Chinese banks score some of the lowest cost-to-income ratios among major Asia-Pacific lenders, thanks to contained funding costs, adoption of mobile banking as well as income growth from lending, an analysis by S&P Global Market Intelligence finds.

Meanwhile, Japanese banks are among the least efficient lending institutions in the analysis, as they are saddled by extensive and inefficient branch networks as well as muted growth in income.

Cost-to-income ratio, which measures operating expense as a percentage of operating income, is used to gauge efficiency and productivity for banks. Lower ratios generally indicate higher efficiency, but factors such as a bank's business model and size can affect the ratio.

In the analysis of 50 largest banks in Asia Pacific by assets, the top third with the lowest cost-to-income ratios were all Chinese banks.

Leading the pack was Bank of Shanghai Co. Ltd., which had the lowest ratio at 20.36% as of end-March and improved from 25.20% in the prior year. China's four biggest banks in terms of assets — China Construction Bank Corp., Bank of China Ltd., Industrial and Commercial Bank of China Ltd. and Agricultural Bank of China Ltd. — also scored well in terms of efficiency in 2019 and improved from the prior year.

At the other end of the spectrum, Japan's Mizuho Financial Group Inc. was the least efficient among the largest banks in Asia with a cost-to-income ratio of 69.31%, down from 70.40% in 2018. Japan's Resona Holdings Inc. and Mitsubishi UFJ Financial Group Inc. and South Korea's KB Financial Group Inc. took the next three spots in the list.

Best of both worlds

Jieyuan Zheng, research analyst at Phillip Securities Pte. Ltd., told S&P Global Market Intelligence in an email that Chinese lenders' efficiency benefits from both growing demand for loans as well as funding costs contained by government policies.

The People's Bank of China has cut the reserve requirement ratios five times since the beginning of 2018 in an effort to boost liquidity amid an economic slowdown. Improved liquidity and lower reserve ratios have enabled banks to extend more loans, with outstanding yuan loans up 13.4% year over year in May from a year earlier. The easing environment has also kept a lid on interbank interest rates at which most wholesale funding, the main source of funding for smaller banks with weak depositor base, is priced.

Due to the fast adoption of financial technology, "Chinese banks will be able to reduce the branch network faster than most other markets," said Andrew Gilder, Asia-Pacific banking and capital markets sector leader for Ernst & Young.

"The other thing we've been seeing is a reduction in branch numbers. The top six banks in China have I think like 80,000 branches across the country. So that's a huge number of branches but each year they're declining," Gilder said.

Japan's old problem

For Japanese banks, elevated cost-to-income ratios are a problem "of low income rather than high costs," said Michael Makdad, senior equity analyst at Morningstar.

Due to weak loan demand amid shrinking population and muted economic growth, the nation's outstanding bank loans rose 2.5% in the second quarter ended June 30 from the same period in 2018, according to Bank of Japan data.

"Banks have been taking efforts to streamline the costs, such as reduction of branch network and use of technology in operations," but it will take time for Japanese banks to cut costs substantially, said Toshihiro Matsui, director for financial services and international public finance ratings at S&P Global Ratings.

The three megabanks have stepped up on their cost-cutting measures amid weak earnings in recent quarters.

Mizuho said it would cut 100 branches by March 2022, doubling its target of 50 it set in November 2017. MUFG plans to reduce its total domestic branch count by 35% by March 2024, up from its initial target of 20%. SMFG expects to achieve annual cost reduction of more than its target of ¥50 billion by March 2020.

"I think their efficiency ratios will improve in the early 2020s owing to cost reductions, but not enough to shrink the gap with other Asian banks because banking revenues are not growing in Japan," Makdad added.

As of July 29, US$1 was equivalent to ¥108.86.