Vulnerability of banks coming into focus

Pressure on Macau banks’ asset quality is expected to intensify, said international rating agency Fitch in a note released yesterday. The agency has forecast a further decline of Macau’s real GDP by 6.5 per cent in 2016. Last year, Macau’s economy shrank 20.1 per cent.
Indicators for the banking sector usually lag the economy. In addition, Fitch highlights the risks to Macau’s banks as having risen ‘as their loan books have expanded rapidly while deposit growth has not kept pace’.
This follows a note on March 10, 2016, in which Fitch Ratings affirmed Macau’s credit ratings, namely long-term foreign and local currency issuer default ratings, at ‘AA-‘ with a ‘stable’ outlook, attributable to the SAR’s prudent fiscal strength, strong external financial position, credible policy framework and high per-capita income.

Exposure to gaming
Fitch Rating pointed out that Macau’s loan-to-nominal GDP ratio had jumped to 206 per cent by end-2015 from 156 per cent at end-2014. The large increase was driven by a 16.9 per cent decline in nominal GDP and a 10.3 per cent increase in loans.
The agency reckons this structural disconnect stems from Macau’s gaming-driven economy, to which the banking system is mainly indirectly exposed. As such, the latest spike in this high and volatile systemic indebtedness, which the agency have been flagging in its Macro Prudential Indicator of ‘3’ since 2012, has remained less of an issue but it points to the concentrated nature of Macau’s economy.

Vulnerabilities highlighted
The key structural characteristics of Macau’s banking system – concentration on property lending – accounting for 44 per cent of loans; and large assets and deposits; direct and indirect gaming exposure – accounting for 1 per cent and 15 per cent of loans, respectively; and dominance by Chinese-owned banks, which make up 70 per cent of assets – highlight its vulnerabilities, but thus far have supported the system’s stability, Fitch noted.
So have consumption and investment, which both continue to grow, albeit at a subdued pace, and unemployment remains less than 2 per cent, reflective of a labour force comprising heavily of non-resident workers and ongoing casino project expansion.
Nevertheless, Fitch says the risk remains that a prolonged period of anaemic gaming activity could eventually spill over into the domestic economy.

Macroeconomic performance
“Banks could become more vulnerable to the volatile economy if the current weak environment persists”, reads the agency’s report. This will lead to a weakening of Macau bank’s ability to generate earnings.
Two possible scenarios are cited: firstly, if the trend of tighter structural liquidity was to continue; and secondly, if the credit enhancement that Chinese banks provide to their Macau operations also declines.
The rating agency once again points out that Macau’s prudential supervision is less onerous compared with other Asia Pacific markets. It indicates that in the SAR regulatory exemptions are common, impaired-loan recognition standards are weak, and industry-wide stress-testing has yet to be established.