Banks in Emerging Markets Will Struggle to Service Growing Corporate Clients

Despite concerns about political instability, banks in rapid-growth markets (RGMs) are bullish about their short-term performance, according to a survey on banking in emerging markets by Ernst & Young Seizing Opportunities and Overcoming Challenges.


However, the survey highlights that demand for credit is expected to grow exponentially in the next five years and, with pressures on margins and restricted balance sheets, banks in emerging markets will struggle to meet this demand.


Many are also not yet equipped to help clients access funding through the capital markets, opening the door for larger international banks to poach domestic banks’ most profitable clients.


More than 50 major institutions were surveyed across 10 key RGMs – Chile, Colombia, Egypt, Indonesia, Malaysia, Mexico, Nigeria, South Africa, Turkey and Vietnam. The banks surveyed represent over 40% of the combined banking assets of these markets.


High hopes for short-term performance
While just over half of respondents (56%) expect economic conditions in their local market to improve in 6 out of 10 RGMs surveyed, concerns were raised about political instability. When asked about their own bank’s prospects, interviewees were overwhelmingly confident – 79% of respondents in the RGMs forecast that their financial performance will improve this year, with 25% expecting it to improve significantly.


The outlook for business lines varies considerably – the outlook is best for deposits; the outlook for lending is good, but there is less optimism about the outlook for private banking and investment banking.


“Banks in RGMs are universally positive about the outlook for business lines with vanilla products, where it is straightforward to capture natural growth, but their reticence about corporate and investment banking is telling," says Steven Lewis, Ernst & Young’s Lead Global Banking Analyst. "It is not that there will be no demand for these services in RGMs – we expect more corporates to have to turn to capital markets for funding in the next year or so. However, many domestic banks are currently not well-placed to help their client’s transition to the next level.”


Demand for lending will outstrip domestic supply
Seventy percent of respondents anticipate significant growth in demand for loans for infrastructure and from SMEs.


More than half of respondents also expect increases in demand from the following sectors: IT, retail and consumer products, energy mining and minerals, media and telecoms, financial services, and construction.


Ernst & Young’s analysis estimates that combined private sector credit will grow by about 65% over the next 5 years in the 10 RGMs covered by this survey. This is more than twice the rate of growth expected in the US and more than five times the rate of growth expected in the UK.


“High demand for corporate loans and project and trade finance reflects the fast growth and increasingly globalized nature of these economies," notes Steven. "However the balance sheets of domestic banks will struggle to meet this demand, especially when much of the private domestic wealth continues to be held overseas."

Steven adds that banks in RGMs are also facing increasing regulatory pressures and raising additional capital to try to meet funding demands will be expensive – their sovereign ratings are generally lower than those of developed markets and so they have to pay more than global competitors.


Eighty-one percent of bankers expect the regulatory burden on banks in RGMs to increase, and the introduction of new capital standards is increasing the cost of funding.


Respondents anticipate that the implementation of Basel III will reduce the availability of credit for trade financing (27% of respondents), households (31%) and project finance (43%).


Given the likely shortfall in traditional funding, corporates in RGMs are going to have to look to capital markets to raise funds. Ernst & Young’s analysis of historical data suggests that debt and equity markets become more developed when countries reach about US$6,000 per capita GDP – this means that 6 of the 10 markets studied are now in a position to build capital market depth.


Steven says: “There is significant scope to develop the capital markets in most of the 10 RGMs we have looked at. Strong capabilities in debt and equity financing will be critical as banks try to move the financing of larger commercial activity onto the capital markets and free up their balance sheets to lend to smaller companies and individuals.


“If banks want to retain and grow with their business customers they need to invest in staff and technology to support alternative financing options now. Banks must not only meet current demand, they need to move ahead of it or they risk losing ground to global and regional banks,” he continues.

Worryingly, while 58% of respondents expect to increase their headcount in the next 12 months – none have said they are looking to hire investment banking expertise and just 7% expect to build their corporate banking teams.


Consolidation and the rise of regional banks
A third of respondents (37%) expect to expand into new markets. More than 80% of South African banks expect cross-border expansion in the next 12 months though only into other African countries. Similarly, respondents in Egypt, Nigeria, Malaysia, Indonesia and Colombia identified banks from neighboring countries as their greatest competitive threat.


Consolidation within markets is also expected; 44% of respondents expect the landscape of their banking market to change significantly. Forty-eight percent who expect significant change anticipate that domestic banks will be acquired by larger foreign banks already present in their market, and 43% expect smaller banks to be bought by larger domestic players.


Steven says: “We are beginning to see the emergence of Pan-Latin American, pan-African and Pan-Asian retail banking networks. As regional competitors reach the limits of easy growth in their domestic markets, there is real potential for those with stronger balance sheets to use lessons learned at home to serve customers in neighboring countries.”


“It is clear that competition for the safer and easier areas of the market will be fierce – with price wars on lending eroding profit margins, but it looks as if domestic banks in RGMs aren’t as focused on fighting for their share of the often more profitable corporate and investment banking market. If banks in RGMs don’t anticipate their customers’ demand for these services they risk losing their strongest corporate clients and high net worth individuals to international banks.”

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