Credit FAQ:

Can The Largest Emerging Market Banking Systems Withstand Jitters About Economy And Financial Markets?
Primary Credit Analysts: Cynthia Cohen Freue, Buenos Aires (54) 114-891-2161; cynthia.cohenfreue@standardandpoors.com Geeta Chugh, Mumbai (91) 22-3342-1910; geeta.chugh@standardandpoors.com Secondary Contacts: Goeksenin Karagoez, FRM, Paris (33) 1-4420-6724; goeksenin.karagoez@standardandpoors.com Natalia Yalovskaya, Moscow (7) 495-783-4097; natalia.yalovskaya@standardandpoors.com Jose M Perez-Gorozpe, Mexico City (52) 55-5081-4442; jose.perez-gorozpe@standardandpoors.com Qiang Liao, PhD, Beijing (86) 10-6569-2915; qiang.liao@standardandpoors.com

Table Of Contents
Frequently Asked Questions Related Research

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Credit FAQ:

Can The Largest Emerging Market Banking Systems Withstand Jitters About Economy And Financial Markets?
There has been increasing interest over the largest emerging market banks and Standard & Poor's Ratings Services' expectations for their future performance. Below, we answer questions that investors and other market participants have asked us about the largest BRICMT (Brazil, Russia, India, China, Mexico, and Turkey) banks' asset quality, their capital levels to support a still high lending growth, their profitability, and what effect the slowing economies in these six countries and the Federal Reserve's expected tightening monetary policy will have.

Frequently Asked Questions

Will slowing economies take a toll on the banks' asset quality?
The BRICMT household debt burden to GDP rose faster than the GDP per capita, except for India, where consumer lending has been growing at a slower pace, as banks have been cautious due to prior large credit losses among unsecured consumer loans and as high real estate prices have led to a slower rise in residential mortgages volume. Given the cyclical nature of these economies and their still low GDP per capita, we expect this trend to pressure the banks' asset quality performance. Economic imbalances in Brazil have increased due to a sustained credit expansion, especially following the recent boost by government-owned banks amid a slowly growing economy in the past few years. Further lending would increase an already hefty debt burden on households, subjecting Brazilian financial system to incremental credit risk. We expect a slight deterioration in asset quality among Mexican banks as a result of increased growth and loan loss provisions in consumer lending activity, coupled with a GDP growth of only 1.5% in 2013. We believe that sharp growth in consumer lending could spike nonperforming loans (NPLs) if the economic fundamentals or credit market conditions weaken. The troubled homebuilders' defaults contributed to higher provisions but weren't the main driver behind asset quality deterioration. Nonetheless, we expect the Mexican banks' NPLs to remain at manageable levels and reserved at more than 100%. Real disposable income growth in Russia lags behind credit growth that stemmed largely from the rapid increase of highrisk unsecured lending through consumer and cash loans and credit card debt, which together represented 64% of total retail loans at the end of 2012. Still, we expect the Russian banking sector's credit losses for the next 12-24 months to remain well below the peak of 2009. We believe that rapid loan growth in Turkey in recent years, notably in retail loans, pressures its economic imbalances. Inflation is still in high-single digit area, but the retail segment's credit growth is above those in many of Turkey's peers even on a real basis. Yet, if Turkey experiences another slowdown owing to a domestic or external shock, we believe that the extent of asset quality deterioration and banks' credit losses could be significantly above what they were in

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Credit FAQ: Can The Largest Emerging Market Banking Systems Withstand Jitters About Economy And Financial Markets?

2009. India's sluggish economic growth, rising interest rates, and the volatile currency are hurting the country's highly leveraged corporate sector. We expect continued weakness in infrastructure-related loans, metals and mining, commercial real estate, and construction-related sectors. We expect the banking sector's NPL ratio to surge to 4.4% of total loans by March 31, 2015, from 3.4% as of March 31, 2013, due to increased defaults among corporates. We believe the Chinese banks' satisfactory asset quality ratios don't fully reveal their asset portfolios' vulnerability to a severe economic downturn. In our view, Chinese banks are significantly exposed to lackluster export growth, debt-laden local governments, and many manufacturers suffering from oversupply. However, in our view, a still robust economy, supportive credit conditions, and continued regulatory forbearance to local government financing platforms (LGFPs) will prevent a surge in NPLs.

How will still strong lending growth and Basel III Rules affect the banks' capital levels?
Banks in the BRICMT countries will require large amounts of capital to support the double-digit lending growth and comply in certain cases with the upcoming implementation of new Basel III rules, except for Mexico where Basel III has already been implemented. According to our risk-adjusted capital (RAC) measure, the Russian, Brazilian, Indian, and Chinese banks' capital adequacy ratios have continued to drop, as lending growth has outpaced their earnings generation capacities. These banks' current RAC ratios are on average between 5% and 7%, which according to our bank criteria, are "moderate" (see "Banks: Rating Methodology And Assumptions," Nov. 9, 2011). Mexican and Turkish banks have the strongest capitalization levels in the peer group, with an average RAC ratio of 9.7% and 8.3%, respectively, as of Dec. 31, 2012. Brazil announced changes to its Basel III implementation guidelines at the beginning of the year. The changes could mitigate pressures on additional capital, given the potential credit growth fueled by government banks and current capitalization ratios. However, we view the rescheduling as somewhat negative, because we believe banks would benefit from more and higher-quality capital amid the rapid credit expansion in Brazil since 2006. The recently announced delay in implementing the tougher capital requirements for the Basel III rules mitigated immediate pressure on the Russian banking sector. We understand that Russia's central bank intends to start transitioning the banking sector in 2014 to meet the Basel III capital requirements. We note, however, that the implementation will be gradual, might be further delayed, or might take longer than the currently envisaged for two-three years. Turkey's regulatory preparations for the implementation of Basel III gained momentum in 2013. The regulator has requested opinion of the banks for its draft proposals, and it aims to finalize its rules in coming months. In July 2013, Turkish regulator stated that the new rules will start to be implemented from Jan. 1, 2014. Indian banks began implementing the Basel III capital requirements on April 1, 2013. The regulatory requirements in India are more stringent than the Basel Committee on Banking Supervision guidelines. Large Indian banks hold sufficient capital with reference to regulatory requirement, though in our opinion, adjusted for risk, this capital is moderate. We believe top-tier Indian banks are well-placed to achieve Basel III targets, while potential difficulties

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Credit FAQ: Can The Largest Emerging Market Banking Systems Withstand Jitters About Economy And Financial Markets?

among some smaller banks could lead to consolidation in the sector. For regulatory purposes, major banks in China hold sufficient core capital with common equity tier 1 ratios between 9% and 10%, exceeding the regulatory requirement for 2019. However, in our opinion, adjusted for risk on a globally comparative basis, this capital is moderate. In our view, major Chinese banks face two key issues in meeting future requirements: They need to maintain capital in line with high asset growth, and globally systemically important banks in China need to prepare for possible additional capital requirements. In January 2013, Mexico completed the implementation of the Basel III capital requirement with a small impact of 0.2% on the regulatory capital ratio reaching 15.7%. However, the average risk-adjusted capital ratios, according to our methodology is 9.7% and we consider this ratio to be adequate for future credit growth.

Will the BRICMT banks' profitability suffer?

We expect the BRICMT banks' profitability to decrease, but to remain stronger than that of developed economies. The banking systems of the peer group have remained profitable for the past three years, with an average return on assets (ROA) of about 1.5%. Turkish and Russian banking sectors have been the most profitable out of the peer group, with an average ROA of 2.0% and 1.8%, respectively. The banking sectors in Mexico and Brazil generated an average ROA of 1.7% and 1.4%, respectively, and the ones in India and China with an average of 1.1%. The banking sectors in all six countries have been more profitable than those in the U.S. (0.9%), U.K. (0.1%), and Japan (0.3%) as they struggled with the fallout from the 2008 global financial crisis. The Brazilian banks' ROA has declined in 2012 to 1.1% from 1.6% in 2010, reflecting higher NPLs, stronger competition from public banks, and a continued reduction in net interest margins (NIMs). We expect the Brazilian banks' 2013 and 2014 earnings to remain around their current levels given the difficulties to significantly improve the efficiency ratio, which is currently about 64%. Also, we expect a marginal spread increase to a good level, of about 6%. We expect the Russian banking sector's ROA to decrease to 1.5%-1.8% in 2013 and 2014 due to increasing credit losses in the retail segment. However, this metric continues to compare well with those of global and other BRICMT banks. The Indian banks' earnings should remain stressed through fiscals 2014 and 2015 due to high credit costs. The banks' earnings in fiscal 2014 are also likely to suffer from trading losses due to sharply higher interest rates. We expect the ROA to be below 1% for the next two years. We expect the Chinese banks' profitability to drop in 2013-2014 because of their falling NIMs and rising credit losses amid an economic slowdown and gradual financial deregulation. We forecast the large rated Chinese banks' ROA of 1.1%-1.2% on a weighted average basis for 2013. The Mexican banks' financial performance remained adequate in 2013. We don't expect their 2014 ROA to improve but rather to slightly decrease to about 1.5%, given the slow economic prospects. A healthy fee revenue and efficiency ratios at 52% will partly offset additional credit provisions. The Turkish banking sector's profitability remained strong in 2012 and its net income increased by 18.5% over 2011. However, in 2013, we expect a reversal in this trend due to a gradual margin squeeze and higher net loan loss

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Credit FAQ: Can The Largest Emerging Market Banking Systems Withstand Jitters About Economy And Financial Markets?

provisions. We expect the rated banks' NIMs to drop to about 4.0%, a level still relatively high, in our view.

What are our expectations for credit growth for the six countries in 2013 and 2014?
After slowing more than expected in 2012, we expect the credit growth in these six countries to recover in 2013 and 2014, although at slower levels. Credit growth prospects across the BRICMT countries remain favorable, as their comparatively strong GDP growth prior to 2012 helped shield these countries from the stagnant global economy. The BRICMT economies are expected to grow at 3.5% on average this year, compared with 2.3% for the U.S., 0.6% for the U.K., and 2.2% for Japan. According to our base-case scenario, Brazil will register a moderate strengthening, growth will ease in Mexico and India, and China will show fairly high growth rates of 7.3%. In recent years, the BRICMT financial systems have experienced a rapid credit growth, while their operating performance has remained healthy. Sustained GDP growth has led to higher employment and purchasing power, and has allowed a greater share of population to access banking products, spurring lending activity. Although we expect a lower economic growth cycle than the previous one in the BRICMT nations, still strong credit demand should support continued credit growth in 2013 and 2014, which we expect to be on average about 15%. We expect the credit expansion to be the fastest in Turkey, Russia, and Brazil and the slowest in India and Mexico.

What is the expected effect of global capital outflow on BRICMT nations?

We expect the liquidity outflow and weaker local currencies to have a moderate direct effect on the Brazilian, Chinese, Indian, Mexican, and Russian banking sectors, given their modest external financing needs. In addition, most of these countries have low exposure to foreign currency denominated loans and deposits. However, higher interest rates, inflationary pressures, or currency mismatches at the borrower level could weaken the banks' asset quality in these five countries. The effect on the real economy could be even more significant if the Federal Reserve takes long-term measures that could result in a structural change on the dynamics of the global capital flows; however, this scenario has not been incorporated into the expectations described below. We expect the reversal in global capital flows to have a limited effect on liquidity in China because its banking system has a conservative loan-to-deposit ratio (about 70%) thanks to strong domestic savings. For most of 2013, yuan continued to appreciate against the dollar. Moreover, in our view, the Chinese central bank has plenty of monetary policy tools to offset liquidity drain from capital outflows. We believe that the expected change in U.S. monetary policy won't affect interest rates in China, mainly due to strict capital controls, strong domestic liquidity, and strong government control over the financial system. However, Turkey looks particularly vulnerable to capital outflows due to its large and recurrent current account deficit (about 6.2% of 2013 GDP), dependency on short-term debt financing, sensitivity to high energy import prices, and a sluggish monetary response to exchange-rate pressures. While Turkish foreign currency reserves, at $124.2 billion as of July 2013, are close to an all-time high, they cover only an estimated 73% of short-term debt (our short-term debt data includes an adjustment for repo financing), and just over 100% of the Turkish corporate sector's substantial net short foreign exchange position. India also has some vulnerability, as the banks' asset quality could suffer due to their exposure to Indian corporates that may have unhedged foreign currency loans.

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Credit FAQ: Can The Largest Emerging Market Banking Systems Withstand Jitters About Economy And Financial Markets?

What are our ratings expectations for BRICMT banks?

Our outlook on the major rated Brazilian and Indian banks is negative, reflecting the negative outlook on their sovereigns. Their stand-alone credit profiles are higher than the sovereign ratings, but their ratings are constrained by the sovereign ratings as we don't expect these banks to withstand a sovereign-related stress. If we lower the sovereign ratings, we would downgrade the banks as well. Our outlook on the large rated banks in Russia, China, and Turkey is stable, reflecting our expectation that these countries' banking sectors will experience only a moderate deterioration in asset quality and earnings amid slower economic growth. Our expectations already factor in some level of volatility that is inherent to these emerging markets. Our outlook on the largest rated Mexican banks is positive due to the positive outlook on the sovereign and our view that the banks' SACP are stronger than their current ratings. An upgrade of the sovereign would also result in higher ratings on these banks, everything else being equal.

Related Research
Are Good Old Days Over For The Largest Emerging Market Banks?, Oct. 8, 2013

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