Asia Pacific banks may have to raise their loan loss provisions further in the near-term as the Iran conflict darkens economic prospects in the region heavily reliant on Middle Eastern oil, analysts said.
Banks in countries including Australia, Singapore, and India flagged possible credit hits of hundreds of millions of dollars each as they reported their March quarter earnings, blaming the indirect cost of the conflict.
The surging credit loss provisions come at a time when the lenders are also facing the prospects of higher-for-longer oil prices, supply chain and trade disruptions, rising interest rates and weaker corporate balance sheets.
While higher loss provisions would not make a big dent in the short term given strong capital buffers, analysts warn that prolonged energy market disruptions could result in actual credit losses and pile pressure on banks to replenish balance sheets.
"More Asian banks have increased provisions and forward-looking overlays to reflect the risks from the Iran war," said Gary Ng, senior economist for Asia Pacific at Natixis CIB, though as yet there has not been a wave of credit defaults.
"The bottom line is that even if the war ends soon, energy prices may remain elevated due to supply destruction. Interest rates may not fall, which can hurt corporate repayment capacity and pressure credit demand," he said.
To be sure, current credit loss provision levels at Asia Pacific banks are much smaller compared to the charges they took to cope with the COVID-induced economic shocks five years ago.
For the top four Australian banks the total of A$957 million ($694.40 million)in provisions set aside for war-related risks is 80% lower than the buffer created in 2020. For eight large Asian banks, excluding China and Japan, it's 70% lower at $2.8 billion, according to Reuters calculations.
ELEVATED OIL PRICE
But it's possible to see an uptick in Asian banks' actual credit losses, Ng said, though the magnitude will depend on the duration of the war, which is now in its 11th week.
The economic toll of the conflict is mounting in the region. The Asian Development Bank cut its growth forecast for developing Asia and the Pacific to 4.7% this year and 4.8% in 2027, down from 5.1% for both years previously.
The regional banking sector's earnings are set to worsen next quarter in light of the elevated oil prices, weaker currencies, and soaring bond yields, said Interactive Brokers senior economist José Torres.
Australia's top lender, Commonwealth Bank of Australia (CBA.AX), lost nearly $22 billion in market value on Wednesday, after it set aside more cash to prepare for risks linked to the Middle East conflict.
Over the past two weeks, Australia's other three leading banks have raised provisioning by A$757 million ($549.13 million) to cover future potential bad debts arising from the war.
Still, Australian banks' current provisions could prove too low if the turmoil leads to a credit market disruption, investment bank Jarden's head of financial research Matthew Wilson said.
"It's all ahead of us. Banks are late cycle and we'll see the real impact on the domestic economy via industrials and cyclicals in the next 6 months," Wilson said, adding it was too early to tell if a credit market disruption was on the cards.
'CONSERVATIVE ESTIMATE'
In Singapore, while all three big lenders have limited direct exposure to the Middle East with the region accounting for less than 3% of their total lending, No.2 lender OCBC (OCBC.SI) set aside S$216 million ($170 million) in provisions.
Singapore's United Overseas Bank (UOBH.SI) CEO Wee Ee Cheong said last week the bank's direct exposure to the Middle East was "insignificant", but warned that second-order effects could raise costs for small and medium-sized enterprise customers.
London-headquartered HSBC (HSBA.L) and Standard Chartered (STAN.L), which make the bulk of their revenues in Asia, booked $300 million and $190 million charges, respectively, in the March quarter citing caution.
"We think further provisions (at HSBC and StanChart) are not impossible, given the fluid nature of the ongoing conflicts," said Kathy Chan, equity analyst at Morningstar, adding the two banks have been quite prudent in assessing risks.
In India, about half a dozen lenders, including HDFC Bank (HDBK.NS), Axis Bank (AXBK.NS), and Blackstone-backed Federal Bank (FED.NS), have created provision buffers, though they have not seen any deterioration in asset quality yet.
Shares of Australian banks have taken the biggest hit in the Asian banking sector, with National Australia Bank (NAB.AX) falling 21.2% and Westpac (WBC.AX) dropping 12.4% since the U.S. and Israel's war on Iran started on Feb. 28.
"The provisioning that has currently been made represents a conservative estimate of the effects to date," said Angus Gluskie, managing director at Whitefield, which owns Australia's big 4 bank stocks and manages A$1.5 billion in assets.
"If the issue can be quickly solved the provisions may be partly wound back. If the issue persists, the banks may need to provide more."
($1 = 1.3785 Australian dollars)
($1 = 1.2723 Singapore dollars)
