Despite economic headwinds stemming from the weakening of demand in key global export markets, high inflation and the lagged effect of higher interest rates in most Asia-Pacific economies, the banking sector outlooks for the region’s emerging markets (EMs) and developed markets (DMs) remain neutral, according to a recent report.

Asia-Pacific EM banking systems will report steady financial performance in 2023, or only mild variance versus 2022, the Fitch Ratings agency report predicts. This partly reflects the agency’s forecasts for continued robust economic growth in India and Southeast Asia, and stronger growth in China, despite the weaker external environment, which should support loan expansion, with benefits to net revenue that will largely offset weakening asset quality.

Banking systems in Asia-Pacific DMs will post more mixed financial performance, but key metrics in most will be steady or at least maintain a degree of headroom relative to their viability ratings.

“We forecast all seven system average common equity tier-1 ratios, a key metric for loss absorption buffers, to remain at broadly similar levels to 2022,” the report states. “Moreover, we generally expect Asia-Pacific DM banking systems to weather the deteriorating global economic landscape in 2023 better than those in other regions.”

Sri Lanka and Singapore are exceptions to the generally neutral country banking sector outlooks. Sri Lanka’s is deteriorating as its operating environment faces acute challenges, Fitch points out, following the sovereign’s default on its foreign currency obligations in May 2022. Sri Lankan banks’ financial profile vulnerability will be the highest in the region.

By contrast, in Singapore, the rating agency predicts, an improving outlook as profitability metrics strengthen further to above pre-pandemic levels, even with normalized credit costs and loan growth hit by the generally unfavourable external environment. Nonetheless, this is unlikely to be sufficient to drive Singapore bank ratings higher.

Following interest rate increases in 2022 in most Asia-Pacific markets, excluding China and Japan, the dynamic between asset quality and net interest margins, the report notes, will be an important factor to monitor.

“We expect loan deterioration across Asia-Pacific to be largely moderate, even as support measures unwind,” it shares. “Relief and forbearance measures may be extended in parts of the region – mainly in EMs – and loan-provisioning appears sound in most markets. Indian state banks generally have the lowest buffers, though their ratings benefit from assumptions around sovereign support – a common trait among Asia-Pacific EM bank ratings.”

Adverse housing market dynamics could have significant repercussions – particularly for DM banks in the region – though property sector refinancing risk has risen in Vietnam, the report makes clear. Australia, New Zealand, Hong Kong and South Korea are experiencing house price declines after years of sustained increase. A sudden drop in market confidence could heighten systemic risks, Fitch cautions. Nevertheless, healthy loan-to-value ratios (Hong Kong, Korea, Singapore), mortgage insurance (Australia) and debt serviceability limits/tests (Australia, Korea, New Zealand, Singapore) should partly mitigate asset quality risks.

Sovereign ratings will remain important for many bank issuer default ratings in Asia-Pacific, owing to assumptions around support. Fitch Rating outlooks on sovereign ratings are mostly stable, except in the Philippines (negative), Sri Lanka (defaulted) and Vietnam (positive).

“A more severe downturn in Asia-Pacific than the one we currently forecast could present downside risks for banks in 2023,” Fitch states. “It could push unemployment rates above our assumptions, further damaging households’ debt-servicing capacity. It might also affect sovereign ratings, depending on its impact on sovereign credit metrics, as well as government policy responses.”