English 
Vietnamese Banks in the Asia Pacific region have performed remarkably well through more than three years of financial turmoil, including the ongoing European sovereign and banking crisis.
Our central scenario is that this resilience will generally persist. However, we observe that the risks to that scenario have increased, warranting a closer examination of how bank creditors could be affected under “tail risk” developments.
We remain cautiously optimistic, but we acknowledge that a further deterioration of the euro area crisis could significantly, and perhaps rapidly, increase the odds of spillovers on some banking systems in the region.
We provide our preliminary view on which banking systems are most vulnerable to such a downside scenario.
Although of a modest magnitude, some evidence that the economies and banking systems of Asia Pacific are not decoupled from the euro area crisis has started to emerge. Since the second half of 2011, we have noted a broad slowdown in exports from Asia Pacific, general weaknesses in Asian currencies that have reversed their earlier strengths, and increasing anecdotal evidence of European banks selling their portfolios of Asia-Pacific-related loan books
These developments suggest that, for the region’s financial systems, the proximate impacts of a worsening euro area crisis could come from:
- the asset side of banks’ balance sheets, such as through weakened corporate credit profiles, especially for exporters
- the liability side, via higher debt refinancing risks and credit risk premia pushing up wholesale funding costs, and
- additional strain on the balance sheets of banks in the region as they try to absorb the loan books of retreating euro area banks
We analyze and classify 16 banking systems in Asia Pacific into three categories, in terms of their exposure to extreme distress in the euro area: More Exposed, Exposed, and Less Exposed.
The classification is based on our assessment of five main areas:
1) a banking system’s dependence on external funding;
2) the significance of euro area banks in individual banking systems;
3) economic dependence on exports;
4) the overall challenges faced by the banking system; and
5) government’s or central bank’s capacity to support banks, if needed.
We conclude, based on these factors, that the banking systems in Australia, New Zealand, Korea and Vietnam are the ones most exposed to fallout from the euro area.
While these systems appear less exposed than they were at the time of the Lehman Brothers shock in 2008, we assess them as more vulnerable to the first-round impact of a further worsening of the euro area crisis that could pressure their standalone financial strengths compared with other systems in Asia Pacific, notwithstanding the possibility that some of their governments could provide support to alleviate these impacts.
Meanwhile, we classify ten banking systems under “Exposed” category. They are, in alphabetical order: Cambodia, China, Hong Kong, India, Japan, Malaysia, Mongolia, Singapore, Taiwan, and Thailand.
Those in the “Less Exposed” category are Indonesia and the Philippines.
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Impact on Asia of an Accelerated Euro Area Crisis
More Exposed: Australia, New Zealand, Korea, and Vietnam
Banking systems in Australia and New Zealand are exposed to high refinancing risks, as well as potential spikes in both borrowing and hedging costs. The proportion of their external funding in their total funding is 19% for Australia, and 16% for New Zealand.
These are among the highest in the region, and expose banks in both systems to increased funding costs and refinancing risks at times of wholesale funding market stress. However, there are important offsets that serve to reduce risks to bank creditors in both markets.
Korea’s banking system is also highly exposed to refinancing risks, as it has a very high foreign currency loan-to-deposit ratio of 328%, and the proportion of external market funding accounts for 9% of its total funding.
Moreover, Korea’s economic dependence on exports is strong, and the presence of euro area banks in Korea is also relatively high among Asia Pacific countries excluding financial hubs such as Hong Kong and Singapore. These make Korea the most exposed system after Australia and New Zealand.
We also believe that Vietnam’s banks are highly exposed to external shocks because of the country’s relatively undiversified economy and weak financial system. We are concerned about the corporate sector’s dependence on low-cost US dollar loans, which exposes the system to a sudden tightening in foreign currency liquidity.
Exposed: China, Japan, India, Malaysia, Hong Kong, Singapore, Taiwan, Thailand, Mongolia, and Cambodia
A sharp deterioration in the euro area will affect China’s economy through slower exports. The country’s banking system also relies on the wholesale market to fund its foreign currency lending, as shown by a loan-to-deposit ratio of 200% in its foreign currency books.
Yet the very scale of China’s economy means that its relative exposure is small, in either GDP or domestic credit terms. The country’s large coffer of foreign currency reserves, plus its controlled capital account regime, means that the government’s capacity to shield banks from an external crisis and provide them with foreign currency liquidity is exceptionally strong.
While Japan – as a major credit-exporting nation – is not directly exposed to the risk of a foreign currency liquidity squeeze, its banking system is still exposed to the potential setbacks to Japan’s exporting companies from a strong yen.
In areas like high-end capital goods – where Japanese and European brands compete head-on – a potential weakening of the euro against the yen could put Japanese producers at a disadvantage.
The Japanese economy is already struggling with the general impact of a strong yen. A further deterioration in the euro would exacerbate that trend negatively, affecting the quality of the loan portfolios of banks. In addition, a spreading euro area crisis may prompt further downward adjustments in equity prices, which could mean another wave of investment losses from the banks’ equity holdings, and thus a capital depletion.
India’s direct dependence on euro area economies, both as a destination for its exports and a source of foreign capital, is limited. Nonetheless, its banking system fundamentals have been weakening from a slowing economy and high inflation.
The sharp rupee depreciation in the ending months of 2011 is also a warning that its overall capital balance is prone to further disruption if the euro area crisis continues to worsen. While the banking sector does not rely on currency funding, we are concerned that it could be exposed to large, un-hedged foreign currency positions among corporate borrowers.
Malaysia’s exposure comes from the high export dependency of its economy, as well as an elevated level of euro area bank claims as a percentage of its GDP. There are nonetheless strong mitigating factors as its economy has benefited from commodity buoyancy, while the banks are amply capitalized and show no significant liquidity distress.
Hong Kong and Singapore – as regional financial centers – are intrinsically exposed to potential hiccups in the international capital markets as a result of an escalating euro area crisis. Hong Kong’s currency board arrangement reduces the Hong Kong Monetary Authority (HKMA)’s flexibility to provide liquidity support for banks, although the HKMA has accumulated substantial excess reserves which can be used to defend the local currency.
In both economies, domestic activities are largely funded by sticky domestic deposits, yet money market rates have been rising along with global risk aversion, a development that has underpinned gradual rises in retail lending rates. Both economies also serve as major regional trade hubs, exposing them to a Europe-led slowdown in regional trade flows, and any weakening in Asia’s corporate sector as a result.
Taiwan’s dependence on exports and reliance on euro area bank credit are both relatively high. Yet its foreign currency loan-to-deposit ratio runs as low as 40%. This suggests that the system, which has abundant customer deposits, will mitigate a potential tightening in foreign exchange liquidity stemming from a euro area crisis.
Besides high export dependency, Thailand’s banking system runs a foreign currency loan-to-deposit ratio of around 192% that warns of its strong reliance on market funding to support its foreign currency lending. Yet in terms of absolute size, or as a share of total funding, we consider the potential shortfall in foreign currency supplies in Thailand to be relatively small.
Having said that, the overall loan-to-deposit ratio has approached 100%, which places the domestic system in a situation of stress, if it is to absorb the impact of any retreat by European banks.
The indicators used in our analysis show that the Mongolian banking system could be less exposed to a euro area crisis.
However, major domestic banks in the country are rapidly growing their assets by over 30% per year, and its banking system is increasing its dependence on external funding by extending USD loans to its corporate clients – both of which are indicative of potential exposures to a liquidity pullback. Nonetheless, foreign claims on Mongolia by euro area banks are still low, which gives us some comfort.
Cambodia’s economic dependence on exports is high, but we derive some comfort that (1) most of the banks’ foreign currency funding comes from their depositors and shareholders, and (2) the foreign claims of euro area banks on the country are negligible.
Less Exposed: Indonesia and the Philippines
Indonesia’s economic dependence on exports is relatively low, and its reliance on euro area banks’ credit is relatively small.
Nonetheless, the broader financial system, especially the government bond market, has benefited from stronger foreign capital inflows and is thus exposed to a general retreat, if an escalating euro area crisis triggers a pull back in global risk appetite. Foreign currency liquidity in its banking system is also tightening, with the related loan-to-deposit ratio at 100% and rising.
Financial contagion risk to the Philippines is limited. Its banking system’s foreign currency loan-to-deposit ratio is at a very comfortable 24%, showing abundant customer deposits. In addition, euro area banks’ foreign claims on the country are relatively small.
However, the sharp weakening in 2011’s export performance is a warning that the banks may see a worsening in the debt-servicing capabilities of exporters.
Source:CFOInnovationAsia Author: Moody
