Banks are the heart of an economy. If they stop working, the rest of the economy dies.
So it’s scary when the share prices of some of the world’s biggest banks collapse. For the year to date, a U.S. big bank index is down 11 percent; the S&P Pan Asia Financials Index is down over 4 percent; and the MSCI Europe Bank Index is down almost 15 percent.
Asian and European banks’ shares are also down overall since 2010 – the MSCI Europe Bank Index is down 29 percent for the past 6 years, hugely underperforming the market as a whole. The U.S. and European banks indices shown below are also well below their all-time highs. Europe’s banks are down 70 percent from their highest point.
The question is whether sick banks are just a European thing – or if their problems will spread to Asia.
When taken at face value, Asia is not likely to have its own European-style banking crisis. But Asia needs to be wary of creating its own version.
Europe’s banks took on too much debt before the 2008-2009 financial crisis. The repeated rounds of existential European crises – whether Greece and the other laggards of Europe would remain part of the euro – battered banks’ balance sheets. More recently, enormous capital raising efforts (when banks raise new money from investors) have pressured bank shares.
Perhaps more through good luck than good judgment, Asian banks managed to avoid a lot of exposure to the toxic assets that plagued other banks during the crisis. Asian banks were more conservative and focused more on lending to their own neighborhood, instead of the rest of the world.
That was partly because many of Asia’s banks were still recovering from the Asian financial crisis of 1997. Asian banks mostly missed out on a lot of risky debts over the following decade. They have also benefited from stronger economic growth in recent years.
Bad loans for European banks were estimated by the International Monetary Fund at €1 trillion (US$1.12 trillion). According to a November 2015 European Banking Authority report, about 6 percent of European bank loan books were troubled. That’s double the level of the U.S. banking sector.
For ASEAN countries, according to other sources, Malaysia’s bad-loan ratio stands at 1.6 percent, Indonesia at 2.4 percent and Thailand at 2.8 percent. Commentators expect the ratio to peak at less than 4 percent across the region. (Different levels of disclosure across markets can make direct comparisons difficult, though.)
Despite slower economic growth in the region, Asia’s growth is still expected to be better than Europe’s in 2016. That has helped strengthen the Asian banking sector, and banks are now better capitalized.
That fact is illustrated by five Asian banks being among the top 10 in Bloomberg Markets’ ranking of the world’s strongest banks for 2015. On Bloomberg’s full list of 20 names, six are Asian and six are European.
But Asia isn’t immune. Asian banks don’t have much exposure to Europe, but they do have a lot of exposure to China. Asian banks are exposed to Chinese companies that carry a lot of debt. China’s banking regulator said in January that new non-performing (bad) loans held by Chinese banks more than doubled to US$297 billion in 2015 compared to the previous year.
This is a bit more alarming because none other than the People’s Bank of China head Zhou Xiaochuan over the weekend warned about high corporate lending. This is another way of saying that the country’s banks are lending too much to China’s companies.
China’s banks have been pushed to increase lending so that the country’s economy doesn’t slow down too much. And now China’s banks could be in trouble if those companies have a tough time paying.
Zhou’s solution is for the capital markets – instead of banks – to take on some of the risk of funding China’s companies, and taking on banks’ debt. This would involve creating a credit-default swap market, as well asset-backed securities and collateralized debt obligations. These kinds of instruments take loans that banks issue, repackage them and sell them to investors. It’s a way for banks to reduce their exposure to potentially bad debt.
If these instruments ring a bell, it’s because they were some of the weapons of financial mass destruction during the 2008 global economic crisis. But maybe China’s regulators will have learned the lessons of what happened then.
Europe’s banks are still sick. Asia’s banks look healthy by comparison. But that doesn’t mean that they’ll stay that way. And problems in China could rapidly become big problems for banks throughout Asia.