More emerging banks were teetering on the edge of a credit rating downgrade at the end of September than during the height of the global financial crisis, Fitch Ratings has said.
At the end of the third quarter, the US agency had 118 emerging market banks, 33 percent of the institutions it rates, on negative outlook, narrowly above the previous peak of 32 percent, recorded at the end of the second quarter of 2009.
The tally has since edged down to “slightly below 30 per cent,” according to James Watson, head of emerging Europe financial institutions at Fitch, after the agency returned a number of Russian banks to a stable outlook, in line with its view on the Russian government.
Sonja Gibbs, senior director of global capital markets at the Institute of International Finance, whose membership includes many EM banks, says it “makes sense” for as many banks to be on negative watch now as during the financial crisis, given that “what is happening now in the global economy is hitting emerging markets proportionately more than the crisis did”.
The concerns are twofold, Gibbs says: weak EM growth, “because banks are highly cyclical and geared to their local economies,” and “the big increase in debt levels taken on by emerging market corporates”, with the latter having risen beyond 100 per cent of EM GDP, from 70 per cent in 2009, above levels found in the developed world.
Fitch is not anticipating a sharp upturn in the fortunes of the financial sector. “Pressure on emerging market banks’ credit profiles and ratings has increased during 2016 and is likely to remain significant in 2017, notwithstanding the stabilisation of EM economic growth and commodity prices,” says Mr Watson, who cites the drag from still relatively sluggish GDP growth, the lagged impact of previous commodity price and exchange rate shocks and, in some markets, increased political risk.
The toll of banks with a negative outlook includes 18 in Turkey, where financial stability was buffeted by July’s attempted coup and 15 in recession-hit Brazil, as well as 11 in Saudi Arabia, seven in Colombia and six in Oman, all countries struggling with low oil prices.
But while Watson believes September was “probably the peak” of the negative outlooks, 2016 has once again been a difficult year for banks in a swathe of emerging market countries.
In the first nine months of the year, Fitch downgraded 33 banks and upgraded 23. This at least represents a slowing in the pace of deterioration in the sector, after 53 institutions were downgraded in 2015 (and only 23 upgraded) and 50 in 2014 (versus 35 upgrades). Before this Fitch had just 13 per cent of banks on negative watch.
Many of the downgrades were concentrated in Saudi Arabia and Brazil, following similar downgrades of their sovereign governments, with others in Colombia, Bahrain, Lebanon and Poland (outweighing upgrades focused on the Philippines and Uzbekistan).
However, the problems of the banking sector are probably more acute in Azerbaijan, Nigeria and Belarus, where Watson says “stress has increased significantly” this year as a result of “sharp asset quality deterioration and foreign currency liquidity squeezes” in the wake of slumping economic growth and devaluations.
Some 15.8 percent of loans in Azerbaijan were classified as “impaired” by Fitch at the end of June (a definition that in most cases refers to loans that are overdue by 90 days or more), a sharp rise from the 9.5 percent figure at the end of 2015.
“Banks have been failing and defaulting. They have suffered significantly from the devaluation of the currency last year,” Mr Watson says of the oil and gas-dependent former Soviet republic, which saw the man at crash after it abandoned its dollar peg in December 2015.
“Banks had lent a lot in foreign currency and some borrowers were unable to repay. In addition, the banks have short forex positions on their own balance sheets. More may yet fail.”
Belarus, another former Soviet state, has seen an even sharper rise in impaired loans, which jumped by 7 percentage points to 14.3 per cent of all loans in the six months to June, as the first and second charts show, again the result of currency depreciation and a sharp recession.
The same bitter cocktail, allied to a severe shortage of foreign currency, has afflicted Nigeria, where the proportion of loans that are impaired rose 6.4 percentage points to 11.7 percent in the six months to the end of June.
While banking systems in many countries rely on the ultimate backstop of the national government, Watson says, “we don’t think the Nigerian sovereign has sufficient forex reserves for us to rely on sovereign support of the banks”.
The Ukrainian banking system is arguably in much worse shape still: although the ratio of impaired loans only rose 2.8 percentage points in the first half of 2016, the stock of dud loans has now hit 34 per cent.
“Many banks have failed already and been closed down. Probably there will be more to follow, although we think most of the sector clear-up has been done now,” says Mr Watson, who notes that Fitch upgraded Ukraine’s sovereign rating a notch to B- in November, off the back of an easing of financing pressures, rising foreign reserves and improving growth prospects.
JP Smith, partner at Ecstrat, an investment consultancy, attributes many of the banking sector problems in some eastern European countries to weak governance, with industries dominated by state banks or “banks that are nominally private but in reality are closely affiliated to oligarchs or families who are close to the ruling elite,” meaning loans are not always made for purely financial reasons.
Elsewhere, following “rapid credit growth” in the first half of 2016, Fitch expects China’s credit-to-GDP ratio to hit 258 per cent by December 31, up from 250 per cent a year ago and just 125 per cent in 2008.
Based on its estimate of inefficient, or non-productive, credit, the rating agency estimates that 15-21 per cent of loans could now be non-performing, translating into a potential capital gap of 11-20 per cent of GDP, although it remains confident that “the authorities are likely to provide support to systemically important banks, as required”.
On India, Fitch believes the ratio of “stressed” assets, at 11 percent, is close to peaking, but estimates that $90bn will need to be injected into the country’s banks by 2019 to reach Basel III norms, of which the government has so far committed just $11bn.
“The authorities have been hoping that the market will be willing to contribute most of the rest,” Watson says.
Smith argues that many India’s problems also stem from the misuse of the banking sector to channel cheap credit to favoured borrowers, almost irrespective of their ability to repay. “It’s directly a governance issue, given the links between the big state-controlled banks and the conglomerates,” he says.
An emerging 2017 risk for many banking systems is the renewed strength of the dollar, which has rallied since the election of Donald Trump. If this was continue, and was potentially allied to higher US interest rates, Fitch fears this could undermine EM banks that rely on foreign financing by raising their cost of funding and making capital scarcer.
Turkey is potentially one of the countries most exposed here. “Renewed pressure on the lira heightens asset quality and forex funding vulnerabilities,” says Mr Watson. “Most of the external funding is market funding. If there was any significant loss of market access or ability to roll over foreign funds, that would be negative.”
A stronger dollar could also wreak havoc in countries where banks have made a lot of foreign currency loans, which may become harder for some borrowers to repay.
Parts of the former Soviet Union, such as Armenia, Georgia, Belarus, Ukraine and Azerbaijan are particularly vulnerable here, alongside some Latin American states such as Nicaragua (where they account for 93.1 per cent of all loans) and Uruguay, as the final chart shows.
Gibbs says IIF data suggest that Hungary, Singapore, Malaysia and Turkey have particularly high levels of foreign currency-denominated debt as a proportion of GDP.
Furthermore, a large chunk of local and foreign currency debt is owed by companies “that don’t have a long track record of managing high debt levels”, she said. “That’s fine if you have rapid growth, but if you don’t you can see why Fitch is worried.”