asean squeeze
DESCRIPTION
About ASEANTRANSCRIPT
Following years of easy liquidity, loan-to-
deposit ratios in ASEAN are some of the highest in the region and across EM…
…while not posing serious systemic risks, this will likely constrain credit and, therefore, GDP growth in coming years
This applies mainly to Thailand, Malaysia, Indonesia, and Singapore, but less so to the Philippines and Vietnam
How concerned should we be? Well, it’s important to keep things in perspective. Rising loan-to-
deposit ratios in most of ASEAN suggest that rapid credit growth
will be difficult to come by. And since GDP growth has largely
been driven by credit in recent years, things are bound to get a
little tougher. Countries that have current account deficits or
shrinking surpluses (think Indonesia, Thailand and Malaysia)
may also see local financial conditions become more volatile.
But this, in itself, doesn’t signify imminent systemic financial
risks. For this, FX reserves appear robust enough, bank capital is
generally at comfortable levels, regulatory supervision has vastly
improved and, most importantly, the global monetary policy
setting remains friendly enough. “Ah”, you might say, “what
about Fed hikes next year and a stronger dollar?” True. But there
is also the BoJ and the ECB, and even the Fed is merely in the
early stages of what looks likely to be an unusually drawn-out
tightening cycle. Tighter bank liquidity in ASEAN will constrain
credit growth, reining in demand – nothing more sinister.
But all this warrants a tempering of growth expectations for
ASEAN. The credit cycle is maturing. From here, we believe
faster growth will only come through reforms.
Macro Asian Economics
ASEAN squeeze
Tighter bank liquidity to weigh on growth
4 December 2014 Frederic Neumann Economist The Hongkong and Shanghai Banking Corporation Limited +852 2822 4556 [email protected]
Joseph Incalcaterra Economist The Hongkong and Shanghai Banking Corporation Limited +852 2822 4687 [email protected]
View HSBC Global Research at: http://www.research.hsbc.com
Issuer of report: The Hongkong and Shanghai Banking Corporation Limited
Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
Chart 1: ASEANs loan-to-deposit (%) ratio is steadily climbing…
Source: CEIC, HSBC. NB: weighted regional average
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All about liquidity
It’s difficult to talk about growth in Asia without
mentioning the L-word. The region has delivered a
strong rebound since the Global Financial Crisis,
propelled by leverage. This, in turn, was fanned by
extremely loose monetary conditions in the West
and plenty of excess liquidity locally. Banks in Asia
mostly held excess deposits that they could turn into
loans once funding costs tumbled. This helped to
sustain demand, even as exports to Western markets
fizzled. The story, of course, is by now familiar.
What’s less well understood, however, is that bank
liquidity in many parts of ASEAN is getting tighter.
This raises two immediate challenges. First, it means
that credit growth and, therefore, demand overall
could slow. Second, it renders local financial
systems more vulnerable to volatility in global
markets and a sudden rise in funding costs, for
example, prompted by Federal Reserve rate hikes
(see Frederic Neumann and Ronald Man, Asia and
the Fed, 19 November 2014).
At issue, here, is the rise in loan-to-deposit ratios
(LDRs). In much of ASEAN, as elsewhere in the
region, banks primarily fund lending with deposits.
Their growth, however, has slowed of late (Frederic
Neumann and Rupali Sarkar, Chart of the Week:
Liquidity is getting tighter, 15 November 2014). As
excess deposits shrink, banks are left with two
choices: they can slow lending or borrow from
wholesale markets to top up their funding. The
former inevitably harms GDP growth, the latter
leaves banks more exposed to swings in financial
conditions. Lending in emerging markets is
especially sensitive to financial market volatility.
This is even more so when banks rely on wholesale
Liquidity’s tightening
Loan-to-deposit ratios have increased sharply in recent years in
most ASEAN markets following rapid credit growth since 2008
While this doesn’t signify imminent risks to financial stability, it
means that banks’ ability to sustain loan growth is getting impaired
Given the high credit intensity of GDP growth in the region,
demand may, therefore, remain lacklustre, especially in Singapore
and Malaysia
Chart 2: Credit-to-GDP in ASEAN approaching historical highs
Source: CEIC, HSBC
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or interbank sources to fund credit growth (i.e., when
their LDRs exceed 100).
Shallow capital and interbank markets can quickly
restrict access to affordable funds when volatility
climbs. In addition, unless directly offset by the
central bank, balance of payment positions have a
bigger impact on local liquidity than in advanced
economies, with capital outflows or current account
deficits, for example, draining aggregate liquidity
from the local financial system. This also explains
why the coexistence of high LDRs and current
account deficits is usually less of a challenge in
developed markets, Australia being a key example.
Lastly, many years of low US interest rates brought
substantial foreign portfolio flows, abetting the
creation of excess liquidity. We are now starting to
see signs of the flip side of this equation across
certain markets in ASEAN, such as Malaysia, where
outflows are partly contributing to tightening
interbank liquidity and a depreciating currency.
Why do LDRs matter?
LDRs are, therefore, a good measure of banks’
robustness and their capacity to extend loans
(though it is not the only indicator: capital buffers
and regulations matter, too). A low LDR signifies
that a bank has excess deposits to deploy, and
because deposits are a relatively cheap and stable
funding source, loan growth is easier to sustain. In
this report, we look at aggregate LDRs for entire
banking systems. While this may obscure
differences between individual lenders (some may
have low, others high LDRs), it still tells us
whether a given banking system has excess
deposits or is in short supply.
Generally, LDRs follow a common cycle over time.
At the start, they are relatively low. Gradually, as
credit growth accelerates, they tend to rise. Note that
when a bank extends loans, a part of the proceeds are
ultimately recycled back into banks as deposits (e.g.,
a firm takes a loan to pay its suppliers who put the
cash into their accounts), ready to be lent out again.
However, the process isn’t exactly water-tight:
there is some leakage in the sense that not the
entire loan amount returns to banks as deposits –
some money ends up elsewhere, funding
transactions in the wider economy. This means that
credit will rise faster than deposits over time. As
mentioned, when LDRs rise above 100, a bank can
turn to wholesale or interbank markets to top up
its funds. But this is risky and drives up the cost of
funding (and of loans, all else equal). As a result,
bank lending slows or at least becomes more
sensitive to potential shocks (like financial market
volatility). Finally, if (or, rather, when) a recession
ensues, credit sharply contracts and risk-averse firms
and households raise their deposits. This brings the
LDR back down and the cycle can begin anew.
Chart 3: Judging by LDRs, ASEAN and US have switched places in their respective leverage cycles
Chart 4: Growth is highly credit intensive in ASEAN
Source: CEIC, HSBC. NB: weighted average for ASEAN-5 LDR Source: Bloomberg, HSBC estimates
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To be sure, this is a simplified model of what occurs
in the real world; however, it is relevant enough
for us to keep an eye on LDRs in Asia as a
measure of the credit growth capacity of the
banking sector and its vulnerability to financial
volatility. Chart 1 on the previous page shows the
rise of loan-to-deposit ratios in ASEAN in the run-
up to the Asian Financial Crisis of 1997 and the
more recent climb.
The rise of ASEAN LDRs
We have written at length about leverage in Asia,
including ASEAN (see Frederic Neumann, Ronald
Man, and Joseph Incalcaterra, Leverage still rising,
19 May 2014). For example, household debt-to-
GDP ratios in Malaysia and Thailand are among
the highest in Asia (and higher than they currently
are in the US). Indonesia has also seen a rapid
increase in consumer debt, if from a low base and
more concentrated in consumer finance. Meanwhile,
corporate and even fiscal debt has climbed in many
economies as well.
Recently, however, loan growth in much of ASEAN
has started to moderate. Successive rounds of macro-
prudential tightening, especially in Singapore and
Malaysia, in addition to increasingly burdensome
corporate debt servicing levels (see Asia Credit
Today, 5 November) have begun to weigh on the
demand for loans. Still, LDRs are not improving
since deposit growth has slowed even more. This
suggests that banks’ capacity to expand loans rapidly
is increasingly becoming constrained.
Let’s look a bit closer at how loan-to-deposit ratios
have evolved in the region. ASEAN has some of
the highest LDRs in Asia, with Singapore and
Indonesia being the two countries where LDRs are
rising at the fastest pace. In Indonesia, a further
tightening of LDRs may prove especially
challenging. Because it still runs a relatively large
current account deficit, financial system liquidity
is easily affected by volatile capital flows. A
sudden risk reversal, therefore, can quickly sharpen
funding pressure for Indonesian banks if the
excess deposit cushion is relatively thin. As a
Chart 6: Singapore and Indonesia have seen the fastest increases in LDR in Asia, while Thailand and Malaysia are at elevated levels
Source: CEIC, HSBC
Chart 5: Household debt-to-GDP in Malaysia and Thailand is higher than in the US
Source: CEIC, HSBC
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financial centre, Singapore has more robust
wholesale markets, including deep non-bank
corporate and interbank lending channels, in line
with the level of financial activity, given its role
as a global financial hub. Malaysia is an
interesting case. Though at 82, the official system-
wide LDR is still relatively low, the largest
domestic banks – which have a significant impact
on domestic funding – actually have ratios that are
a bit higher. Meanwhile, Thailand has the highest
loan-to-deposit ratio in ASEAN, even though the
recent LDR trend has been affected by the ‘bills of
exchange’, which we’ll discuss below. Thai LDRs
look set to rise further next year, given that the
largest banks may see a pick-up in credit growth
when infrastructure investment begins to accelerate.
The rise of LDRs has sparked growing competition
for deposits in much of ASEAN. Walk down the
street in Singapore, Jakarta, Kuala Lumpur or
Bangkok and you’ll quickly see enticing deposit
rates on offer and new saving products being
advertised. This applies especially in Indonesia,
where the central bank has set a soft LDR ceiling of
92%, with banks facing penalties if these are
exceeded, but also Singapore and Malaysia, where
banks must prepare for liquidity coverage ratios
(LCRs). However, the competition for deposits may
actually tighten financial conditions since it drives
up funding costs and, therefore, weighs on credit
growth. To rein in fierce competition, Indonesia’s
central bank also capped interest rates on fixed
deposits for banks that have core capital of more
than IDR30trn (USD2.5bn). These can now only
offer a maximum rate of 9.75%, 200 basis points
above the policy reference rate.
The regulatory focus on capping LDRs in Indonesia
is prudent, given the high current account deficit.
However, outside of Indonesia, regulators in
ASEAN have yet to address LDRs in any systematic
fashion, though Singapore and Malaysia are
implementing liquidity coverage ratios in line with
Basel III (these stipulate that a bank needs to holds
a share of its assets in relatively liquid form to meet
the risk of a sudden funding squeeze). Regulators in
Chart 7: Loan growth has started to slow across ASEAN (% y-o-y)
Chart 8: But deposits are ‘collapsing’ at a much faster rate…
Source: CEIC, HSBC Source: CEIC, HSBC
Chart 9: Thailand LDR adjusted for bills of exchange
Source: CEIC, HSBC
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Thailand, the other current account deficit country
after Indonesia (at least in 2013), have a relatively
sanguine approach to LDRs, which have hovered
over 100 for some time now (see chart 9). Still,
while domestic liquidity is ample for now, it may not
always be so.
It all boils down to funding
When we talk about liquidity in ASEAN, it is
natural to think back to the role that currency
mismatches played in the Asian Financial Crisis,
caused in part by short-term bank lending in USD.
Since then, the situation on the ground has
changed substantially, and the core banks are
known to prudently manage their FX exposure,
thanks, in part, to robust central bank oversight.
However, foreign currency LDRs are creeping up
in some countries, and are the highest in Thailand
and Singapore, followed by Indonesia, where the
foreign currency LDR is a tad below the domestic
currency measure.
Data on foreign currency LDRs are a bit harder to
come across. We have system-wide data from
Singapore, Indonesia, Thailand and Malaysia, and
data from Moody’s only covering the banks in their
coverage universe – thereby a proxy for the largest
and generally strongest banks. In Thailand and
Vietnam, Moody’s data show high ratios, while in
Singapore and Indonesia we see higher readings
based on systemic calculations (chart 10).
Taking a step back, we must think about the
implications of foreign currency LDRs. First, they
contribute to the high local currency loan-to-
deposit ratios. While banks have been attracting
foreign currency deposits to try and organically
fund their foreign currency loans, a portion of
these foreign currency deposits may otherwise
have ended up in local currency deposits. This is a
development that the Monetary Authority of
Singapore (MAS) has identified as a reason
driving overall LDRs higher in the city state.
Moreover, higher foreign LDRs imply that the gap
has to be met by other sources: hard currency
bonds, direct overseas foreign borrowing, or short-
term market funds, among others. In any case, the
liabilities are usually hedged by banks and USD
funding conditions have been quite favourable
recently. ASEAN banks’ USD bond issuance and
borrowings have surged 70% from 2009 to 2013.
Rating agencies look closely at the foreign funding
mix in assessing creditworthiness, and a higher
degree of diversification away from market funds
and toward longer-dated paper is positive.
Chart 10: Foreign currency LDRs according to our system-wide calculation, and the calculation based on Moody’s
Chart 11: Resident banks’ net foreign asset exposure has deteriorated in recent years
Source: CEIC, Moody’s, HSBC estimates Source: BIS, HSBC
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However, while banks may have largely improved
their exchange rate risk, there are signs that some
corporates have left some currency exposure
unhedged. For example, during the protests in
Thailand earlier this year, one reported a FX
translation loss due to an unhedged position of
USD2bn of foreign currency debt used for an
acquisition. While banks tend to lend USD to
firms with USD revenues to use as a partial
hedge, it is unclear how many firms are fully
hedged, especially since certain some derivative
markets are quite shallow across ASEAN,
resulting in expensive hedging costs.
The foreign funding should not only be seen in the
context of foreign borrowing, as entire banking
systems in Singapore, Indonesia and Thailand are
showing net liabilities with respect to the rest of the
world, as seen in the BIS data in chart 11. This is
likely a direct result of high LDR growth. In
Singapore, for example, as foreign banks entered
the market over the past decade to profit from the
city-state’s rise as a financial hub, they weren’t able
to build their deposit bases sufficiently. As loans
picked up – in local currency and USD terms – to
help fund loan growth in ASEAN more broadly,
this contributed to the higher LDRs and reliance on
foreign funding.
This is not only limited to Singapore, seeing that
Japanese banks, for example, have sharply expanded
their lending presence across almost all of ASEAN,
especially Thailand, Indonesia and Malaysia.
Quick word on current accounts
We already hinted at the fact that when looking at
LDRs, and financial system liquidity more broadly,
current account positions matter, too. Briefly: this is
because a surplus implies that national saving
exceeds investment and, therefore, excess local
liquidity (by contrast, there tends to be a shortage of
Chart 12: High LDR and tightening liquidity is most troubling for the countries with current account deficits, such as ID and TH
Source: CEIC, HSBC
Chart 13: Current account balances (as a percentage of GDP) have deteriorated everywhere in ASEAN, except Vietnam
Source: IMF, HSBC
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local liquidity if there is a current account deficit).
To the extent that LDRs reflect the overall liquidity
position of the financial system, they go hand in
hand with a country’s current account position.
However, it is not just the overall position that
matters, but the direction of current account balances
over time. For example, a shrinking surplus implies
that excess liquidity is diminishing as well, which
we can generally expect to be associated with rising
LDRs. And this is exactly what happened in many
ASEAN economies in recent years: deteriorating
current account balances coincided with rising loan-
to-deposit ratios among banks.
The main point here is this: deteriorating current
account balances (even if still in surplus) and rising
LDRs point to the same thing: excess liquidity in
the financial system is diminishing, with banks’
ability to maintain rapid credit growth deteriorating.
What’s more, the increasing reliance of banks on
wholesale markets (or of the country on capital
inflows) raises the sensitivity of the financial system
to volatility and reversals in risk appetite.
Importantly, the way to think about current account
balances and LDRs is as a continuum, rather than a
binary position: deteriorating current account
balances and rising LDRs increase an economy’s
sensitivity to global financial developments. It is
not so much that current account deficit countries
and banking systems with LDRs below 100 are
immune and others are not, rather the degree of
exposure changes as the two measures shift.
A quick look at chart 13, therefore, confirms what
we already hinted at in our discussion about LDRs.
With the exception of Vietnam, current account
balances have deteriorated across ASEAN in recent
years, suggesting that financial vulnerabilities have
risen as well. In Thailand (last year at least) and in
Indonesia, current account deficits highlight greater
risks to ongoing credit growth than elsewhere, but
the sharp decline in the current account surpluses
in Malaysia and Singapore suggests that the relative
financial vulnerabilities have perhaps increased here
the most.
Liquidity coverage
Officials in Singapore and Malaysia are in the
process of implementing liquidity coverage ratios
in line with the Basel III framework. In the
former, the rules are a bit more stringent: local
banks will have to meet 100% of their net-cash
needs over a 30-day period with liquid local
currency assets by 1 January 2015. Foreign banks
will have to meet a LCR of 60% starting in 2016,
increasing by 10% annually until 2020. SGD/USD
Basis swaps (a benchmark of the cost to swap
variable USD Libor cash flows for SGD) have
Chart 14: 3M KLIBOR fixing is pointing to a tightening in domestic liquidity (%)
Chart 15: Rising SGD basis swaps show the impact of LCRs (bp)
Source: CEIC, HSBC Source: Bloomberg, HSBC
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increased over the past year, suggesting that there
is strong demand for SGD-denominated liquidity,
especially by foreign banks (Chart 15).
Meanwhile, in Malaysia, BNM seems set to
implement a LCR of 60% starting in 2015 for all
banks, increasing to 100% through 2020. These
rules are contributing to already tightening liquidity
conditions, as measured by KLIBOR. Banks are
seeking long-term funding, corresponding with
what can be described as a fierce war in fixed
deposit rates.
The increase in KLIBOR is also compounded by
signs of capital outflows, due to fading interest by
overseas investors (note that foreigners hold 70%
of short-term bills), as well as overseas
investments by local agencies. Moreover, we see
signs that deposits have been shifting to non-bank
financial intermediaries, such as the Tabung Haji,
a government-run cooperative to enable Muslims
to fulfil the Haj. One last sign of the tightening
conditions is manifested in the moderation of
excess liquidity stored at BNM (if gradually).
These trends may be shrugged off as temporary,
reflecting banks’ funding adjustment as new
regulation is brought into force. And regulators
are adopting these for a reason: to render financial
systems more robust in the long run. However, the
capacity of banks to extend credit at a rapid clip is
thereby constrained, with the inevitable impact on
growth in the near term. This is all the more so as
LDRs were already on the rise when banks started
to apply the new liquidity ratios.
Fortunately, banks are strong
Large banks across ASEAN generally look quite
healthy. They have on average higher tier-1 capital
ratios than their Asian peers – 12.5% compared to
10.5%, according to Moody’s – while their liquidity
management and corporate governance tend to be
quite sound. However, financial systems are much
broader than the largest banks – even if these often
hold the vast majority of financial assets.
As we have mentioned, it is increasingly foreign
banks that have expanded locally. Given that they
tend to be funded from headquarters and mostly
hedge their FX exposure, these banks generally
don’t represent a systemic financial risk. However,
foreign banks’ lending can be sensitive to overseas
financial conditions and moves in exchange rates,
owing to their often external funding.
It is important, here, to distinguish between outright
systemic risk and changes in financial conditions.
Memories of the Asian Financial Crisis of 1997 cut
deep. Back then, overseas borrowing from foreign
banks was largely denominated in USD, and with
few official FX reserves offering protection, left
the region vulnerable to currency mismatches and
Chart 16: Japanese bank lending to Asia and ASEAN Chart 17: ASEAN banks are resilient and can withstand 10%/15% deposit runs (judging by liquid asset ratios)
Source: CEIC, HSBC Source: Banking Financial Metrics, Moody’s
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rapid balance sheet deterioration once exchange
rates plunged and foreign currency loans needed
to be repaid.
However, things are a lot more stable now. Even
though foreign bank lending into ASEAN now
exceeds the mid-1990s peak, there are a number of
factors that have sharply reduced, if not entirely
eliminated, the region’s exposure. For example,
more stringent regulation means that FX
mismatches of assets and liabilities have been
sharply reduced through outright hedging (whether
by borrowers or lenders). In addition, central banks
for the most part have built up comfortable FX
reserve buffers that can be used to supply dollars in
the event of stress.
Meanwhile, the global interest rate environment
continues to be highly accommodative. Even if
the Fed raises rates next year, as HSBC’s US
economists expect, more easing in Europe and
Japan appears likely. Unlike 1997, therefore, the
world is not (yet) in the stages of an advanced
tightening cycle.
Therefore, it is difficult to characterise the current
strength of the USD and possible, initial hikes by the
Fed as events that present a systemic risk to ASEAN
banks like in the mid-1990s. However, this is not to
say that local financial conditions will not tighten
gradually, as a result. And it is here that rising LDRs
become relevant: by raising the sensitivity of credit
growth to global financial conditions and swings in
exchange rates, banks may become more cautious,
or even constrained, in their lending.
ASEAN and the BoJ
After the Fed, the next best friend of ASEAN
liquidity is the BoJ. The link between the BoJ’s
monetary easing and the liquidity flow to ASEAN
has been abundantly clear in the past (chart 16). This
is, in part, what is motivating a more dovish tone by
central banks in the region, in spite of high
household debt and the prospect of Fed tightening
next year. In a nutshell, Japanese bank liquidity is
yet another factor that should keep local financial
systems relatively stable, especially over the course
of the next 1-2 years. Still, it may pose some
problems further down the road, as we will explain.
The monetary scenario we expect for next year is not
entirely new. The 1990s saw a similar dynamic: in
the early part of the decade, the BoJ cut rates in
the wake of the collapse of Japan’s property bubble.
Given weak growth at home, banks increasingly lent
money to emerging Asia, fuelling the region’s boom
in spite of the start of a Fed tightening cycle in 1994
(see Don’t sweat the Fed, here comes the BoJ,
31 October 2014, Frederic Neumann).
Greater regional lending by Japanese banks helps
counteract the effects of Fed tightening and dollar
Chart 18: US rates remain low and anchored for now… Chart 19: But there are signs of global USD liquidity tightening (bp)
Source: Bloomberg, HSBC Source: Bloomberg, HSBC
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strength. The risk, however, is that this increases
local debt further, possibly leaving the region more
vulnerable once G3 monetary conditions tighten.
Moreover, foreign funded bank lending will only
worsen system-wide LDRs, as we aren’t seeing a
balance of local funding (most overseas bank
lending is funded from headquarter to regional
offices). As mentioned, while this doesn’t directly
present issues for financial system stability, as the
local branches will likely be supported by their
parents in the event of a funding crunch, it still
highlights that aggregate credit growth is becoming
less reliant on deposit funding and, therefore, subject
to financial market volatility and risk appetite.
Further, if leverage rises, the eventual transition to
higher rates will prove challenging because of
climbing debt servicing costs. Indirectly, there will
also be a negative wealth effect as the debt supported
rise in asset prices (think property) reverses. In
ASEAN, Malaysia and Singapore appear relatively
more vulnerable to this process, given that
household borrowing is generally undertaken at
variable interest rates. In Thailand, by contrast,
mortgage tenors are often lengthened when rates
go up, resulting in monthly repayment amounts
staying unchanged.
So what does this all mean?
In spite of the challenges we outline above, we
still believe that liquidity conditions will remain
supportive enough in 2015 to support at least
moderate credit growth.
First, while the Fed may hike rates in 2Q14, the
cycle should be slow and HSBC strategists forecast
continued low 10-year US Treasury bond yields (at
2.5% by end-2015).
Second, ASEAN banks have built up strong buffers
to withstand shocks to asset quality. The major
banks in the region have an average core capital ratio
of 12.5% compared to 10.5% for Asia as a whole,
according to rating agencies.
Third, outright exposure to USD funding sources is
much lower than it was in 1997, when banks turned
increasingly to hard currency loans in capital
markets to shore up their balance sheets. This time
around, the exposure to USD is more indirect, but,
nonetheless, constitutes residual risk.
Fourth, BoJ liquidity should help offset imminent
Fed tightening through the bank lending channel.
However, there are some risks to watch out for.
First, we watch for further increases in LDRs
towards and above the 100-threshold, especially
in Indonesia, given its current account deficit, but
to some extent also in Thailand, where it may
exacerbate household leverage.
Second, low inflation pressures, subdued growth
prospects and the relative insensitivity (compared
to 1997 at least) of local financial conditions to
exchange rate swings open the door to most
central banks staying accommodative. This could
leave the region more susceptible to liquidity
tightening in the future.
Third, although banks are strong, consumption and
private demand may not be so resilient, thanks to
variable rate pass-through (especially in Singapore
and Malaysia). This implies that while the financial
system may prove to be resilient, a slowdown in
credit growth coupled with somewhat higher rates
may put pressure on demand.
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What about shadow banking?
In an update on Asian leverage published earlier
this year (see Frederic Neumann, Ronald Man, and
Joseph Incalcaterra, Leverage still rising, 19 May
2014) we pointed to the growing, but still small
amount of non-bank financial intermediation
across Emerging Asia. However, given the role
that non-bank institutions played in exacerbating
liquidity conditions during the Asian Financial
Crisis (think finance companies and repo markets
in Thailand), it is worth keeping an eye on the
development of this sector.
However, the term is a bit more pejorative than
what it actually reflects. For example, money
market funds, insurance companies, consumer
finance companies and pension funds are all
considered a part of shadow banking, but perform
vital functions for the financial sector – arguably
functions that developing ASEAN needs more of.
But, there are risks. According to the Financial
Stability Board (FSB), the regulatory body set up in
the aftermath of the Global Financial Crisis, there are
key areas of risk to look out for:
(1) interconnection between the banking system and
shadow banking that raise spill-over risks; (2)
susceptibility of money market funds (MMFs) to
runs; (3) risks posed by other shadow banking
entities; (4) assessment and alignment of incentives
associated with securitisation, and (5) risks and pro-
cyclical incentives associated with securities
financing transactions such as securities lending and
repos, which may exacerbate funding strains in times
of runs.
In ASEAN, traditional banking dominates the
financial system, constituting more than 50% of
total assets, with the exception of Malaysia, which
is a tad smaller. For most countries, non-bank
financial intermediaries represent less than 30% of
total assets (see chart 21). So, on the surface, there
is a relatively little risk from shadow banking type
contagion. However, even though in 1997 banks
were dominant, Thailand and Malaysia,
nonetheless, saw a further tightening of liquidity
conditions due to finance companies and money
market funds coming under pressure, as well as
complications in repo markets.
Malaysia perhaps has the largest non-bank financial
sector in ASEAN, though it still remains small
(approximately 18% of total financial system assets
as measured by the FSB, not including pension
assets, which encompass 21%). These undertake
relatively little in terms of securitisation (only 3.2%
of total activity) and work primarily in loan and
equity provision.
For the most part, across the region there are few
finance companies that single-handedly propagate
maturity and currency mismatches, according to the
FSB. In ASEAN, today, the limited interbank and
wholesale channels are less discrete; however,
nonetheless, introduce risks that have to be
monitored.
It is important to keep in mind, however, that non-
bank financial institutions play an important role
in the development and growing sophistication of
ASEAN financial markets. For example, they
perform socio-economic roles that expand the
provision of basic financial services to individuals
and SMEs, such as credit-unions and
cooperatives, micro-finance and specialised loan
products. This is important in countries such as
Indonesia, where, in 2011, only 20% of the
population had access to a formal bank account,
according to a World Bank report.
Moreover, they undertake important functions in
making markets more efficient, such as managing
loan provisions and cash pools, intermediating
market activities and facilitation of credit creation
and securitisation-based credit intermediation, which
serves as one way to mitigate systemic risk.
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Chart 20: Traditional banking assets as a percentage of financial assets
Chart 21: Other financial intermediaries (OFI) as a percentage of system assets
Source: FSB, HSBC Source: FSB, HSBC
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60
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100
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Country overview
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Over the past two years, Singapore witnessed one of
the fastest increases in loan-to-deposit ratios in the
region, measured in local currency units (classified
by the MAS as Domestic Banking Units). However,
we are seeing increasing evidence that credit growth
is slowing in Singapore, especially in the household
segment, and at a faster rate than in other
ASEAN markets.
Nine rounds of macro-prudential measures to tame
the housing market, in addition to slow consumer
credit growth – echoed by relatively soft retail sales
– confirm this. However, there remains a good deal
of lending to the corporate sector in both SGD and
foreign currencies – mostly a result of Singapore’s
status as a regional corporate hub. Meanwhile,
deposit growth has slowed sharply and even turned
negative for a few months, especially for foreign
bank branches operating in Singapore.
The signs of increasing bank liquidity are coinciding
with various market indicators. This marks an abrupt
change from the recent past. A few, short years ago,
Singapore was so flush with liquidity that the Swap
Offer Rate (SOR) was fixed at a negative rate for the
first time in history. However, in recent months we
have seen positive momentum in the SOR, showing
signs of domestic liquidity start to tighten – in part
due to expectations of a depreciating SGD. Our rates
strategy team is expecting SOR rates to head further
higher in 2015, both due to expectations on
USD/SGD and also a higher USD Libor
Singapore
Singapore has seen one of the fastest increases in LDRs
This was driven by foreign bank expansion without strong deposit
bases, as well as the rise in foreign currency LDRs
The implementation of Liquidity Coverage Ratios (LCRs) for
foreign banks by 2016 is resulting in demand for SGD liquidity
Chart 22: Singapore’s LDR is approaching the pre-Asian Financial Crisis high
Chart 23: Even though loan growth is moderating, it is still running well above deposit growth (in DBU terms)
Source: CEIC, HSBC. NB: DBU is Domestic Banking Unit; ACU is Asian Currency Unit Source: CEIC, HSBC
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92 94 96 98 00 02 04 06 08 10 12 14Loan growth y-o-y Deposit growth y-o-y
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(Asia-Pac Rates: Top Five Trades for 2015,
20 November 2014, for more details). 3M SIBOR,
on the contrary, should remain relatively flat until
the Fed Funds rate in the US starts to actually
increase. In the past, 3M SIBOR has lagged the Fed
Funds and increased at a lower magnitude.
We estimate that in the past, for every 100bp of Fed
Funds hikes, SIBOR increased by 45bp. However, if
liquidity tightens faster than expected (not our base
case) and capital leaves Singapore, rates could
increase at a faster pace. This is a central concern to
the economy, seeing that roughly 70% of Singapore
mortgages are taken out at a variable rate, with most
linked to SIBOR.
Back to deposits
Domestic deposit growth is weak for a variety of
factors. On the one hand, money is heading
increasingly to money market funds and overseas
investments, a trend that we suspect has been
gaining traction across ASEAN for many years,
especially as authorities employ macro-prudential
measures locally. There has also been an increase in
foreign currency deposits to coincide with the
increase in related non-SGD lending, measured by
Asian Currency Units (ACUs, which include USD),
due to fairly attractive rates.
For example, local banks have rapidly increased
their loan book exposure to China, and the SGD
has recently started direct trading with the RMB.
This has led to a push to increase RMB deposits,
(though they are still a small part of system
deposits). In turn, this contributed to a dearth of
local deposits.
While ACU deposit growth is significantly higher
than local currency units, it is not high enough to
prevent an increase in ACU loan-to-deposit ratios.
The trend of increasing ACU loans is also
indicative of the Singapore dollar’s role as a
regional funding currency. In spite of the strength
in USD/SGD, the SGD is appreciating against its
regional peers, and the market is confident this
will remain the case, thanks to strong signs of
policy continuity from the MAS.
The dynamic described above has caused intense
retail deposit competition by banks – local and
foreign alike, even if the former have stronger
retail franchises and deposit bases. It is possible
that higher retail deposits – and, therefore,
funding costs – might actually further tighten
liquidity. However, if higher domestic fixed and
demand for SGD results a significant increase in
domestic rates, the MAS would likely sell SGD
(and buy USD) to guide the SGDNEER and keep
it in the band. This isn’t expected to be too much
of a concern at the moment, seeing that the
Chart 24: Household leverage remains high, although mortgage growth has started to slow (SGDm)
Chart 25: Basis swap trend highlights approaching LCR(bps)
Source: CEIC, HSBC Source: Bloomberg, HSBC
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SGD Basis 6M SOR vs 6M Libor 5Y
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SGDNEER is trading around the mid-point of the
band at the time of writing (see chart 26), and that
the SGD is expected to weaken vis-à-vis the USD.
Moreover, the expected implementation of LCRs
by the MAS in 2015 is contributing to strong
demand for certain SGD risk-free assets, which is
resulting in higher SGD/USD basis swaps,
especially by foreign banks that are seeking to
increase local liquidity exposure (the original plan
for USD LCRs was shelved by the MAS).
In the unlikely case, however, that an exogenous
financial shock transpires and Singapore witnesses
a spell of asset price volatility and potential
funding issues, the MAS has made it clear that the
preferred monetary setting would continue to be a
widening of the band to give the SGDNEER
‘room to breathe.’ That said, given the liquidity
dynamic, as well as inflationary concerns related
to economic restructuring, the overall monetary
policy trajectory will likely remain unchanged (a
SGDNEER appreciating slope of 2%).
Chart 26: By targeting the SGDNEER in the middle of the band, the MAS hopes to keep liquidity and funding conditions stable
Source: Bloomberg, HSBC
105
110
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Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Index 1999 = 100 Index 1999 = 100
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Deposit competition in Indonesia is probably the
most intense in ASEAN, the reason being that BI has
set a soft 92% LDR ceiling for commercial banks.
This has had a clear impact on funding costs as
banks compete, simply because the alternative
funding sources in Indonesia are quite limited, such
as wholesale financing. Moreover, with Indonesia’s
sizeable current account deficit and the
corresponding currency volatility it brings, a reliance
on foreign funding is risky. However, foreign
funding, nonetheless, makes up roughly 15% of the
commercial bank funding profile in 2013, the
highest in the region outside of Singapore.
First, let’s put Indonesia’s leverage rise into context.
Indonesia has seen rapid growth in consumer credit,
even if from a relatively low base. This involved
foreign institutions, too: banks from Japan and the
West made acquisitions to offset slow growth at
home – for example Mizuho purchased an auto-
finance firm in 2013 to gain a foothold.
The rise in consumer leverage echoes Indonesia’s
private consumption-driven GDP growth in recent
quarters – which has exacerbated the country’s
external imbalances. To make matters worse, the
country’s perennially weak current account has
added to financial and credit growth risk even if
overall debt is lower than elsewhere.
We believe that this structural issue is one of the
factors driving the high LDRs. As we mentioned
above, it is not the level of loans that worries us,
but the fact that the money multiplier is somewhat
distorted and loan origination doesn’t easily feed
Indonesia
Indonesia’s LDR is under 100%, but the current account deficit
leaves the country vulnerable if there are financial imbalances
Bank Indonesia enforces a LDR soft ceiling of 92% for banks
Structural reforms should lessen financial imbalances
Chart 27: Deposit rates have increased due to the strong competition (percent)
Chart 28: Bank Indonesia policy rate and inflation
Source: CEIC, HSBC Source: CEIC, HSBC. NB: Inflation is headline CPI % y-o-y
5.0
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09 10 11 12 13 14CPI y-o-y BI Repo rate
% y-o-y % y-o-y
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Macro Asian Economics 4 December 2014
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back into deposits. Oil subsidies, now mostly
repealed, constituted a part of the dilemma. First,
pricing energy at artificially low levels gave an
artificial boost to consumption – and, therefore,
demand for loans. Second, the funding gap
brought about by the current account deficit
reduced excess liquidity in the system and led to
greater sensitivity of financial conditions to
swings in exchange rate.
On the bright side, President Widodo has already
started adjusting the fuel subsidies – even if at a
slow rate – with the first hike announced on 18
November. However, this came together with a
rate hike on the same day by Bank Indonesia.
With credit growth already slowing in the country,
we think there will be increasing pressure on
growth. That said, most importantly, structural
imbalances are being tackled to ease structural
liquidity issues.
Bank Indonesia has a difficult task at hand. Seeing
that growth is slowing, a further drop in liquidity
would weigh further on demand. That said, with
the system-wide LDR near BI’s soft ceiling of
92%, there isn’t much that can be done apart from
accelerating structural reforms (i.e. GDP growth
needs to be driven more by productivity gains
than credit). Banks can compete against each
other for deposits, but the effect this most likely
has is to just steal them away from other banks –
not necessarily increasing the system-wide stock.
In tandem with the recent rate hike, BI announced
a change in methodology for the LDR, by
including bonds and securities issued by banks in
the denominator. This should free up some
liquidity for lending, but with higher interest rates
and slowing growth, it is unlikely that banks
aggressively ramp up loan origination.
Chart 29: Indonesia loan-to-deposit growth (%) Chart 30: Indonesia current account trend and forecast (2014-16)
Source: CEIC, HSBC Source: CEIC
40.0
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1993 1996 1999 2002 2005 2008 2011 2014f
% GDP
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Malaysia has the ominous honour of having the
highest household debt-to-GDP ratio in the
region. These credit conditions arose in part due
to a structural liquidity surplus in the banking
sector, which survived the Global Financial Crisis
mostly unscathed, as well as foreign capital
inflows. As we noted earlier, Malaysia has started
to see a tightening of liquidity conditions on
several fronts.
First, BNM has hiked rates to a cycle-high in July
2014, given the household leverage dynamic and
the desire to offset the inflationary effect of fuel
price adjustments by the government. Although it
is increasingly clear that the central bank has
concluded its tightening cycle for now
(see That’s a wrap, 31 October, Su Sian Lim, for
more details), thanks to dovish comments by
Governor Zeti, the market is, nonetheless,
showing signs of interbank funding costs
increasing, as measured by KLIBOR (see below).
While this should help the deleveraging process,
or at a minimum discourage incremental
household leverage, we still see strong momentum
in mortgage-related lending.
Malaysia tends to be much more reliant on interbank
funding sources than other ASEAN markets, mostly
from non-financial corporations, as well as pension
funds, and some foreign sources as well.
Chart 31: Liquidity as measured by excess reserves at the BNM has likely plateaued (MYRm)
Chart 32: LDR, loan and deposit trends (%)
Source: CEIC, HSBC Source: CEIC, HSBC
Malaysia
Malaysia has seen one of the quickest tightening of interbank
tightening in recent months, as shown by rising KLIBOR
Some key banks show LDRs higher than the official number
BNM has likely concluded its short-lived tightening cycle, but
portfolio outflows may keep short-term rates high
4,000
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07 08 09 10 11 12 13 14Local LDR Loan y-o-y Deposit y-o-y
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Another important measure of liquidity in Malaysia
is excess bank liquidity at BNM (essentially a
measure of the structural liquidity surplus). The
measure has started to moderate since reaching a
high in 2012, which effectively represents a
tightening in financial conditions.
To add to the weight of external liquidity conditions
filtering through to domestic funding, Malaysia has
also been facing low deposit growth. While the
official LDR, at around 82%, doesn’t seem too high,
this number can be somewhat misleading as some
key local banks have higher LDRs of around 90%.
They are reporting a particularly sharp slow-down in
deposits from the business sector. One reason for
this may have to do with interest rate sensitivity and
self-financing by corporates for their investment –
which thereby detracts from deposits. Like
Singapore and Malaysia, potential incremental
deposits are probably finding their way outside the
country, while on the other hand the frothy property
market is also a likely destination for potential funds.
Banks have engaged in competition and increased
deposit rates, but they are increasingly reaching a
level close to where certain economic actors (non-
bank financial companies, certain corporates with
access to interbank funds) could effectively arbitrage
by borrowing on the interbank market and
depositing in banks, which implies that there is not
much room left to hike deposit rates. The result?
Credit growth may have to slow even more. True,
loans destined for the property market have
remained robust; however, if conditions continue
to tighten, we may eventually see a turnaround.
Chart 35: Personal loans have slowed, but mortgage loan growth remains strong
Chart 36: Interbank liquidity is starting to tighten in Malaysia, as loan growth moderates
Source: CEIC, HSBC Source: CEIC, HSBC
Chart 33: The spread between the policy rate and interbank rate is at a decade high (bp)
Chart 34: Interbank rates imply a fast degree of tightening, even if the BNM has likely finished its hiking cycle for now (%)
Source: CEIC, HSBC Source: CEIC, HSBC
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Thailand is an interesting case study, and the only
country that has seemingly reversed the rising
LDR trend in recent years. However, this mostly
boils down to a change in regulation.
The pick-up in deposits that occurred in 2012 was
due to a change in how bills of exchange (BE) were
regulated – including them in the deposit insurance
scheme. Before 2012, banks had to pay 0.4% of the
deposit base to the deposit insurance agency;
however, bills of exchange were not subject to the
charge – which made them a cheaper way to raise
funds. Since 2012, however, this approach was
closed by including BEs in the calculation of the
deposit insurance fees. This caused a market return
to deposits, while BEs mostly expired over time and
are now an insignificant part of deposits. If we factor
them into the deposit equation – we actually would
see a steady increase in LDRs since the Global
Financial Crisis.
Since 2013, overall deposit growth started
moderating again due to a large part of potential
deposits going into money market funds that sit
outside of Thailand, in the form of Foreign
Investment Funds (FIFs), due to the relatively low
rate environment, as well as political uncertainty.
However, deposit growth has moderated in line
with loan growth. This has contained LDRs – but
they remain above the crucial threshold of 100%,
implying financing vulnerabilities. Moreover, as
we mentioned before, even though USD assets
constitute a small portion of total financial assets,
the high USD LDR mismatch represents an
imbalance that could be exacerbated in a tight
global funding scenario.
Thailand
Thailand’s LDRs are some of the highest in the region
Foreign currency LDRs have especially increased, as banks raise
USD to fund corporate expansion by Thai conglomerates…
However, local liquidity conditions remain ample
Chart 37: Foreign bank borrowing has increased in Thailand (y-o-y)
Chart 38: Commercial bank foreign funding has increased as a percentage of total funding
Source: CEIC, HSBC Source: CEIC, HSBC
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Thailand’s economy has withstood a great deal of
turmoil amid a low rate environment, and continues
to hold up nicely. Currently, we see no real signs of
tightening liquidity. Moreover, with some dovish
comments coming from the Bank of Thailand, it is
hard to imagine imminent tightening.
2014 so far was a slow year in terms of loan
growth for Thai commercial banks. Anecdotal
evidence suggests that Thai banks will ramp up
loan growth next year (around 6% y-o-y,
compared to 3% so far in 2014). A part of this
should go to the SME sector, but also to fund
government-led infrastructure.
As we mentioned before, this will only exacerbate
leverage accumulation (helped by the BoJ, too),
which implies a rougher transition to a high rate
environment when this actually occurs. Moreover,
though Thailand’s current account will likely turn
positive in 2014, the surplus will be quite small and
may deteriorate again. This will only keep the
prospect of increased volatility if the funding
mismatches continue to grow.
Chart 39: There are different ways to measure LDRs in Thailand, but they remain uncomfortably high
Chart 40: Thailand received the largest share of Japanese bank lending in Asia
Source: CEIC, HSBC Source: CEIC, HSBC
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The Philippines is in a bucket of its own, and
actually resembles other parts of ASEAN in the
recent past. There is clearly excess liquidity in the
system, with robust consumer demand growth and
property prices continue to pick up steam. The
Bangko Sentral ng Pilipinas (BSP) is currently the
only central bank in Asia that is expected to hike
rates next year, and it has implemented some
macro-prudential measures to prevent asset bubbles.
Accordingly, we don’t really worry about bank-
related liquidity in the Philippines as banks are in
better shape from an LDR perspective, as we show
in Chart 42. Meanwhile, liquid assets as a share of
deposits have also increased, which implies that
banks also have ample buffers – not to mention the
robust external fundamentals on the sovereign side.
Credit growth may stay strong in the Philippines
over the next year. In addition to the BoJ, the
country is also in the process of further opening up
the financial sector to foreign banks. On 17
November 2014, the Philippine government passed a
law allowing foreign banks to operate in the country
and to acquire up to 100% of a local lender
(previously they could only buy up to 60%).
This move is in line with increased services
integration with ASEAN under the ASEAN
Economic Community (AEC), which is expected
to come into force on 31 December 2015. The
increased foreign financial presence is quite
timely, and provides an additional conduit for
Japanese bank lending to flow into the Philippines
to increase liquidity, which will give the BSP
good reason to be vigilant.
Chart 41: Rates are near all-time lows, while monetary supply growth has seen moderation after strong growth
Chart 42: Banking system metrics in the Philippines (LDR)
Source: CEIC, HSBC Source: CEIC, HSBC
The Philippines
The BSP is tightening monetary policy to soak up liquidity
LDRs are low and most financial metrics are healthy
The Philippines is set to allow a larger foreign bank presence
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Vietnam’s financial sector is struggling with
legacy bad loans still clogging bank balance
sheets, constraining liquidity and stunting credit
growth. This has resulted in sub-trend credit
growth in recent years that has fallen short of the
central bank’s targets.
In late 2013, the government formed the Vietnam
Asset Management Company (VAMC) to help
restore bank liquidity by allowing banks to swap
bad loans for special bonds that could then be
repo’ed with the SBV for more liquid assets. This
effectively solved the liquidity issue stemming
from high NPLs. However, seeing that the main
structural issues behind the bad loan phenomenon
– inefficient state-owned enterprises (SOEs)
crowding out the economy, cross-ownership
between banks and corporations and poor
regulatory frameworks persist – the structural
issues behind the liquidity problems will not be
fully resolved. This will continue to weigh on
credit growth until the government enacts various
structural reforms (see Vietnam at a Glance,
Trinh D Nguyen, 1 August 2014).
As a manufacturing-driven economy following an
East Asian model of development, Vietnam has a
far less robust consumer demand trajectory than
some of its ASEAN neighbours. That said, credit
growth is much needed to fund the investment in
infrastructure and export zones to allow Vietnam
to continue moving up the value-added scale.
Given its low level of development, investment is
still a crucial component of Vietnam’s growth,
which is why the structural issues must be cleared
so that the liquidity may emanate from banks.
Over the past few years, LDRs in Vietnam have
come down as credit growth slowed but deposits
increased. In fact, banks have lowered their deposit
rates significantly, given the high demand for
deposits, resulting in a sizeable spread between
deposits and loan rates. While this benefits bank net
interest margins, it bodes quite poorly for growth.
However, to us this is a clear side-effect of the NPL
phenomenon mentioned earlier.
Like we mentioned, to solve the liquidity issues in
the short-term, far-reaching reforms are needed.
Some argue that even if the structural problems
aren’t solved, the NPL issue can solve itself once
(and if) the real estate market recovers sufficiently
to increase the value of the collateral underlying
many of the NPLs. However, it goes without
saying that a structural fix would be the most ideal
outcome for sustaining long-term growth.
Vietnam
Vietnam has a liquidity problem of a different sort than the rest
A prior credit binge resulted in NPLs constraining liquidity
This has been partly resolved with the VAMC, but issues persist
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Macro Asian Economics 4 December 2014
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Macro Asian Economics 4 December 2014
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