And which are the best banks? EM finds out in a new ranking that focuses on the banks' intrinsic strengths. We also ask three experts for their views on the industry. Tomorrow we focus more specifically on the best banks in North Asia
EM: How strong is banking in Asia generally?
Russell Kop: The banking system has come through a tough period since the 1990s, from the Asian Crisis right up to Sars. But banks have reflated their balance sheets in what has been a low rate environment. On a ten years view, things are in a pretty good shape.
David Marshall: Banking systems in Asia range from strong, like in Hong Kong or Singapore, through adequate, as in Korea, Malaysia, Thailand, Indonesia, to weak, in China and the Philippines.
Klaus Felsinger: There are very significant differences in the efficiency and robustness of banking systems from country to country. The countries most affected by the Asian financial crisis, such as Thailand, Indonesia and South Korea, have improved the most. Banks in 'transition countries', in particular the People's Republic of China (PRC) and Vietnam were largely sheltered from the crisis and remain mainly under government control. There, major steps towards restructuring, commercialization and privatization are still underway, but inherent weaknesses remain.
EM: One of the biggest problems facing banks in some countries, notably China, is that they are effectively bust. Should they be propped up or left to go out of business?
Russell Kop: China needs a working banking system, and I cannot see the government letting one of the main banks go. China's main banks are very substantial banks; four banks command around 60% of the sector. The regulators have done a good job in shepherding the banks towards a market economy lending structure. This is a process that you have to look at over time. Over the next five years we will see the banking system evolving into one that suits a market economy.
Klaus Felsinger: Letting major banks go out of business is rarely an option, even in other parts of the world. This is because of the impact on depositor confidence and the economy, and risk of knock-on effects on the financial system. Key banks have to be recapitalized and ultimately privatized. Operational restructuring should be a condition for recapitalization assistance. Once a core of well-capitalized and sound banks is established, remaining problem banks can be merged with good banks or closed. In the PRC, which faces the most daunting task, this seems to be well understood by the authorities. It is normal that the process is lengthy and at times seems to make little progress.
David Marshall: At present China's banking system is so weak that a systemic crisis may occur if a bank closes and depositors lose money. For now the government must support all banks to the extent of protecting retail depositors. To apply some market discipline, management should be fired and shareholders should suffer losses. Imposing losses on institutional depositors and creditors – foreign and domestic – would enhance discipline but would need to be handled carefully to avoid a crisis.
EM: How rife is corruption in the regional banking industries?
Russell Kop: This is a very difficult thing to quantify. Comparing the region with western Europe, Japan and the US is not quite fair, because these are different kinds of markets. Figures from Transparency International [a corruption-monitoring organization] show that China is in a similar position to Mexico, India and Russia. Over time, people accept that the system works better with rules that apply to everybody. Yes, there is a lot of graft and corruption. But was this any different in the UK or US 100 years back? If you look at the more developed economies like Malaysia or Taiwan, the situation has become much better in the last 10-15 years. These countries are moving towards the OECD model.
Klaus Felsinger: Some Asian countries have a high incidence of corruption – as shown in relevant global rankings. In these places banks are one of the obvious targets of abuse. Collusion between employees and customers to defraud banks does happen, as a number of recent high-profile cases show. This problem needs to be addressed primarily at the level of the individual bank – by implementing appropriate organizational structures, operating processes and adequate corporate governance systems. This is most difficult and most necessary for institutions under government control. Privatization is certainly one way of accelerating this process, also improvements in banking regulations and supervision.
David Marshall: Corruption is a major issue in China and a significant one in Indonesia. Less so in other countries.
EM: How can we be sure that the non-performing loan problem is being addressed and not getting worse?
Russell Kop: NPLs were part of the price that the Chinese government was prepared to pay for having a command economy. A big chunk of the NPLs have already come off the books; since 2001 there has been a dramatic improvement of the balance sheets. Going forward, it is very tough to know what will happen. If China wants to continue to grow at the rates it's seen in the past 10 years, you will see some NPLs. But there is a lot of pressure on the regulatory level. Still, it's a substantial problem, that you won't solve in two or three years.
Klaus Felsinger: The old stock of NPLs from the Asian financial crisis has largely been dealt with through restructuring, provisioning and disposals. Whilst there are still many such assets on the banks' balance sheets, they do not pose a particular threat to the system. More concerning is the rapid expansion of consumer financing in a number of Asian countries. This could result in new credit losses, as has been observed in the recent credit card crisis in South Korea. The PRC is a special case with a significant stock of NPLs in the system and the potential for new NPL flows from the ongoing accelerated credit expansion.
David Marshall: The NPL situation is improving in most banking systems except China, where we think the underlying trend is deteriorating, and the Philippines, where NPL problems have not been fully addressed. This is also true for some banks in Thailand, Malaysia and Taiwan but the problem is not systemic.
EM: Are banks' balance sheets being managed more effectively?
Russell Kop: Everywhere, the banking markets are becoming more competitive. Therefore, they have to improve the management of their balance sheets. In Asia, banks have gone through a severe crisis, which has strengthened their awareness of this issue. Many bankers have become very cautious. So yes, I think they are a little more discerning in their management.
Klaus Felsinger: This is certainly the case in several markets. Tier 2 capital and hybrid tier 1 capital are being used in larger volumes and in more sophisticated structures. Korea, Singapore and Hong Kong have been leading the way for more advanced structures. Domestic markets also provide, and have the potential to provide increasingly more, tier 2 and hybrid tier 1 capital to local banks – as domestic bond markets mature and longer tenors become prevalent.
David Marshall: It is hard to generalize. Most attention is focused on credit risk management for Basel II compliance. Interest rate risk in the balance sheet, e.g. arising from holdings of fixed rate bonds, might not be getting enough attention.
EM: Which countries' banking industries offer value for foreign banks?
Russell Kop: People will continue to look to China, just because of its sheer size. There is the expectation that this market will be thrown open, although I think that there will be hurdles and landmines along the way. There is great interest in South Korea, with Standard Chartered and Citigroup entering the market and HSBC looking to enter it too. This interest will continue. Indonesia is a bit of Wild West, but it is one of the largest countries in the world with a growing population and economy. It has come out of the worst crisis in Asia and is performing quite well. If I were head of business development in any bank in the region, I would have a very busy agenda.
Klaus Felsinger: The main focus is on the large economies of the PRC and India. The longer -term growth and profit potential is clear – but near-term there remain significant obstacles both to acquisitions and organic growth. Despite this, a number of transactions have been done in India and the PRC, demonstrating the eagerness and commitment of international players. Indonesia has also been a firm favourite, with a number of banks being acquired by foreign players. All three markets have large populations, high economic growth potential and still offer opportunities for attractive spreads. Vietnam is another market that fits these criteria and will likely see increased attention going forward.
David Marshall: The most stable banks are in Hong Kong and Singapore, while those with potential to grow and achieve higher ratings are in Korea and Indonesia and more selectively in Thailand, Malaysia and Taiwan. China is attractive long term for those with nerves of steel and deep pockets.
EM: In what ways are Asian banks trying to improve risk management practices?
Russell Kop: The most obvious way is that they are talking about it. Risk management has become a front and centre position. Now, when you go to executive meetings, you often have a senior risk manager there. The Bank of China hired HSBC's head of Asian risk management. All banks have taken western-schooled risk managers on board. As we see the rise of the publicly listed bank, this issue will grow in importance. This is in line with the development of better corporate governance and improved transparency. Risk management is here to stay.
Klaus Felsinger: Improving risk management is seen as a priority by Asian bank regulators and individual banks. Banks are adopting international best practices in terms of organizational separations, approval authorities, monitoring etc. International consultants are used and implementation is strengthened through strategic hires from the leading multinational banks. Information technology plays a key role in the implementation, and substantial investments have been made.
David Marshall: The main effort at present is to improve credit-grading systems so as to achieve Basel II compliant internal ratings.