Powerful storm set to hit Asian bank profits, McKinsey says

[HONG KONG] Asia-Pacific banks face "a powerful storm" which will probably hurt profit growth in an industry that earned half a trillion dollars last year, according to McKinsey & Co.

A triple threat of slowing economic growth, technology disruption and weaker balance sheets could come together to "cripple" returns on equity by 2018, the New York-based consultancy said in an analysis of 328 banks in the region. Profit growth may slow to below 4 per cent annually between 2016-2021, down from about 10 per cent in 2011-2014, said Joydeep Sengupta, one of the report's authors.

The region's slowdown has led to weaker lending growth and surging loan defaults, sending stressed assets in China, India, Indonesia and Japan to almost US$400 billion last year, according to McKinsey.

Since the 2008 global financial crisis, lenders have been grappling with tighter regulatory and capital requirements that have curtailed their ability to dole out credit.

Banks in the region have "seen extraordinary growth" over the past decade, Mr Sengupta, a senior partner in McKinsey's Singapore office, said in a phone interview.

"At this point in time, we would say we're at the end of the golden era. There is a trinity of threats which we are seeing." Asia-Pacific banks have accounted for almost half of global banking profits each year since 2009, according to the report. In 2015, the region's lenders represented 46 per cent of the US$1.1 trillion in after-tax earnings generated by the industry worldwide, the report showed.

The McKinsey study showed that ROE for the Asia-Pacific lenders had fallen to 14 per cent in 2014 from 15 per cent the previous year. That figure may fall to "single digits" if banks don't take action, Mr Sengupta said.

China, which had led regional banks' profit gains for most of the past decade, is now dragging on growth as its economy slows, according to the report. That's a challenge for the financial hubs of Hong Kong and Singapore, which had benefited from the years when China's super-charged expansion spurred its industrial giants and banks to tap the cities for financial know-how and billions worth of debt and share issues.

Hong Kong's economy unexpectedly contracted in the first quarter, while Singapore eked out only a modest expansion in the same period.

"China is certainly a very important factor," Mr Sengupta said. "Undoubtedly a lot of Asia's fortunes are linked to how China does and that's something we're going to be keeping a very tight eye on."

The consultancy is calling on banks to build their digital capabilities to fend off rising competition from technology start-ups and more established digital companies including Alibaba Group Holding Ltd and Tencent Holdings Ltd, which are offering financial services from mortgages to payment systems.

A customer-focused digital strategy would foster loyalty, as well as cut costs, according to McKinsey.

"In surveys, banking customers in Asia-Pacific frequently list limited digital financial offerings and unsatisfactory service as major sources of frustration," the report said.

"A well-designed digital bank could address these disappointments." To ease the impact of slowing economies, McKinsey recommended banks to tap into "growth pockets" in the region: the 1.1 billion individuals with no formal banking relationships, the region's affluent middle class, and small to mid-sized businesses.

The consultancy's analysis indicates banks in Asia need to raise US$400 billion to US$600 billion in additional capital by 2020 to cover losses from nonperforming loans, while maintaining capital adequacy ratios.

"The reality is that doing things the way you do will create significant challenges," Mr Sengupta said. By addressing these, "there are opportunities which are hitherto untapped, but significant and large, that banks can pursue," he said.

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