an expectation that most banks in their coverage will have sufficient buffers, such as loan-loss reserves and capital, to withstand a cyclical downtrend.

For its part, BMI Research cautions that in addition to the slow economic recovery, the banking sector should be wary of two key risks that send the sector into a tailspin.

The first risk is the high level of household debt in the country, which could result in rising NPLs while acting as a drag on private consumption, and hence consumer loan growth, says Chan Jin Lai, Asia analyst, BMI Research.

Official data showed that in the first quarter of 2015, Thailand’s household debt as a percentage of annualised gross domestic product is among the highest in the region. The second major downside risk could come from renewed political turmoil.

Regulatory shifts
To make the year even trickier for Thai banks, a crop of regulatory changes, from deposit insurance to liquidity coverage ratio, will be coming online. Analysts say some of these changes will improve the sector as a whole, but there will pronounced winners among the pack.

In August 2016, the minimum amount that qualifies for protection under Thailand’s deposit insurance will fall from THB25 million per depositor per bank to THB1 million.
While the number of accounts affected are small with 98.5% of bank accounts under THB1 million, the total amount of deposits involved in the regulatory change is substantial as accounts with over THB1 million make up 76% of total deposits.

Fitch Ratings expects larger banks with well-known franchises and branch networks to benefit from some deposit shifts, although the overall effect on the industry will be limited.

“Banks and depositors have had many years to prepare, and most banks have been trying to reduce dependence on large deposit concentrations,” says Fitch Ratings.
Commercial banks, which continue to be pressured by state policy banks in the area of deposits, may also find reprieve with the Ministry of Finance looking to finalise a deposit levy on state policy bank deposits which will likely be implemented in 1Q16 with an initial charge of 0.18% of deposits.

This regulatory change will help reduce the competitive disparity experienced by commercial banks, says Fitch Ratings. By not paying any deposit insurance premium, state policy banks have had a clear competitive advantage in garnering deposits over commercial banks, which pay total fees of around 0.47% of deposits.
Moreover, state policy banks gain public support due to a perception of strong state support.

Banks have not been caught flat-footed by the growing popularity of mutual funds, making moves to service the demand themselves. Currently, the eight largest mutual-fund providers are subsidiaries of the eight largest commercial banks.

But banks still have to grapple with sustained low growth in bank deposits which lead to liquidity management challenges. Fitch Ratings reckons that Thai banks’ loan-to-deposit ratios are already relatively high compared with other countries in the region.

In 2016, the requirements on the Basel III liquidity coverage ratio will commence as well. Starting at 60%, the ratio requirement will increase 10% annually until 100% is reached in line with the Basel Committee recommendations.

Similarly, the Basel III conservation buff will commence in 2016, slapping an additional 0.625% initially into all capital ratio requirements, although Fitch says that since capital levels in the Thai banking system are generally sound, this not be seen as a threat.

Potential threats
What could pose as threats, though, according to analysts, are foreign banks such as Australia and New Zealand Banking Group Limited and Sumitomo Mitsui Trust Bank, Limited that have set up Thai subsidiaries in 2015 and plan to ride out the near-term turbulence.

“The new entrants are likely to concentrate on niche markets in the short term, and have a limited impact on the sector. But the large capital that each bank has committed to Thailand (THB20 billion each) points to the longer-term opportunities that some regional lenders see in the Thai banking sector,” says Fitch.