Asia Frontier Bank Reforms Likely to Weigh on Growth

Fitch Ratings-Hong Kong/Colombo/Singapore-11 July 2018: Asia’s frontier markets are pushing ahead with banking sector reforms that should ultimately improve weak regulatory frameworks and strengthen banks’ buffers against shocks. However, capital shortages, asset-quality problems and regulatory efforts to address these weaknesses are likely to constrain the growth of even stronger banks over the next two years, says Fitch Ratings.

Mongolia has completed an asset-quality review, followed by a stress test, as of part its IMF arrangement, which should raise the comparability of banks’ financial profiles after adjustments are formally booked into their end-June 2018 statements. New laws could further strengthen the authority of the regulator if consistently enforced. Moreover, the operating environment has become more supportive as economic growth has accelerated and government refinancing risks have declined. Fitch upgraded its two rated Mongolian banks – Khan Bank and XacBank – in July 2018 to reflect these improvements.

The transparency of the recapitalisation process and NPL resolution will test the credibility of the reform process. Banking system asset quality remains weak, with a high reported NPL ratio of 8.2% at end-May 2018. Many NPL accounts have remained unresolved for some time. The government may inject capital into systemically important banks if they are unable to raise sufficient capital by end-2018. Fitch does not believe shortfall amounts would pose a significant funding challenge to the Mongolian sovereign if public funds are required.

Vietnam has scheduled Basel II implementation for 1 January 2020, which will further pressure local banks’ already-thin capital buffers that were diminished by rapid lending growth. We estimate Basel II will reduce banks’ capital-adequacy ratios by up to 4pp, with some state-owned banks likely to fall short of minimum requirements. These challenges are balanced by upbeat economic conditions, which are supporting the efforts of some banks to reduce or write off bad debt. Under-reporting of asset quality issues remains widespread, reflecting how regulatory development has trailed economic progress. Nevertheless, the fall in major banks’ weighted-average problem loan ratio to 6.0% in 2017, from 9.2% in 2014, indicates some progress.

Sri Lanka has moved faster than the other two markets in adopting international regulatory standards; it began implementing Basel III in 2017, and is scheduled to introduce IFRS9 in 2018. Fitch estimates some large banks will, in total, require an additional USD120 million of capital to meet full compliance by 2019. The shift to SLFRS 9 could add to capitalisation pressure. Moreover, the country’s banks are likely to face a more challenging operating environment than those in Mongolia and Vietnam, which could place modest pressure on ratings unless sufficient loss absorption buffers are maintained.

For more information, see Fitch’s “APAC Frontier Market Banks Dashboard 2018”, available on or through the link above.

APAC Frontier Market Banks Dashboard 2018