Oxford Economics’ in-house financial conditions index reveals that while overall conditions are tight compared to pre-pandemic levels, Asia’s financial conditions have been improving thanks to central banks’ pause in rate hikes, lower long-term rates, and more stable currencies.
We examined banks’ balance sheets in light of the US banking sector turmoil to check for potential risks in the region. Overall, we think banks are well capitalised, and there is low systemic risk. The non-performing loans (NPL) ratio is declining and the capital adequacy ratio is at a comfortable level.
Our view is that the impact from recent banking sector turmoil to the real economy, if any, will come via tighter credit conditions and slower credit growth.
For now, the real credit growth rate shows that most economies are expanding, suggesting there are no substantial bottlenecks either on the supply or demand side. In fact, surveys suggest credit standards are not tightening excessively yet.
That said, slowing economic growth could present a downside risk, making banks more cautious about lending. Such risks are most elevated in economies where housing market issues exist – namely China, South Korea and Singapore.
Our financial conditions index (FCI) shows Asia’s financial conditions are relatively tight compared to 2019 levels, but things have already turned (Exhibit 1). Although only State Bank of Vietnam has cut rates, other central banks paused their rate hiking. Relatedly, long-term rates have trended down since late last year in most places as inflation declined. As a result, term spread has also narrowed. Despite the improvement, we think the shocks of the past few years have left strains on banks’ balance sheets. We therefore examine the banking sector’s health to see how vulnerable Asia is to potential financial market disruptions.
Exhibit 1: FCI shows a pivot, but conditions are still tight
Balance sheet health remains intact
Balance sheet health is important in examining banking sector resilience, as it is stocks that reflect post-pandemic scars, not flows. The NPL ratio has been trending down after peaking during the pandemic and overall remains manageable (Exhibit 2). However, it’s worth noting that these figures might be artificially contained due to easing of regulation including debt moratorium. Those regulatory measures are still in place in some economies, and once they are relaxed, the NPL ratio may tick up.
We are now past the initial recovery phase post-pandemic and instead face slower global growth given monetary tightening and geopolitical conflicts. So, higher interest rates and pandemic-related loans coming due might burden businesses. Indeed, more timely national data suggest the NPL ratio in the Philippines (where monetary tightening has been the most severe) saw a pickup in recent months, likely in part due to higher interest rates. That said, Philippines’ NPL coverage ratio is still above 100%, which means the surge in NPLs is already accounted for in their financial statements.
Exhibit 2: NPL ratio is either declining or contained
The capital adequacy ratio, which measures banks’ insolvency risks using capital and risk-weighted assets, also indicates some buffer, as it is higher than the 8% minimum standard set by Basel III standards, and as high as about 20% in places like Indonesia, Thailand and Malaysia.
Our Banking Sector Risk Indicator collaborates this sanguine view on Asia, as it shows many Asian economies are relatively well shielded from systemic banking risks.
Confidence is holding up
Deposit drain, whereby depositors withdraw their money from banking deposits, was also another concern in the US, at least in the initial stage of the market turmoil. So far, there is no deposit drain in Asia, at least where there is data (Exhibit 3).
Exhibit 3: Bank deposits show no sign of depositors’ flight
Credit standards have yet to tighten
The main impact of banking sector turmoil to the real economy will be via credit standards and their effect on credit growth. If banks become worried about asset quality and their financial position, then they could squeeze credit supply, which will exert downward pressures on credit growth.
Credit standards have yet to tighten in Asia, in contrast to the US or the eurozone, where credit standards have been tightening for a while now, and have accelerated of late. Even in Thailand where credit standards are tightening, the compression has not been excessive (Exhibit 4).
Exhibit 4: Credit standards are not tight by historical standards
Real credit growth, which is adjusted for inflation and better captures the loan volume, shows most economies are still seeing expansion, although there is some divergence (Exhibit 5). Singapore is an underperformer given the high interest rates that track those in the US and the economy’s position in the economic cycle, which is more advanced compared to its regional peers.
Exhibit 5: Real credit is still expanding in many economies
We expect real credit growth to remain in place, albeit at varied pace. We look for nominal credit growth to moderate in several economies, but declining inflation means real credit will continue to expand.
Pockets of weakness exist
While we expect solid health in the overall banking sector, slowing growth itself can damage banks’ balance sheets and lead banks to tighten credit standards, looping back to weigh further on economic growth. This is because slowing growth makes banks cautious about their asset quality. We also forecast most economies to post slower growth this year amid harsh external headwinds and the full impact of tighter monetary policy. At the same time, higher risk aversion by investors may lead to capital outflows particularly out of emerging markets, which will leave the overall financial system more vulnerable.
Another concern exists in the housing market. As widely acknowledged, China is still suffering from its residential property market downturn. South Korea faces a similar issue given declining housing price and high mortgage loans. Lower house prices and higher interest rates may lead banks to tighten their credit exposure to the sector, exacerbating the pressures on house prices.
On the other end of the spectrum is Singapore where residential prices are growing rapidly. Both demand and supply factors are likely at play, but fast-rising prices also risk a correction down the road. Here too, expectation for lower prices might keep banks cautious, resulting in squeezed credit lines to the residential property market. One structural backstop in Singapore is that most people live in public housing and take out mortgages from the Housing Development Bureau at a fixed rate, so the potential risks to private banks should housing price correct may not be as big as elsewhere.
In all, we think the financial conditions in Asia are set to improve, given limited damages to banks’ balance sheets as well as peaking interest rates and lower inflation. That said, slower global growth later in the year and into 2024 could pose downside risks through tighter credit standards, especially in economies where other sectoral vulnerabilities exist, such as in the residential property market.
Makoto Tsuchiya
Makoto Tsuchiya is an Assistant Economist at Oxford Economics. He is responsible for forecasting and providing analysis on the Philippines. Makoto has a Bachelor's degree from Temple University Japan where he majored in Economics with a minor in Business Studies.
