Global Banking Sector Outlook - Q214

We are forecasting accelerating loan growth in 2014 in 40 of 72 commercial banking sectors covered by BMI, led by developed countries including the US, UK, and various eurozone member states. Conversely, in many emerging markets, we project decelerating loan growth, including in China, India, and Brazil (emerging European banking sectors including Russia are notable exceptions). In line with this divergence, one of our global themes for 2014 is that emerging market countries face a credit hangover at some point in the immediate future. Developed markets have undergone a severe deleveraging since 2008, starting with the US and spreading to Europe. At the same time, emerging markets have ramped up credit growth, and the level of private credit as a percentage of GDP in several countries (Turkey, Brazil, and the Philippines, to name a few). While emerging market private sector credit-to-GDP is still low by developed world standards, at approximately 100.5% of GDP versus 199% for developed countries, its recent acceleration has been breathtaking, rising from just 65% of GDP in 2008.

Now, it looks as though there is likely to be a reversal of fortune, with the private sector in developed markets reasonably leveraged, if not under-leveraged in some cases, with emerging markets on aggregate set to see credit-to-GDP growth moderate. In Asia, while China's bubble is perhaps the most concerning, loans to the household sector have also surged in the ASEAN countries of Singapore, Malaysia, and Thailand. Even though interest burdens remain low in general thanks to low real interest rates, they are nonetheless creeping higher. The virtuous cycle - falling interest rates fuelling more borrowing, accelerating growth and improving the creditworthiness of households and governments - may well begin reversing in 2014. The increase in US interest rates will continue to force an across-the-board reassessment of the structural macroeconomic picture in many key markets, and test the vulnerabilities of several major banking sectors.

Regional Outlooks

Dangerously Above Trend
Emerging Markets Private Credit As % of GDP

We are forecasting accelerating loan growth in 2014 in 40 of 72 commercial banking sectors covered by BMI, led by developed countries including the US, UK, and various eurozone member states. Conversely, in many emerging markets, we project decelerating loan growth, including in China, India, and Brazil (emerging European banking sectors including Russia are notable exceptions). In line with this divergence, one of our global themes for 2014 is that emerging market countries face a credit hangover at some point in the immediate future. Developed markets have undergone a severe deleveraging since 2008, starting with the US and spreading to Europe. At the same time, emerging markets have ramped up credit growth, and the level of private credit as a percentage of GDP in several countries (Turkey, Brazil, and the Philippines, to name a few). While emerging market private sector credit-to-GDP is still low by developed world standards, at approximately 100.5% of GDP versus 199% for developed countries, its recent acceleration has been breathtaking, rising from just 65% of GDP in 2008.

Dangerously Above Trend
Emerging Markets Private Credit As % of GDP

Now, it looks as though there is likely to be a reversal of fortune, with the private sector in developed markets reasonably leveraged, if not under-leveraged in some cases, with emerging markets on aggregate set to see credit-to-GDP growth moderate. In Asia, while China's bubble is perhaps the most concerning, loans to the household sector have also surged in the ASEAN countries of Singapore, Malaysia, and Thailand. Even though interest burdens remain low in general thanks to low real interest rates, they are nonetheless creeping higher. The virtuous cycle - falling interest rates fuelling more borrowing, accelerating growth and improving the creditworthiness of households and governments - may well begin reversing in 2014. The increase in US interest rates will continue to force an across-the-board reassessment of the structural macroeconomic picture in many key markets, and test the vulnerabilities of several major banking sectors.

Regional Outlooks

US And Eurozone: We expect US commercial banking sector client loan growth to accelerate in 2014, as stronger real GDP growth buoys consumer confidence and businesses increase investment to meet rising demand. Amidst a backdrop of rising interest rates and a reduction in quantitative easing, we believe banks will begin to shift their historically large cash assets into lending. In Europe, a new era beckons for eurozone banking as the European Central Bank is due to take over supervision of national credit institutions in 2014, which will herald the next stage of economic integration. Though certainly a step in the right direction towards euro federalism, reforms geared towards banking union will likely mirror the mistakes made at the birth of the euro. By failing to forge a credible framework for risk sharing across the bloc, the end result will be a banking union in which federal level supervision has improved but the economic and political foundations of the euro remain weak and vulnerable to fracturing.

Emerging Asia: One of the major concerns for the global outlook is the prevalence of unsustainable lending in the Chinese banking sector. Moral hazard within the banking system - namely, the government's implicit backstop for lending - has been a major factor in allowing the Chinese credit boom to continue to its current level, and the new government appears in favour of tacking this issue. In doing so, however, this looks set to create instability in the banking system, which in turn is likely to undermine economic growth over the coming quarters, if not years. This quarter, our Asia team has focused on South Asian banking sector opportunities. While South Asian banking systems are similar in many ways, with relatively low penetration rates, rapid growth, and a heavy focus on lending to the public sector, there are a number of important differences. We see Sri Lanka's low share of total banking sector assets as positive for long-term banking sector and economic growth, while Pakistan's excessive public sector credit exposure is a major risk. Bangladesh's low exposure to government credit, meanwhile, is a significant positive, notwithstanding the risks posed by ongoing political unrest.

Emerging Europe: While emerging European banks were not immune to the tightening of global credit conditions in the second half of 2013, they proved more resilient than both LatAm and emerging Asian banking sectors, a symptom of significant deleveraging since 2008. This places the sector in a good position to capitalise on improving demand for credit from both commercial and consumer segments in 2014, with positive implications for profit margins. However, credit growth will remain relatively tepid for most of the region compared to pre-2008 levels, implying a limit to both profitability and share price performance for locally-listed regional lenders. There will also be significant sub-regional divergence performance this year and next, with Central European and Baltic lenders on a stronger footing than their South East European peers, whereas Russian and Turkish banks face their own idiosyncratic challenges.

Significant Progress
Loan-To-Deposit Ratios For Selected CE and Baltic Economies

Latin America: Latin America's commercial banking sectors hold enormous growth potential over the long term, as a larger share of the population moves out of the grey economy and demand for financial services rises. As a result, despite forecasting more moderate economic growth trajectories in the majority of Latin American economies over the next two years, we believe that banking sector asset growth will remain relatively elevated throughout the region. In the near term, we believe that a major challenge confronting retail banks in Latin America will be shifting monetary policy cycles and rising local interest rates. This could stifle demand and increase asset quality risks, requiring higher provisions for delinquencies and squeezing banks' profit margins.

Commercial Banking Will Play An Increasingly Important Role
Latin America - Banking Sector Assets, % of GDP

Sub-Saharan Africa: We are optimistic about the prospects for Sub-Saharan Africa banking sectors believing that asset growth will be strong in the years ahead, particularly in those countries where sector penetration remains low. However, asset expansion will not be without its challenges. High interest rates will continue to exclude many would-be borrowers and banks will continue to face difficulties in assessing credit-worthiness. The informal nature of many SSA economies and corporate governance weaknesses also present challenges.

Middle East And North Africa: The outlook for the banking sector in the Middle East is relatively bright over 2014 and beyond. We expect a slight convergence in growth rates across the region, mostly due to base effects, but the GCC will remain the outperformer. The Gulf countries, particularly Saudi Arabia and Qatar, will be buoyed by heavy government spending, especially on large-scale infrastructure projects. Elsewhere, we are forecasting an uptick in banking sector assets on the back of low base effects and, in the case of Egypt and Iran, a decrease in political risks.

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