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ADB Review [ July - August 2004 ]

Asia’s banks are recovering from years of ill health, but challenges remain

By Henrike Feig (hfeig@adb.org)
Principal Financial Sector Specialist
Regional and Sustainable Development Department

JEJU, REPUBLIC OF KOREA

Asia’s crisis-affected economies have made a substantive effort to clean up, recapitalize, and restructure their banking system and have adopted diverse approaches, according to a seminar in Jeju.

But while restructuring has occurred, the banking systems are not robust and actual nonperforming loans (NPLs) are estimated to be higher than reported, said Shamshad Akhtar, Director General of ADB’s Southeast Asia Department.

She was speaking at a seminar on Banking Sector Reforms in Asia, held alongside the 37th Annual Meeting of ADB’s Board of Governors. At the seminar, experts from around the region discussed the state of reform efforts, and the future challenges facing Asian banks.

Competitive forces arising from World Trade Organization (WTO) commitments and other global developments require regulators and banks to continue to reposition themselves to deal with emerging developments, Ms. Akhtar said. While Asian banking has good potential for growth, particularly in consumer finance, sustained economic growth and increases in personal income levels will be a condition for this process.

On the panel of experts, Liu Mingkang, Head of the China Banking Regulatory Commission, said that changes in ownership and mindset will be critical for successful bank restructuring, and improvements in corporate governance and credit culture in PRC. For large state commercial banks, diversifying ownership would be achieved by introducing private capital and foreign strategic investors. Foreign financial investors would also have a role to play. However, Mr. Liu said that strategic investors would be considered first, as their skills are crucial to improving the capacity of PRC banks, particularly in retail lending.

Mr. Liu said that recent improvements in NPL ratios were mainly due to new loan growth. In the future, banks need to resolve NPLs through all means including legal recourse, which would be facilitated by further improving the legal and institutional environment for NPL disposal.

Shaukat Aziz, Minister of Finance, Pakistan, described the challenges political decision makers face in undertaking reforms. “Reformers require a vision, and need nerves of steel to deal with vested interests,” he said. To effectively carry out banking reforms, problems related to nonbank financial institutions, corporate governance, and accounting and audit practices have to be addressed simultaneously. Also, without a legal environment that enables the enforcement of contracts, “banking sector reforms do not work.”

Tarisa Watanagase, Deputy Governor of the Bank of Thailand, outlined Thailand’s financial sector master plan, which seeks to broaden access to financial services, increase efficiency through regulatory and tax changes, and improve consumer protection. Remaining weaknesses in the system need to be addressed through continued legal and capital market reforms. Bank risk management, operational efficiency, and business strategies also have to be improved.

Deborah Schuler, Vice-President of Moody’s Financial Institutions and Sovereign Risk Group, said that with the exception of Hong Kong, China and Singapore, and possibly Malaysia, most banking systems remain undercapitalized. Although asset quality was generally improving across the region, the share of consumer lending, particularly unsecured credit card business, is rapidly increasing and gives rise to new concerns.

She said many Asian banks are still not earning a risk-adjusted return. Future bank profitability remains constrained by excess liquidity and capacity. Moody’s expects excess capacity and policy makers’ financial sector master plans to lead to a further consolidation of the banking industry.

Jeunglak Lee, Senior Executive Vice-President of Kookmin Bank (KB), pointed out the progress made in improving corporate governance structures in the Republic of Korea, citing the example of KB, which had introduced an independent board of directors, a code of ethics for its employees, and increased transparency and accountability for financial management and accounting.

He said that Korean banking sector reforms have managed to eliminate structural risk factors and improve financial performance. Restructuring efforts in the future would need to address the lack of global competitiveness, nonperforming consumer loans, a weak long-term profit base, and the privatization of government-owned banks.

Dominic Barton, Asia-Pacific Chairman of McKinsey, said that Asian banks and their regulators face a number of challenges including macroeconomic uncertainties that could radically affect industry outlook, continued significant levels of NPLs, lack of resilience at bank level, increasing foreign competition, and demographic shifts that could lead consumers away from traditional deposits. His company expects further substantial consolidation of the industry over the next 5 to 7 years.

At the same time there are also significant opportunities for banks. Asia represents the single fastest growing retail market in the world. McKinsey expects new growth in revenues from personal financial services in Asia of about $180 billion by 2010, which is equivalent to the new growth in the US between 1994 and 2001. Revenue pools from low-income urban populations could be substantial and Asia’s high mobile phone penetration may create a unique opportunity for reaching the “unbanked.” Mr. Barton cautioned that a push into consumer lending without positive credit bureaus and adequate risk management systems would be problematic.

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