Impact of the Current Financial Turmoil on Commercial Banks

3.1 Impact of the Financial Turmoil on Commercial Banks in the PRC

As of the end of 2008, financial institutions in the PRC—including banks and non-banks—consisted of 3 policy banks, 5 large state-owned commercial banks, 12 joint stock commercial banks, 136 city commercial banks, 22 rural commercial banks, 163 rural cooperative banks, 22 city credit cooperatives, 4,965 rural credit cooperatives, 1 postal savings bank, 4 financial asset management companies, 32 locally incorporated foreign bank subsidiaries, 54 trust companies, 84 finance companies of enterprise groups, 12 financial leasing companies, 3 monetary brokers firms, 9 auto financing companies, 91 village and township banks, 6 lending companies, and 10 rural mutual credit cooperatives.

In 2008, there were noticeable changes in the market shares of banking institutions (Figure 5 [ PDF 84.9KB | 1 page ]). Measured by asset scale, the three largest banking institutions were large state-owned commercial banks, joint stock commercial banks, and rural cooperative financial institutions. In 2008, the market shares by asset scale of these three types of banking institutions were 51.0%, 14.1%, and 11.5%, respectively. The market shares of large state-owned commercial banks and foreign bank subsidiaries were reduced by 2.22% and 0.23%, while those of the policy banks, rural cooperative financial institutions, joint stock commercial banks and postal savings bank increased by 0.92%, 0.81%, 0.34% and 0.19%, respectively. On the other hand, there was a rise in the market shares by asset scale of other institutions.

The impact of the current financial turmoil on PRC's investments in security and relevant derivatives in the US and the EU may be observed from three dimensions: government's investment in the US government's bonds; financial institutions' investment in corporate bonds; and strategic overseas investments by the main state-owned banks.

According to estimates by the PRC media, Asian financial institutions incurred total losses amounting to approximately US$24 billion as a result of the financial crisis, with Japan suffering the biggest loss. Chinese financial institutions, meanwhile suffered a loss of about US$3.1 billion.

The Report on Situation of Oversea Holding America Securities (issued by American Finance Ministry and Federal Reserve System at the end of April 2009), estimated that PRC's total holdings of US stocks, bonds, and asset-backed securities (ABS) was US$1,174.8 billion at the end of June 2008. This was second only to Japan's holdings, which amounted to US$1,184.8 billion. Of the US$375.7 billion in ABS holdings, around US$368.7 billion were issued by Fannie Mae and Freddie Mac (Table 6 [ PDF 81.8KB | 1 page ]).

According to these statistics, PRC financial institutions suffered limited foreign security investment losses as a result of the global financial turmoil. The main reasons for this could be summarized as follows:

1. Financial openness was still far lower than the global average level. Overall system risks were therefore kept under control.
2. Funds remained in surplus and overall liquidity risk was low.
3. Direct and indirect financial systems in PRC are not fully integrated. As such, the high leverage ratio of derivatives does not exist in the financial market.
4. Reforms of large commercial banks significantly improved their asset quality. Banks' corporate governance and management ability also continue to improve.
5. Foreign exchange reserves rose to US$2.1 trillion in July 2009, allowing PRC to absorb overseas investment losses.

Major commercial banks in PRC also suffered lower investment losses compared to US and EU derivatives or securities. For example, risk exposure in the China Construction Bank peaked at US$17.814 billion in September 2008, accounting for less than 2% of total assets. Direct risk exposure in other PRC commercial banks listed in Hong Kong, China was also kept under control (Table 7 [ PDF 81.9KB | 1 page ]).

The impact of the financial turmoil on the PRC banking industry was assessed in the 2008 Annual Report issued by CBRC. The report noted that the net profit (after-tax) of the banking industry in 2008 was CNY583.4 billion, an increase of 30.6% from 2007. The net return on assets (ROA) was 17.1%; this was the highest figure in the global banking industry. Net interest income, investment returns, and net fee-based income constituted the three major contributors to the income portfolio (Figure 6 [ PDF 21.4KB | 1 page ]).

The overall weighted average capital adequacy ratio (CAR) stood at 12% by the end of 2008. This was higher than the 8.3% registered at the end of 2007. The number of banks which met the CAR requirement of 8% reached 204, higher by 43 compared to 2007. There was only one bank with a CAR below the statutory minimum. The assets of these qualified banks accounted for 99.9% of the total assets of commercial banks, up by 20.9% from the end of 2007.

The banking industry's overall liquidity remained stable at the end of 2008. The overall loan-to-deposit ratio of banking institutions was 69.2%, which was 5.8% lower than regulatory ceiling of 75% (Figure 7 [ PDF 93.8KB | 1 page ]). The liquidity ratio stood at 50.07%, up by 9.9% from the beginning of the year (Figure 8 [ PDF 93.8KB | 1 page ]). The excess reserve ratio was 5.6%, up by 2.6% during the same period.

Due to the financial turmoil, the provision for asset impairment set aside by major commercial banks totaled CNY $773.5 billion in 2008, an increase of 174.7 billion from the previous year. The provision coverage ratio also increased by 75.2% to 114.4%. The banking industry had thus enhanced their resilience to risks.

3.2 The Impact of the Financial Turmoil on Commercial Banks in Hong Kong, China

As a result of the global financial crisis, the profit of banks in Hong Kong, China was significantly lower in 2008 than in 2007. Many retail banks registered a significant reduction in profits in 2008. The aggregate pre-tax operating profits of retail banks fell by 35.7% in 2008 compared to 2007.

The net interest margin (NIM) of retail banks fell to 1.84% in 2008, compared to 1.90% in 2007. Measured on a quarterly annualized basis, however, the NIM of retail banks rebounded from 1.75% in the third quarter of 2008 to 1.78% in the fourth quarter of 2008 (Figure 9 [ PDF 86.2KB | 1 page ]).

The non-interest income of retail banks declined due to trading investment losses and lower income from fees and commissions. The cost-to-income ratio of retail banks climbed up to 45.1% in 2008, from 40.5% in 2007.

Impairment charges increased significantly in 2008 as the economic and financial environment deteriorated. Net charges for debt provisions surged to HK$10.7 billion in 2008 from HK$2.1 billion in 2007. Net charges for other provisions, mostly related to impairment allowances for securities holdings, tripled to HK$14.6 billion from roughly HK$4.4 billion in 2007.

Investments by retail banks in debt securities, which were classified as “substandard”, “doubtful” or “loss”, stood at 0.06% of the banks' assets by the end of December 2008. Debt securities investments classified as “special mention” increased to 0.39% of banks' assets in the same period, from 0.31% by the end of September 2008.

The credit quality of retail banks' loan portfolios deteriorated further in the last quarter of 2008. The ratio of overdue and rescheduled loans also increased to 0.68% from 0.55% by the end of September 2008 (Figure 10 [ PDF 85.2KB | 1 page ]).

As the financial crisis deepened after September 2008, banks generally became more cautious in lending. Total loans and advances of retail banks fell by 3.1% in the final quarter of 2008. On the other hand, total customer deposits increased by 2.7% during the same period. The overall loan-to-deposit ratio of retail banks fell to 47.2% by the end of December 2008, from 50.1% by the end of September 2008 (Figure 11 [ PDF 100.2KB | 1 page ]). The Hong Kong dollar loan-to-deposit ratio also fell to 69.4% from 72.9% during the same period.

In the final quarter of 2008, domestic lending (loans for domestic use plus trade finance) declined by 3.3% despite growing by 2.6% in the previous quarter. Trade finance lending fell significantly by 14.8% in the final quarter, following a decline of 2.5% in the previous quarter. This was apparently due to reduced trade activities. Loans for use outside Hong Kong, China decreased by 0.6% in the final quarter of 2008, after falling by 0.4% in the previous quarter (Figure 12 [ PDF 106.7KB | 1 page ]).

Figure 13 [ PDF 92.5KB | 1 page ] shows that the quarterly average liquidity ratio of retail banks stood at 45% in the final quarter of 2008, well above the statutory minimum of 25%.

Despite increased provisions for securities investments and bad and doubtful debts, the capital positions of locally incorporated AIs remained sound. Their consolidated CAR stood at 14.8% by the end of December 2008, compared with 13.8% by the end of September 2008 (Figure 14 [ PDF 92.5KB | 1 page ]).

Table 8 [ PDF 81.1KB | 1 page ] summarizes some key performance indicators of the banking industry in Hong Kong, China.

3.3 The Impact of the Financial Turmoil on Commercial Banks in Singapore

As a result of the 2008 global financial crisis and the subsequent decline in commercial activity, the growth of Domestic Banking Units' (DBU) non-bank loans is expected to fall. Spurred by robust economic growth in the first half of 2008, DBU non-bank loans accelerated. While property-related loans—namely loans to the building and construction (B&C) sector and housing—were the main drivers, a number of other sectors such as nonbank financial institutions (NBFI) and general commerce also contributed significantly to the growth in DBU non-bank loans. Despite the strong growth in property-related loans, the exposure of banks to the property sector remained within regulatory limits, and loan books remained well-diversified.

The banking system's NPL ratio is at a historical low after a sustained period of buoyant growth in Singapore. The NPL ratio is expected to rise moderately as the economy slows further and loan delinquencies and defaults rise. Indeed, a slight rise has been seen in the overall NPL ratio, which rose from 0.9% in March of 2008 to 1% in September of 2008 (Figure 15 [ PDF 86.8KB | 1 page ]).

Thus far, the impact of the recent financial turmoil on local banks in Singapore has been contained because of their limited direct exposures to securities linked to US home mortgages, or to those distressed or failed financial institutions such as Bear Stearns and Lehman Brothers. Local banks have yet to make large write downs. In November 2008, the allowances for their CDO portfolios totaled S$937 million, or around 10% of the banks' operating profits in the past four quarters; this brought their outstanding CDO exposures down to less than 0.4% of total assets.

Local banks are still focused primarily on commercial banking, with interest income accounting for four-fifths of gross income, even though they have been expanding their investment banking and fee-based businesses over the years. Non-interest incomes such as trading, investment and fee incomes, which are more sensitive to market conditions, have also been adversely affected (Figure 16 [ PDF 130.7KB | 1 page ]).

The impact on local banks has mainly been on share prices (Figure 17 [ PDF 130.7KB | 1 page ]), reflecting the higher risk premium now required globally and the constrained earnings outlook. Share prices have fallen by about 50% from their highest levels this year, in line with the broader STI Index.

However, the local banks facing these risks remained strong, with high capital requirements. The average Tier 1 capital ratio in the third quarter of 2008 was 11.3%, well above the MAS' minimum requirement of 6% and BIS' recommendation of 4% (Figure 18 [ PDF 95.6KB | 1 page ]).

In addition, local banks have healthy loan-to-deposit ratios, averaging 86% in the third quarter of 2008 (Figure 19 [ PDF 87.9KB | 1 page ]). Having a stable retail deposit base as the primary source of funding implies that they rely minimally on wholesale funding.

Table 9 [ PDF 90.2KB | 2 page ] summarizes the key performance indicators of the banking industry in Singapore.

3.4 The Impact of the Financial Turmoil on Commercial Banks in Taipei,China

The subprime mortgage meltdown has had direct and indirect impacts on financial institutions in Taipei,China. Direct impacts mainly involve investments in overseas securities, and financial distress originating from financial institutions and derivatives. Since financial openness in Taipei,China is relatively less advanced, domestic financial institutions had limited exposure to derivatives or subprime investment securities. In addition, the loss in collateralized debt obligation (CDO) of related securities or structured investment vehicles (SIVs) is mostly written down in financial institutions. As such, the impact of the financial turmoil on Taipei,China's financial institutions has been relatively mild. According to a press release issued by the Financial Supervisory Commission Executive Yuan on 29 July 2008, total subprime losses of financial institutions reached approximately NTD $42.572 billion. The impact on the insurance, bank, and security industries is summarized in Table 10 [ PDF 82.4KB | 1 page ].

The indirect impact of the financial turmoil is mainly reflected in the operating performance of banks and insurers. In addition to dealing with the double shock of financial turmoil and economic recession, local banks also had to contend with an increase in default in enterprise loans. Moreover, due to a steady decrease in the NIM, incremental insurance reserves increased the operating cost of insurers.

The capital structure and operating performance of Taipei,China banks can be described as follows:

Weak fundamentals in financial holding companies. After the 1997 Asian financial crisis, Taipei,China established the financial resolution trust corporation fund (RTC) to deal with problematic financial institutions. In 1999, Taipei,China also adopted policies aimed at decreasing the deposit reserve ratio, increasing the payment of deposit reserve, and decreasing the financial business tax by 3%. These were intended to help banks solve the NPL problem. Due to these policies, the fundamentals of Taipei,China banks have improved.

Compared with the state of banking systems in Europe and US after the financial turmoil, the fundamentals of Taipei,China's banks are relatively sound. However, the fundamentals of financial holding companies have not been as robust as previously thought. This problem has two aspects. First, owing to the Second Financial Reform, several private financial holding companies combined with private funds from abroad to merge with other financial holding company and state-owned banks. These private funds have been affected by the financial crisis, subsequently affecting the capital structure of financial holding companies. Second, because insurance subsidiaries of financial holding companies suffered from investment losses in domestic and foreign security markets, their capital structure has also been affected. As such, even though Taipei,China's financial system remains relatively sound, capital quality in some large private financial holding companies may have been compromised by the financial crisis.

Decrease in banking profitability. The liberalization of the banking sector in Taipei,China has allowed many homogenous competitors to enter the banking industry within a short period of time. Banking business, however, has not expanded at the same speed. Confronted with a limited savings and loan market, competition between old and new banks has become even more intense. Faced with the environment of excessive competition, banks began adopting price competition measures—such as reducing the lending rate—to ensure a stable growth in loan business and increase market share. The NIM between deposits and loans in banks gradually shrank. From 2000 to 2008, the NIM decreased from 2.99% to 1.5%. After tax and deposit reserves, the actual NIM was less than 1.5%. The NIM level in Taipei,China is obviously too low.

In addition, aggressive expansion by and competition among banks created overlaps in inter-banking business. Profits were limited and the market share of more than half of the banks was less than 1%. To expand market share, banks intensified financial marketing, such as increasing service quality and reducing fees. This approach increased costs and reduced actual profit. Although the establishment of new banks reinvigorated Taipei,China's financial market, it also weakened the profitability of banks.

Table 11 [ PDF 81.1KB | 1 page ] shows both the ROA and ROE of domestic banks in Taipei,China, which have tended to decrease over time. According to statistics from the Central Bank, domestic banks as a whole posted a net income before tax of NT$34.4 billion in 2008, a decrease of 55.68% on a year-on-year basis. The net income before tax of domestic banks in the first quarter of 2009 was NTD $19.2 billion, a decline of 21.79% compared with the first quarter of 2008.

Figure 20 [ PDF 88.8KB | 1 page ] shows the revenue and cost structure of domestic banks in Taipei,China. Compared with 2007, the overall operating revenues of domestic banks declined by 13.15% in 2008. This was mainly due to an increase in investment losses stemming from sharp falls in the local and foreign stock markets, and continuously increasing provisions in investment positions associated with US subprime securities. On the one hand, the non-interest income of domestic banks fell dramatically, due primarily to the weakened financial market and increasing provisions for impairment losses on assets linked to the US subprime mortgage-related products. However, net interest income, which is the primary source of operating revenues for domestic banks, leveled off due to a continued low interest rate spread between deposits and loans. On the cost side, although non-interest expenses rose in 2008 as employee bonuses were recognized as expenses, total operating costs fell by 7.3% compared with 2007, as a result of a sharp decline in provisions.

Small increase in the capital adequacy ratio of domestic banks. In the second half of 2008, a general reduction in capital was caused by the negative earnings of several domestic banks. Owing to some banks increasing their issuance of common stocks and subordinated bonds, the average capital adequacy ratio stood at 11.04% by the end of 2008, slightly higher than the 10.80% registered by the end of 2007 (Figure 21 [ PDF 90.8KB | 1 page ]).

Tier I capital, which features the best bearing capacity, accounted for 76.32% of domestic bank's eligible capital in 2008. Tier 2 capital accounted for 23.46%, while Tier 3 capital made up only 0.28%. The percentage of Tier I capital increased slightly by the end of 2008, while the shares of Tier 2 capital and Tier 3 declined slightly.

Increase in overdue risk in domestic banks. The capital quality of domestic banks did not significantly worsen as a result of the financial crisis (Table 12 [ PDF 84.9KB | 1 page ], Table 13 [ PDF 84.9KB | 1 page ], Table 14 [ PDF 83.6KB | 1 page ] and Figure 22 [ PDF 83.9KB | 1 page ]). By the end of 2008, outstanding classified assets of domestic banks as a whole stood at NTD $612.3 billion, and the average classified asset ratio was 2.07%, increasing by 5.61% and 0.02 %, respectively, compared with the end of June 2008. The outstanding NPL of domestic banks stood at NT $285.9 billion, and the average NPL ratio was 1.54%, up by 1.67% and 0.02% when compared with the end of June and September 2007, respectively. The average NPL ratio increased steadily to reach 1.63% by the end of April 2009.

With the rise in NPL in the fourth quarter of 2008, domestic banks raised loan loss provisions, and the NPL coverage ratio increased to 69.48% by the end of 2008. The loan loss reserve ratio increased to 1.07%, indicating that domestic banks allowed for more loan loss provisions to cover possible losses in the future.

As a whole, the capital quality of domestic banks in Taipei,China appear to be sound. However, the expected slowdown in domestic and global economic growth may weaken the financial health of the business sector and compromise the repayment ability of the household sector, hence heightening credit risk.

Funds have remained in surplus, while liquidity problems have eased in some banks. Due to a large amount of capital inflow from overseas, the deposit amounts of domestic banks in Taipei,China increased considerably in the second half of 2008. The annual growth rate in deposits reached 7.66% by the end of 2008. Meanwhile, the annual growth rate in loans slowed down to 3.83%, due mainly to more conservative lending. By the end of 2008, the deposit-to-loan ratio of domestic banks as a whole stood at 122.34%. The funding surplus (i.e. deposits exceeding loan demand) stood at NT $4.16 trillion, reflecting ample liquidity in domestic banks (Figure 23 [ PDF 97.7KB | 1 page ]). This situation continued until the first quarter in 2009, when the deposit-to-loan ratio increased to 127.31%.

Figure 24 [ PDF 97.7KB | 1 page ] shows the average NT dollar liquid reserve ratio of domestic banks in Taipei,China. The average NT dollar liquid reserve ratio of domestic banks rose to 22.70% in June 2008, well above the statutory minimum of 7%, and the reserve ratio of each bank was higher than 12%. This ratio steadily rose to 25.43% in March 2009, suggesting that the quality of liquid assets remained satisfactory and that overall liquidity risk was decreasing.

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