Covid-19 has impacted many businesses and economies adversely. The financial sector in particular has been closely watched for signs of a potential financial crisis. As such, there is heightened focus on the ability of banking systems worldwide to withstand prolonged periods of stress.
National authorities have stepped in with measures such as debt repayment postponement, relaxation in nonperforming asset (NPA) criteria, and credit guarantees to support financial institutions and maintain adequate liquidity in the system.
However, these measures only provide short-term relief. Banks are still required to monitor their asset quality using the usual regulatory standards and build adequate capital buffers over time, in the hopes that any early crisis warning indicators can be addressed promptly.
A test of Asian banks’ vulnerability
Most Asian banks have built up capital buffers and reduced leverage since the 2008 global financial crisis. As a result, prior to the current crisis, Standard & Poor’s had a stable outlook on 19 of the 20 Asia Pacific banking systems. Tier 1 capital ratios were in excess of 11%, while NPA numbers were low for Asia Pacific banks.
Nonetheless, there is some pressure on asset quality. Non-performing loans (NPLs) - especially in China’s consumer segment - are on the rise, as the economic shutdown has pushed up the unemployment rate. However, as work has resumed, defaults should gradually decline. Moreover, the risk can be largely covered by sufficient capital buffers in the system.
In Indonesia, regulators have performed Covid-19 stress tests, and capital buffers for systemically important banks should be able to withstand industry-wide NPLs above 7%. However, a number of small, high-risk banks with already weak capital ratios may be forced to restructure or recapitalise.
Malaysian banks will likely see a gradual pace in build-up of non-performing assets due to Bank Negara’s measures that allow banks to provide a six-month loan moratorium. For now, capital and dividends remain intact based on stress tests.
Notwithstanding the above, Standard & Poor’s have reiterated that the resilience of banks' asset quality hinges on the success of policy responses, while Moody’s believes that Asian governments will likely stand behind the larger, systemically important banks to avert a financial contagion.
Profitability woes linger
The spectre of rising credit defaults is not the only challenge facing banks. Low interest rates since the 2008 crisis have continued to squeeze banks’ net interest rate margins. With interest rates forecast to stay lower for longer, bank profits will face further pressure in the coming years.
Thai banks are at risk of lower operating earnings, but the good news is that they are considered healthier now than during the 1997 Asian financial crisis. Likewise, Indian banks expect a sharp drop in transactions and disbursements owing to concerns over rising NPLs.
Declines in profitability can hamper banks’ ability to provide loans. Smaller banks that are focused on domestic loans and deposits and banks with deposit costs that are near zero and cannot be lowered further will be the hardest hit.
Technology underpins operational resilience
Throughout this pandemic, one feature that stands out is the operational resilience shown by financial institutions. Faced with lockdowns, many banks have had to ensure that staff could work seamlessly from home and continue serving their customers.
Financial institutions that have partnered with technology companies to implement remote customer onboarding, anti-money laundering and fraud detection systems have a competitive advantage. Equally, banks that invest heavily in cybersecurity and secure applications will be winners.
Singapore banks, for example, have been investing heavily in digital transformation strategies to improve customer experiences, while also transforming their back-end infrastructure. Financial institutions that undergo digital transformation will enjoy a higher degree of operational and financial resilience.
The future points to open banking
Asia Pacific is expected to see 100 new financial institutions by 2025, as a result of market liberalisation and new banking licences. Open banking is expected to provide more digital competition and innovation within the sector.
The latest development in Singapore’s financial sector digitisation is the upcoming award of digital banking licenses. The new incoming banks can tap the established base of cheap deposits and experience in credit assessment. Meanwhile, non-banks will bring alternative data which will enable them to understand niche segments better, such as ride-hailing and food delivery.
The region’s digital outlook is optimistic; currently, only 30 percent of Asia Pacific’s banking customers actively use digital banking channels. Offerings from non-bank competitors can also be extended to unbanked and underbanked segments, thereby closing the financial inclusion gap and in turn, hopefully, the income inequality gap.
This is the fifth of six articles in our Asian Expert Series, which explore the future of Asia post-Covid-19.
 Fintech and Digital Banking report by Backbase, a company that offers digital banking platforms, and the International Data Corp. (IDC)