Valuations in recent acquisitions of emerging market banks may have been excessive, according to global accountancy firm PricewaterhouseCoopers LLP (PwC), but long-term growth potential remains impressive. PwC published a report today that forecast banking sector growth in the “E7” economies of Brazil, China, India, Indonesia, Mexico, Russia and Turkey to outpace the performance of these countries’ wider economies over the next half-century.
Nick Page, partner at PwC and co-author of the report, told Emerging Markets that there were concerns about stretched valuations of some acquisitions, as emerging market banks are still subject to cyclical factors even in the context of high structural growth.
“Investors have gone in at very high prices on the basis that the growth will easily outweigh the cost of entry into the market place. But if there was a short term slowdown in economic growth or if a local subsidiary of a foreign bank doesn’t meet ambitious growth expectations, you might find that some foreign banks may feel they have overpaid for one or two acquisitions,” Page said.
Page pointed to China as an example of an immature banking market that would require improved practices in the short run to unlock great potential in the long run. He said that Chinese banks were improving their return on assets and reducing non-performing loans, but conceded that effective risk and liability management exercises in China were yet to take root, despite foreign insistence.
“The degree to which foreign shareholders of Chinese banks are able to improve management and efficiency is pretty limited,” Page told Emerging Markets.
David Marshall, head of Asian financial institutions at ratings agency Fitch, concurred with Page’s concerns about the short-term challenges facing Chinese banks.
“Credit is dispersed through directives as there is no independent monetary policy. As a result, lending rates are far too low,” Marshall noted. Moreover, the low interest rates used to preserve the renminbi peg to the dollar also inhibited deposit growth. “It is not surprising that people are taking money out of banks, as interest rates hardly cover inflation.”
However, Page at PwC anticipated that, once Chinese banks began directing lending toward consumers rather than “big ticket loans to state banks or large domestic corporates,” profitability and efficiency would improve. On this assumption, PwC predicts China to become the world’s largest banking market by 2050, overtaking the UK and Germany as early as 2010.
The projections are based on an analysis of developments in G7 and E7 banking markets since the 1950s. Using projected market exchange rates, the accountancy firm predicts that total profits from domestic banking in the E7 countries could be around half those in the G7 by 2025, surging to outstrip G7 profitability before 2050.
Consequently, Page predicted frenzied M&A activity as local and foreign banks compete to ensure good market share.
“Local banks will acquire one another partly due to protectionism, but also because of natural consolidation processes. Foreign banks will also enter the market and banks from the E7 will seek to expand internationally through acquisitions,” Page told Emerging Markets.
Among the other E7 countries, PwC partner John Hawksworth, co-author of the report, told Emerging Markets that the potential in the Indian banking sector was even greater than that in China, due to India’s more favourable demographic profile. Bank credit in India is growing by 36% of GDP in 2006, against GDP growth of 9.4% in the fiscal year ending March 2007. However, Marshall at Fitch warned that this pace of expansion raised questions about sustainability.
“Consumer demand has been so hot, rapidly outstripping GDP growth, but one is not sure how consumers would react in a downturn,” said Marshall.
Hawksworth acknowledged this cyclical risk, but still remained bullish on the long-term perspective.
“The market is just beginning to take off in India so it is showing very strong growth. You can have a boom and bust, but a common theme is that India is going through an enormous transformation in the last 15 years and an emerging middle class will ensure this long term growth will continue,” Hawksworth concluded.