ASEAN, India banking systems poised to cope with tapering, higher interest rates

Thanks to strong capital buffers.

Moody's Investors Service says that the banking systems in ASEAN and India are resilient to the financial impacts of the reduction of monetary stimulus by the US Federal Reserve, or the risk of higher interest rates more generally.

"The strengths of these banking systems are currently underpinned by their relatively strong capital buffers, modest levels of problem loans, high recurrent profitability and low reliance on foreign funding," says Eugene Tarzimanov, a Moody's Vice President and Senior Credit Officer.

"Moreover, the banks will continue to benefit from a supportive economic environment in the region, characterized by growing trade flows between Asia and the recovering economies of the US and Europe," adds Tarzimanov, speaking on the release of a new Moody's report, "ASEAN and Indian Banks Resilient to US Tapering and Higher Interest Rates".

"At the same time, these systems could also face pockets of risk, as tapering lifts their economies out from a long period of low interest rates and speculative capital inflows into a new credit cycle characterized by slower economic and credit growth, and higher cost of funds," says Tarzimanov.

"In particular, the key downside risks are a sharp rise in debt-servicing burdens in economies that have seen strong credit growth and are now more leveraged, and adverse asset price adjustments that could affect the banks' capitalization position and loan quality," says Tarzimanov.

"We note, for example, that the ASEAN and India economies have seen pronounced gains in real estate prices in recent years."

The report considers that interest rates will likely rise and capital flows should continue to reverse, as a result of tapering, which was signaled by the US Federal Reserve in May 2013 but effectively started last December.
Consequently, ASEAN and Indian banks will see higher problem loans on their corporate and retail exposures, especially on foreign currency loans, if their domestic currencies fall substantially.

Negative financial market adjustments would also lead to mark-to-market losses on the banks' securities investments. Nevertheless, higher interest rates will support the banks' net interest margins, which, to some extent, will mitigate their higher credit costs.

In addition, funding will not be a key risk, because ASEAN and Indian banks exhibit low levels of foreign currency borrowings. Most operate with loan-to-deposit ratios of around 90%, with foreign currency borrowings accounting for less than 2% of liabilities.

The report also notes that, compared with other emerging markets, ASEAN and Indian banking systems are more resilient to the potential adverse impacts associated with tapering, mostly owing to the high economic growth rates in the region, relatively large reserves at the sovereign level, rising income levels, and the banks' own good credit fundamentals.