Asia-Pacific banks with a strong record of digitalization and expansion in fee income will likely grow more quickly than their peers over the next five years, a study by McKinsey finds.
"We are seeing that a lot of institutions [that] are adopting business models which are more capital light, more fee oriented, are being disproportionately rewarded by the market," said Joydeep Sengupta, Singapore-based senior partner at McKinsey. "We will see that diversification [from loan income] because it is a search for fees at this point of time ... in a low interest rate environment."
Banks will continue to see competition from digital entrants, which have managed to accelerate their growth during the pandemic. Around the region, several technology-based companies, such as Altimeter Growth Corp.'s Grab, have acquired digital banking licenses, which will allow them to provide financial services such as deposits, loans and even investments.
"[Many of the licensed players] are getting to a point where they're having for the first time ever material impact ... you'll see the banks having to accelerate their transformation," Renny Thomas, a Mumbai-based senior partner at McKinsey, told S&P Global Market Intelligence in an interview.
The persistently low interest rate environment has also enabled banks to divert from loan revenue to fee income in segments such as insurance and wealth and asset management, which continue to grow in Asia. McKinsey estimates 35% of revenue growth in Asia ex-China over the next five years will come from fee-based income.
Modest growth to continue
Return on equity for lenders in Asia ex-China are projected to grow 7% to 10% between 2021 and 2025, compared to the average of 8.5% between 2015 and 2020, according to a Dec. 2 report by McKinsey. Loans are estimated to grow 4% per year, driven by South Asia and Southeast Asian banking markets, the report said.
"Banks have come out of the second or third wave of COVID much stronger than the first wave. Banks have learned how to operate in this environment," Thomas said. "If we don't have a repeat of another deadly wave, we have a much stronger outlook for the next year."
Thomas added that lenders' balance sheets are much stronger because banks have loaded up on reserves. In several markets, such as Vietnam, an economy known for its manufacturing and exports, businesses have resumed spending on capital expenditures.
"All of this put together, base case, is a better environment to be in [with regard to] profitability, because banks profitability is not driven by what happens in the year. It's driven by what happened the last three years and how the balance sheet is in a particular given year," Thomas said.
Emerging Asia to stand out
Geographically, emerging Asia's high growth rates will continue to benefit the valuation of banks native to the countries.
"In the high growth markets like Indonesia, India, you see banks doing really well and being awarded by the market so they're all in double-digit ROEs or double-digit growth," Sengupta said, adding that some lenders in these markets operate in excess of four times the price-to-book ratio, whereas the entire banking sector just about operates at the book level, with the vast majority operating below.
Meanwhile, Chinese banks will continue to grow their ROE by 11% to 14% between 2021 and 2025. About 30% of that growth will be driven by loans underwritten after 2021, and 40% of global revenue growth will come from China as retail lending continues to rise.