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Oil tankers pass in front of the Singapore skyline last June. Falling commodity prices hit the city-state's banks hard last year.   © Reuters

China's chill hits banks' bottom lines

Ripple effects from slowdown in Asia's biggest economy, falling commodity prices

SHOTARO TANI, Nikkei staff writer | China

TOKYO -- Unable to shrug off its disappointing performance of the preceding year, Asia's financial sector registered a second straight year of decline in its bottom line in 2016. Net profit for the sector came in at $173.1 billion, a decline of 8.8% compared to 2015 and greater than the overall decline in net profit seen by all companies on the Nikkei Asia300 Index.

For Singaporean banks, which were among the hardest hit, the main drag came from the fall in commodity prices. All three of the city-state's major lenders posted a year-on-year drop in net profit in 2016, which translated to an overall fall of 5% for the local banking sector, both in dollar and local currency terms. Exposure to the oil and gas sector meant the banks had to book higher specific provisions for bad loans, as a number of offshore service players ran into financial difficulties over the last year.

"I am not able to say now that the stress on the oil and gas sector has ended," Oversea-Chinese Banking Corp. CEO Samuel Tsien said at a press conference in February. Singapore's second-largest bank saw its net profit drop 11% on the year to 3.47 billion Singapore dollars ($2.4 billion*), the largest drop among the three major Singaporean banks. Total allowance for loans and other assets jumped 49% to S$726 million, mainly due to specific provisions booked for corporate accounts in the offshore marine sector.

"For the [offshore] operators to be able to earn a margin they require for the operation, we think the oil price should be above $70," Tsien said.

The situation was similarly gloomy for DBS Group Holdings, the city-state's largest lender by assets. Its net profit for 2016 declined 5% on the year to S$4.23 billion, while loss provisions jumped 93%. For the No. 3 lender, United Overseas Bank, the net profit decline was more modest, at 4%, but the bank booked a total of S$969 million in specific allowances for the year -- more than double the S$392 million booked in 2015. The surge was mainly attributable to the fact that the oil and gas industry's collateral is now worth much less.

Singapore is home to numerous companies dependent on oil and gas exploration activities, and their troubles have only added to concerns over local banks' credit quality.

A case in point is offshore vessel owner Ezra Holdings. A joint venture formed by Ezra's subsidiary, global offshore contractor EMAS AMC, and Japan's Chiyoda filed for bankruptcy in late February. CIMB Research estimates that DBS Group Holdings' exposure to Ezra is around S$637 million, while for OCBC and UOB it is around S$300 million and S$166 million, respectively.

Mainland blues

The fall in commodity prices over 2016 was due in large part to the slowdown in the Chinese economy. Unsurprisingly, banks in Hong Kong with large exposure to the mainland, as well as Chinese lenders themselves, felt the effects. Accounting for estimates for mainland banks, which have yet to announce their results, the financial sectors in Hong Kong and mainland China collectively saw their net profit for 2016 fall 10%.

Despite aggressive cost-cutting measures, Hong Kong's Bank of East Asia saw its bottom line skid 33% to a seven-year low last year at 3.72 billion Hong Kong dollars ($480 million*), as impairment charges on loans and advances jumped 70.5%. Its mainland unit took a heavy blow, recording a net loss for the first time in its history as its bad-debt ratio shot up 20 basis points (0.2%) to 2.64% from a year ago -- above the group's average of 1.49%.

"Mainland policymakers continued their efforts to rebalance the economy through supply-side structural reforms," the family-run lender said in a statement. "However, adjustments are proceeding slowly against a backdrop of weak external demand, excess industrial capacity and lackluster investment sentiment."

Its rival Hang Seng Bank, which has been cautiously cutting mainland-related lending, recorded a milder net profit drop of 4% discounting the one-off gains it booked a year earlier, but the bank struggled to boost its loan book in a slowing economy. Reported net profits were down 41% to HK$16.21 billion.

Mainland Chinese lenders, the largest players in the Asian banking sector, are expected to announce their latest annual results at the end of March, and market forecasts are dismal at best.

Of the four major state-owned banks, only China Construction Bank (CCB) is expected to see a rise in net profit attributable to shareholders, according to an analyst consensus compiled by QUICK-FactSet as of March 3. That consensus foresees a mere 0.01% rise on a local currency basis, however, as the continued slowdown has put pressure on asset quality, which in turn has added to impairment costs for banks.

Due to the depreciation of the yuan, all four big banks -- which include Industrial and Commercial Bank of China (ICBC), Agricultural Bank of China (ABC), and Bank of China (BOC) -- are expected to report a net profit drop in the upper single digits in dollar terms.

Fitch Ratings said it expects Chinese banks' earnings to "provide further evidence of rising system leverage and profitability pressures from narrowing interest margins and weakening asset quality."

Official data puts the sectorwide ratio of nonperforming loans to assets at a moderate 1.74% at the end of last year, and has the level of "special-mention" loans falling for the first time since 2014. But Fitch said in a note that it "does not believe this apparent improvement reflects underlying credit conditions, as on-balance sheet asset quality indicators have benefited from recently established debt-for-equity swaps and the offloading of distressed debt to asset management companies -- which continue to grow rapidly."

Elsewhere in Asia, Indonesia's Bank Mandiri saw net profit slide 32% from a year earlier to 13.8 trillion rupiah ($1.02 billion*) due to a boost in bad loan provisions for its commercial loan segment. President Kartika Wirjoatmodjo said the bank continued to downgrade loans in the fourth quarter because economic recovery was "not as swift as we expected." Overall, Indonesia's top three banks posted an estimated aggregate net profit decline of 6%.

The bottom line for Indian banks, which have not yet released their annual results, is expected to fall by 15%.

Causes for concern

Not all was doom and gloom, however.

In dollar terms, Thai banks on the Asia300 list registered a 1% drop in net profit for 2016, but this was mainly due to a weaker Thai baht. On a local currency basis, net profit rose 2%, a sign that the sector is picking up even as the country continues to mourn the death of its late king, Bhumibol Adulyadej.

Bangkok Bank, the country's largest lender by assets, was the only Asia300 bank in Thailand to post a net profit drop on a baht basis, suffering from the country's slow economic recovery. The three other banks, Krung Thai Bank, Siam Commercial Bank and Kasikornbank, all registered net profit growth in baht terms: 13%, 1% and 2%, respectively.

South Korea's financial sector was another bright spot, with Asia300 banks' collective net profit rising 24%.

"A stable net interest margin and sustainable increase in loans helped our bottom line jump," said Shinhan Financial Group CFO Yim Bo-hyuk. Shinhan's net profit jumped 17% to 2.77 trillion won ($2.3 billion*) in 2016 from a year ago, with its interest profit increasing 7.7% during the same period.

Lee Jae-keun, CFO at KB Financial Group, echoed with Yim, saying that robust growth in loans and the acquisition of a brokerage helped push up his bank's net income. KB's bottom line came in at 2.14 trillion won last year, up 26% from the previous year.

But the results from South Korea are not without their downside. The net profit rise at banks was supported by a sharp rise in household debt. The Bank of Korea, the country's central bank, said household debt stood at 1.3 quadrillion won in December, up 11.7% from a year before. The sheer size of this debt may eventually prove to be a threat to financial stability in the country.

"In Fitch's view, most Asian banking systems are facing a cyclical deterioration in asset quality in 2017 as a challenging economic environment continues to put pressure on borrowers," said Mark Young, head of Asia-Pacific banks at Fitch Ratings. "While the markets most under pressure from an asset quality perspective are likely to be China and India, these pressures will also be evident in most other markets in Asia."

Young continued: "Some of the pressures in the region can be attributed to a rapid build-up of private-sector debt -- corporate and household -- since 2009, and the vulnerabilities that this has created will continue to be tested in 2017 thanks to moderating economic growth in China and the prospect of higher U.S. interest rates and dollar strength."

*Except where otherwise noted, the exchange rates used in this report are for end-2016.

Nikkei deputy editor Kenji Kawase in Hong Kong and Nikkei staff writers Tomomi Kikuchi in Singapore, Kim Jaewon in Seoul, Joyce Ho in Hong Kong, Wataru Suzuki in Jakarta, Yukako Ono in Bangkok and Kenta Shinozaki in Tokyo contributed to this article.

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