Fitch Ratings expects Asia’s emerging market (EM) banking systems to be better positioned, although not immune to currency risks as currency volatility increases due to rising US interest rates and the slowing regional economic growth.

In a report released yesterday, Fitch compares EM Asia’s banking systems currency risks with those of other emerging market regions. Exposures appear comfortable based on the ratio of foreign-currency denominated loans to total loans and loan to deposit ratios. Greater currency flexibility and foreign exchange reserve accumulation also help mitigate EM Asia’s exposure. However, Asia’s frontier markets such as Mongolia, Sri Lanka and Vietnam are more exposed than elsewhere in the region.

There has, however, been a build-up of corporate (or non-bank private sector) external debt and overall financial system leverage, some of which is in the form of household debt. EM Asia countries rank above the global EM average in leverage, which is now also broadly comparable with past peaks. Higher leverage and, in particular, a combination of weaker currencies and lower commodity prices will increase the vulnerability of commodity producers who borrowed in hard currency. A knock-on impact on asset quality in the domestic banking system would be likely in that scenario, with current indicators already beginning to trend upwards from cyclical lows.

That said EM Asia banking systems are generally well-positioned to absorb the risks from increased currency weakness - those with greater vulnerabilities already have lower ratings. Bank loss-absorption buffers are considered adequate for most systems to offset expected developments in key metrics.