Banking on Asia

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TOWARD A NEW MODEL

In the postwar era, Asia’s banking systems have largely been modeled on Japan’s—strongly influenced by government policy and a web of corporate ties at the top. To be vigorous participants in Asia’s growth, banks must overcome long-standing barriers and look to a new business model.

A comparison with U.S. banking practices helps illuminate how far Asia’s banking systems have to go. Where capital markets are well developed, banks are not the primary conduit for capital—investors and borrowers have choices. U.S. banks have sophisticated credit controls and risk management techniques—and, as a result, a relatively miniscule percentage of non-performing loans (NPLs). Government does not rely on banks as an instrument of economic development, and banking regulation is largely about protecting consumers and savers.

Source: The Economist, Japan Ministry of Finance

LOCKED UP: Asian governments have accumulated very large stores of foreign capital. Yet rather than remit it to their home economies to promote economic growth, they prefer to keep it offshore in “safer” investments such as U.S. bonds. Returning that capital home would mean trusting shaky banks—something they appear unwilling to do.

Deposit insurance reform has only just started to take hold in Asia, notably in Japan in 2002. Deposit insurance protects small savers from losses due to bank failure (like the FDIC does in the U.S.); however, such insurance often includes an explicit cap on reimbursements. This cap forces larger depositors to do their homework to distinguish good banks from bad. Japanese savers previously enjoyed unlimited deposit guarantees, allowing them to park their savings at badly-run banks without much concern. Now, as guarantees have been cut to about US $100,000 Japan’s savers are voting with their money: They are shifting their deposits to safer, better banks, which encourages better practices in the sector.

Technology has transformed America’s banking landscape, improving productivity and accuracy in everything from credit analysis to customer service. Asian banks, however, have been relatively slow to adapt and reap the benefits of technology. Even in Japan, where some of the world’s most advanced technology has been developed, banks run on tired legacy systems, with little in the way of standards or compatibility. More than one big bank merger has run aground in the inability to consolidate systems. In India and China, some banks’ branches still communicate with each other—and with headquarters—only by telephone, unable to share data via networks.

U.S. banks have proven that, through technology-powered efficiency gains, they can be profitable on fairly thin margins. Asian banks, meanwhile, enjoy wider margins because they face less competition from capital markets. Yet they also incur higher costs per dollar of assets, particularly with respect to labor costs. In effect, the excess profitability of many Asian banks has shielded them from market discipline that would otherwise force them to boost productivity, using fewer bank tellers, loan officers and other staff. In many of Asia’s paternalistic societies, where jobs are part of the social compact, and substantial portions of the banking sector are under the government’s sway, “downsizing” is a foreign concept.

A bank employee counts newly printed Japanese BONDS

The strength of a banking system can be measured by the extent to which it can weather crises and move beyond them quickly. The U.S. savings and loan crisis of the early ‘80s had a far-reaching but relatively short-lived impact. Asia’s banking systems were shaken to their foundations by the 1997 currency crisis, and some countries are still working out their problem loans. Countries that were slow to clean up after the crisis saw their banking systems stagnate, resulting in sub-par economic growth.

The most significant difference between Asia and the U.S., however, may be the strength of retail banking networks—the backbone of the U.S. system since A.P. Giannini instituted branch banking and consumer credit products in the early 20th century. For Asian banks to capitalize on rising personal prosperity and consumption, they must be prepared to accept a reversal of the proportion of corporate business (currently 70% of bank assets by some estimates) to consumer banking. They will need to learn how to compete for and serve individuals as valued customers.

It’s starting to happen. The traditional Japanese model is giving way to a more Western model. The role of banks as the primary conduit of capital in the economy is likely to diminish, but they could play a greater role in economic stimulation at the consumer level and make a greater contribution to growth overall. As capital markets develop, the resulting competition should drive interest rates down for borrowers and up for savers.

Change is always fraught with risk, but by avoiding change, the banks risk losing the confidence of the populations they serve, resulting in further erosion and restriction of the capital supply. As with blood in the body, the more freely capital is allowed to circulate, the healthier the economy. The opportunity for banks is to rise to the challenge and become drivers of growth, rather than a drag on it.