Banking crisis unlikely to spare Asia growth but Indian banks fit to fight it out

Asia may not be immune to the downward pressure on developed market growth from recent issues in the banking sector, Morgan Stanley said in a note on March 20.

“But mitigating factors should mean the downside to Asia's growth will be more muted on a relative basis,” Chief India Economist Chetan Ahya said.

On the question if Asia could face similar funding challenges as in the West, Morgan Stanley said that central banks in the region have not had to lift interest rates as much as the US Fed, given that the inflation problem has not been as intense.

Moreover, Asia’s banking systems do not face similar challenges to those of US regional banks, as banks tend to have limited long-duration assets and most loans are floating rather than fixed, they said.

On the likely impact on growth in Asia from the banking crisis, there are two scenarios based on whether there is a mild recession or a deeper recession in the US. In the first case, Asia will face some downward pressure on growth but “it will likely be manageable” as weaker demand will be met with easier financial conditions, Ahya said.

In case the US economy tips into a deeper recession, Asia will not be able to decouple. Tighter financial conditions and a further fall in external demand will bring meaningful downside to Asia’s growth.

Effects on Asia’s financial system likely manageable 

Direct risks from the recent developments in the US and Europe as to Asia’s financial system are limited, according to Morgan Stanley analysts.

This is due to high liquidity coverage ratios, deposit franchises that are typically more reliant on retail deposits and as banks tend not to hold too much in terms of long-duration assets. Banks in the region also have more loans as floating rather than fixed.

Non-performing loans across the region are very low, and banks are well capitalised, Capital Economics pointed out in an investor note over the weekend. “The fact that interest rates across Asia have been raised less aggressively than in other EMs  should also help to reduce credit risks,” it said.

Likely impact on India 

For India, the fallout so far has – like for most other emerging markets – been fairly limited.

India’s growth could receive some hit if the turmoil leads to a tightening of financial conditions in the US or Euro Zone, but neither are particularly large trading partners for India and it’s likely that any hit to the trade position would be offset by a concurrent fall in oil prices, according to Capital Economics.

“But the big unknown is whether banking sector problems will flare up elsewhere. On the liabilities side, Indian banks look relatively healthy: the loan-to-deposit ratio is low and, in general, there is no heavy reliance on wholesale funding,” Shilan Shah, Deputy Chief Emerging Markets Economist, said.

“It is a different story on the assets side. A high ratio of non-performing loans and low regulatory capital are causes for concern. And, in a major study of almost 500 banks across the emerging world, we found that loss absorption capacity – the loan loss rate needed to reduce the tier 1 capital ratio below the regulatory minimum of 4.5 percent – is lower in India than in major EMs. In a handful of banks, the loan absorption capacity is as low as 5 percent.”

It may only take problems at one bank to cause strains across any country’s financial sector, Shah warns.

However, not all agree. Societe Generale’s India Economist Kunal Kumar Kundu said that most of the Indian banks operate in a strict regulatory environment unlike in the US.

Indian banks are well capitalised and the Reserve Bank of India’s latest Financial Stability Report noted that even under a severe stress scenario, the capital adequacy ratio of banks was likely to remain within the mandated range, Kundu added.

“That prudence stands tall in times of crisis was proved once again as current RBI Governor Shaktikanta Das won the award Governor of the Year for 2023 by Central Banking, an international economic research journal for his handling of the economy during the pandemic,” Kundu said. “Eight years ago, his predecessor Raghuram Rajan also won the same award for his deft handling of the economy post Taper tantrum.”

If a few more systemically important global banks get sucked into the maelstrom and banks become over cautious and starting to focus on asset quality, growth concerns could emerge, commodity and crude prices could drop. This could, in fact, bring much-needed relief to India’s inflation headache, the economist said.

India’s tech start-up space may feel the heat 

According to Tracxn, Silicon Valley Bank’s exposure to Indian start-ups is roughly around $9 billion.

Most Indian start-ups that do business in the US use this bank because it is one of the few such institutions willing to work with Indian banks. A number of Indian start-ups without even a single employee or an office in the US had opened accounts with SVB, as it let them do so without many regulatory queries and with a customer-friendly approach, according to Societe Generale.

“Some fear that many Indian start-ups may not be able to pay salaries on time and may even have to resort to reducing headcount. Given the closely knit ecosystem, a start-up has already begun providing bridge loans to companies in distress to enable them to ride out the current crisis. Currently, the central bank and the relevant ministries are coordinating to lessen the pain, but the picture is not clear for sure,” it added.