Since Swift decided to go ahead with Sibos and to defy the doom-mongers about a possible SARS backlash, the economic data from Asian markets has improved. Asian countries offer record-low interest rates, record-high liquidity levels and a banks community with cleaner balance sheets than at any time in the past six years.
The pump is primed. The question for Western investors is no longer whether, but where, to be in Asia.
We see no reason to spoil a festive mood. But a pesky question remains to be answered: Will Sibos be a full-blown party with dancing and revelling the whole weekend long? Or, will it be more like a Friday night cocktail reception, where everyone is home and in bed by eleven? Are Asian expansion plans proposed by Western banks, software houses, data vendors and exchanges backed up by economic realities?
Unfortunately, we find ourselves in the cocktail camp, for two reasons. First, while we do foresee upside from an improved global environment over the remainder of the year, we don’t believe that the regional response will be particularly vibrant. Second, with unresolved structural imbalances plaguing Asia’s major export markets, we have little faith that a cyclical recovery can turn into sustained high growth.
What are the implications for the regional banks, and thus our core constituency, the related software houses and data vendors? Here’s what we think:
· Low interest and competition pose challenges for several Hong Kong and Singapore banks;
· Banks are coping with deflation by lowering deposit rates and controlling costs, but there is less room to protect margins – particularly for the banks in Taiwan and Singapore;
· Dividend payouts and share buybacks favour banks with excessive capital and resilient earnings.
How will Basel II influence this trend? Certainly, there is a danger that Asian banks could be left behind because the cost and complexity of Basel II could cause supervisors and banks to delay adoption, thereby creating a two-tiered market. Banks that are not ready could suffer from increased funding costs and higher risk premiums.
But we also believe that Basel II provides an excellent opportunity for Asian banks to upgrade their business models, risk strategies and disclosure standards. If successfully implemented, these banks will be able to compete with the larger global banks on a more level playing field.
Profound changes will take place in following areas:
· Improvement in capital structure by reducing risk weightings and/or increasing capital funds;
· Change in lending strategy – shifting towards higher quality borrowers and retail banking;
· Mergers and acquisitions – culminating in sector consolidation;
· Closer interaction between regulators and banks;
· Greater transparency via a fully developed disclosure regime.
We believe that the Basel II committee aimed many parts of its regulation at Asian Banks and their supervisors, in part due to the 1997-98 Asian financial crisis and its global repercussions. Massive over-lending and mis-pricing of credit, thought to be major contributing factors to the crisis, will be severely penalized under Basel II.
In the industrialized countries, the three major external rating agencies – Moody’s, Standard & Poor’s and Fitch) are well known, and are used extensively to rate debt of sovereigns, municipals, banks, corporates and asset-backed securities. However, these ratings agencies do not have deep penetration in many Asian countries. While smaller, country-specific agencies operate in this sector – for example, RAM from Malaysia – banks might not be able to use the Basel II approach if the domestic rating agencies do not pass muster.
The Basel committee has stipulated a number of quantitative requirements that must be met before a bank can use the Basel framework:
· Complete data history of defaults, losses, collateral and rating migrations;
· Complete data history of customer balance sheet and P&L accounts;
· Statistically based rating tools developed, calibrated, tested and validated with internal data.
So where does this leave us? Stay away from Asia? By no means! But there won’t be another Asian Miracle with rising inflation, vibrant bank lending, interest-rate pickup and currencies appreciating strongly. In a word, don’t wait for the big party; instead, learn to love the Asia you have today.