Lankan banking sector one of three in APAC to keep asset yields positive despite COVID-19 setback: Moody’s

• Tightened monetary policy between 2015-2018 cited as reason
• Profitability of APAC banks expected to deteriorate in coming years 
• Laggard institutions slow to change biz models at a greater disadvantage

By Shabiya Ali Ahlam
Although the COVID-19 pandemic has hit the profitability of the banks in Asia-Pacific (APAC), Sri Lanka’s banking system has managed to keep its asset yields from falling negative, a position only two other regional economies secured during the crisis, Moody’s latest report on financial institutions revealed.

The sector in-depth report showed that unlike in most APAC systems, asset yields increased materially in Sri Lanka, Singapore and the Philippines. “They rose in Sri Lanka because the Central Bank tightened monetary policy between 2015 and 2018, to cool credit growth,” the report highlighted.

In Singapore, asset yields rose as a result of the increases in the US dollar rates, starting 2015 and the expansion by the banks in overseas markets, where the net interest margins (NIMs) are higher. 

Singapore has an exchange rate-based monetary policy regime, so a rate hike in the US results in tighter monetary conditions in Singapore. 

Whereas in the Philippines, Moody’s pointed out that asset yields improved as a result of the banks increasing the higher-yielding but riskier loans, such as loans to small to medium-sized enterprises (SMEs) and consumer loans.

The report that covered 17 economies in the region stressed that in the coming years, the profitability of the banks in APAC is expected to deteriorate, as the pandemic continues to accelerate structural changes in their markets. 

Moody’s stated that while the banks in the region are facing a growing need to change their business models to overcome these challenges, the laggard institutions are at a 
greater disadvantage. 

The return on assets (ROA) declined in 12 out of the 17 systems in APAC, between 2014 and 2019. In many of the 12 systems, the ROAs dipped due to the net interest income (NII) having decreased as a percentage of total assets, despite the reductions in the operating expenses and loan loss provisions by varying degrees. 

In APAC, the NII is a key determinant of the banks’ profitability because it has accounted about 70 percent of the total revenue on average since 2008.

While the other drags on profitability include flatter yield curves and likely increases in credit costs in the next few years, as the asset quality weakens, Moody’s stressed that an acceleration of the shift among customers to digital banking services, as a result of lockdowns and social distancing measures, will push up the operating expenses over the next few years.The report also observed that the laggard banks will face greater challenges as efforts intensify to change business models.  

Moody’s said the banks will increasingly seek to develop other sources of revenue or expand overseas while continuing to pursue digitisation to reduce their dependence on NII from 
domestic markets. 

Moody’s further identified five key factors that influence the impact of low rates and yield-curve flattening on the banks’ NIM. The factors were identified as the operating environment, competitive dynamics, banks’ funding structures, gap between the durations of banks’ assets and liabilities and any mitigating measures that the banks take. 

“These factors can determine the degree of a banking system’s vulnerability to low rates and a flattening of yield curves,” Moody’s said.