BANKS in the Philippines and most of the Southeast Asian region will see better margins amid higher interest rates, but rising inflation could cause more borrowers to default on their loans, Moody’s Investors Service said on Monday.
“Relatively benign inflation in ASEAN (Association of Southeast Asian) countries has enabled central banks in the region to prioritize economic recovery over monetary tightening. Yet they will step up efforts to contain price appreciation as inflationary pressure grows,” the debt watcher said.
“Rises in interest rates will lead to a widening of banks’ net interest margins (NIMs). However, asset risks for banks also increase when interest rates rise. We expect increases in interest rates in the region will be gradual and growth in problem loans will be modest,” it said.
The report, which focuses on six ASEAN economies, namely Indonesia, Malaysia, Philippines, Singapore, Thailand, and Vietnam, said while banks in these economies may face pressure to keep lending rates low to support recovery from the impact of the coronavirus pandemic, those in the Philippines and Singapore will see the largest increases in margins as interest rates rise.
“The reason why margins will increase more for banks in the Philippines than the rest is that the former has larger shares of current and savings accounts (CASA) deposits in total deposits and modest proportions of market funds in total funding mixes,” Moody’s added.
It said the more a bank uses CASA deposits for funding, the smaller increases in interest expenses will be when rates rise, which will boost the bank’s NIM.
“In addition, we expect interest rates in the Philippines will rise the most among the six ASEAN economies,” Moody’s added.
The debt watcher said it expects credit demand to be stable in most parts of ASEAN in the coming year as these countries continue their recovery from the pandemic, but China’s slowdown could pose a risk to this outlook, as the world’s second-largest economy is a major trading partner for most of Southeast Asian countries.
“An acceleration of inflation and corresponding rate hikes can also hurt credit demand, limiting banks’ ability to grow lending at higher interest rates. Further, rise in inflation leads to increases in personnel and other operating costs for banks. Banks will also face mark-to-market losses on investments, though the impact on profitability will be lower because ASEAN banks do not rely heavily on trading and investment income,” Moody’s said.
Inflation’s impact on banks’ asset quality could also offset the expected improvement in margins, the debt watcher said, as the resulting slowdown in economic activity due to rising rates could increase repayment burdens among borrowers.
“There is a close correlation between inflation and NPL (nonperforming loan) growth across the ASEAN region. The link is the strongest in Indonesia and the Philippines because periods of high inflation rates in the two countries have been accompanied by economic slowdowns and volatility in foreign-exchange rates,” Moody’s said.
“However, we expect increases in NPLs will be modest across the ASEAN region because inflationary pressure will abate in all six economies in 2023 and the pace of rate hikes will be gradual, while the ASEAN economies will continue to recover. Banks will not have to increase loan-loss provisions substantially also because banks have made substantial forward-looking provisioning at the peak of the pandemic,” it added.
Inflation could also lead to an increase in credit costs, the debt watcher said.
“Banks’ credit costs are typically more prone to increases in economies where borrowers’ debt burdens are already heavy and interest rates rise sharply when inflation accelerates. In such countries, higher interest rates significantly reduce borrowers’ cash flow, which are also negatively impacted by weakening consumer demand and business sentiment,” it said.
The Bangko Sentral ng Pilipinas’ (BSP) policy-setting Monetary Board has increased benchmark rates by a total of 175 basis points (bps) so far this year as it battles rising inflation.
Headline inflation picked up to 6.4% year on year in July from 6.1% in June and 3.7% a year ago. This was the fastest in nearly four years and exceeded the central bank’s 2-4% target band for a fourth straight month.
This brought the seven-month average to 4.7%, still below the BSP’s full-year forecast of 5.4%.
Meanwhile, latest BSP data showed the gross NPL ratio of the Philippine banking industry dropped to 3.6% in June, from 4.48% a year ago and 3.75% in May. The June bad loan was the lowest since 3.5% in September 2020.
Bad loans dropped by 12.7% to P421.311 billion in June from P482.991 billion a year earlier. This was also 1.8% lower than P429.106 billion in May.
The Philippine central bank earlier said the NPL ratio of banks might peak at 8.2% this year. — K.B. Ta-asan