The Rise and Rise of Emerging Market Banks Thought Paper www.infosys.com/finacle Universal Banking Solution Systems Integration Consulting Business Process Outsourcing
The rise and rise of emerging market banks Four years after the crisis broke, Greece and a few others are looking to survive, whereas countries like China are trying to use this quiet period to take giant leaps forward and emerge ahead of developed nations in the race for global supremacy. As the backbone of economy, the financial sector will play a huge role in the dynamics of a likely shift in the world order in the twenty-first century. While emerging nations have a host of problems to deal with, they have a lot going for them when it comes to the financial sector. Emerging market banks have done a number of fundamental things right, for instance, banks in China and India have participated in a number of financial inclusion initiatives to take their services to some of the most backward regions and previously untapped markets. Banks in the BRIC nations have used their technological prowess to provide cost efficient platforms and mobile applications, which have helped to catalyze industrial development. Regulatory bodies, i.e. Central Banks, have played a key role in ensuring that their banking sectors are well protected and fundamentally strong. The crisis in Western banking, still reverberating in Southern Europe, seems to have accelerated the shift in banking muscle from rich countries to the developing world. Banks in emerging countries are now measuring up with those in the developed world, when it comes to the real thing, which is money. Not only are they well capitalized and well-funded, they are also really big and growing. By profits, Tier-1 capital, dividends and market value, they now account for a quarter to half of the global banking industry. China s lenders head the list of banks by market value, and Brazilian and Russian banks are among the world s top 25. At current growth rates, India s banks will catch up with the top global banks in a decade. Emerging market banks asset growth has been impressive as well, with Chinese institutions topping the ranks. While emerging market banks already grew faster than their advanced country counterparts prior to 2007, the financial crisis has further accelerated this trend. The expected continued growth of emerging market banks and the likely stagnation (or even contraction) of advanced country banks, many of which still face multiple risks, implies that the relative importance of the former will quickly grow. Yet, in most emerging markets, the banking industry remains immature. As a result, banking revenue as a percentage of GDP is still small, offering great growth potential to incumbents and new entrants alike, unlike in the stagnant and saturated Western markets. Impact of financial crisis There are several reasons why the financial sector in the developing world came through the crisis with relatively little damage. Firstly, loan-to-deposit ratios are very low due to the net saving position of this region. Developing world banks have always gathered savings, in contrast to Western banks, which borrowed heavily. This insulated emerging market banks from the collapse of the interbank market and preempted the need for substantial deleveraging. As a result, these banks have been able to continue lending using a stable and often growing source of deposit funding. Second, most emerging market banks already have high capital ratios which limit pressures for balance sheet adjustments. In addition, the new capital rules under Basel III are likely to be much less painful for these banks as they typically have less risky assets and smaller investment banking businesses. 02 Thought Paper
Role of state Along with the status of emerging market banks, the crisis has also transformed the role of the state in banking. The main reason for the continuing growth in China, which had relaxed its grip on the industry since a decade, was the government s direction to continue lending during 2008 and 2009. In Brazil, India and Russia, state-owned banks have seen a sharp improvement in their fortunes, gaining market share at the expense of private banks. Customer expectations Banks all over the world are trying to reestablish customer confidence and spur organic growth. Global banks are returning to core competencies and simplifying new products in order to adapt to a new era of customer expectations. Emerging market banks are finding it easier to compete with developed market banks by winning over local customers by providing greater access to vital financial services. According to Ernst & Young s recently released global consumer banking survey 2011, titled A New Era of Customer Expectation, the level of customer trust in banks has fallen 55% in the United States and 50% in Europe. But it has dropped far less in key emerging markets such as India (down only 8%) and Brazil (off only 18%). Opportunities for emerging market banks 1. Domestic markets: Emerging market banks face a favorable situation in their domestic markets compared to their advanced country peers. Firstly, their countries have large unbanked populations promising growth opportunities. In contrast, the outlook for credit growth in advanced economies is bleak due to overall economic weakness and ongoing deleveraging among firms and households. Secondly, the macroeconomic outlook of emerging markets is more positive. Unburdened by major sovereign debt problems or large current account deficits, most emerging markets are standing on a solid platform. Even though they will not be isolated from the problems in Europe and the United States, the dependence of their banks on the West has diminished in recent years. 2. Retail banking sector: There is good potential for growth in the retail banking sector in emerging markets, since mortgage and consumer credit lending is not as well developed as corporate and government lending (although both these also offer considerable opportunities). Apart from this, restructuring in emerging economies should also create opportunities for private equity firms in the short to medium term. 3. Mergers and acquisitions: The rise of emerging economies is likely to be associated with rapid growth of their key banking players, as well as increased M&A activity, both within (by consolidation of fragmented banking sectors), and across borders. Large banks in China and other emerging countries are likely to become significant regional or global players over the next 10 to 20 years through outward organic and inorganic expansion. 4. Talent acquisition: With Russian banks hiring investment bankers from London, Chinese banks recruiting American or European executives and Indian banks seeking to attract staff with international experience, developing world banks have started to compete globally for talent. As they internalize the knowledge of these employees, so will their competitiveness in both domestic and global markets increase. Thought Paper 03
5. Technology adoption: Technology has made a major impact on the way banks process information. Financial instruments, such as derivatives that enable risk allocation based on appetite and ability are among the most significant innovations of modern banking. The use of such instruments is not limited to developed market banks alone; thanks to their sophisticated IT infrastructure, emerging market banks are also able to transact in them. As a result, their banking systems and financial markets are positioned to move rapidly from a basic stage of development of risk management and other commercial banking functions to an advanced one. In the same manner, the role of alternative delivery channels, such as ATMs, debit cards, mobile, Internet and electronic banking, in developing commercial banking functions should not be underestimated. Given the poor penetration of these channels (with the exception of ATMs), the vast majority of banks in emerging markets are focused on improving adoption. There is a big opportunity for them to bridge the urban-rural digital divide by reaching out to rural locations. International expansion: similar difficulties Developing world banks face exactly the same set of problems as their western peers as they try to expand abroad. Banks from advanced countries have found that establishing a light presence in lots of countries is a great way to lose money. The same is likely to be true for emerging market banks, so the smarter firms are trying to develop a competitive advantage that they can export E.g. Indians can export the low cost technology. With a large part of funds yet to be allocated to the unbanked population, most emerging market banks face a credit crunch, hampering foreign expansion. Also, regulators might oppose foreign adventures as the use of domestic deposits to finance a subsidiary overseas exposes the bank to foreign exchange and counterparty risk. Conclusion The emerging market banks which were plagued by excess regulation and inefficiency a few decades back have finally come into their own and are here to stay. With strong fundamentals and regulatory mechanisms in place at these banks, the financial crisis has actually accelerated the pace at which these banks will overtake their developed market peers. According to a report by PwC, the E7 banks (7 emerging countries which include the BRIC nations, Indonesia, Turkey and Mexico) will overtake the G7 banks in assets by 2036, which is 10 years ahead of its pre-crisis prediction. Emerging market banks have set new rules in the business of banking, which developed market banks are trying to adjust to, making large investments from their side unlikely in the near future. Banks from emerging markets, being in a much better financial position, are likely to step into the void left by developed market banks, increasing their relative importance as foreign investors. The global financial system is therefore likely to witness a shift towards emerging market banks domination. It will be interesting to see how banks in emerging markets fuel the engine of growth with this shift in global power. 04 Thought Paper
References 1. Special report: Banking in emerging markets/ The Economist/ 13 May 2010 2. Banking in 2050: How big will the emerging markets get?/ Pricewaterhouse Coopers 3. The changing role of emerging-market banks/ Author-Neeltje van Horen/ 25 October 2011 4. A New Era of Customer Expectation /Global consumer banking survey by Ernst and Young/2011 5. The Banking industry in the emerging market economies: competition, consolidation and systematic stability- an overview/ Authors-John Hawkins and Dubravko Mihaljek Varun Chandra Associate Consultant, Infosys Thought Paper 05
About Finacle Finacle from Infosys partners with banks to transform process, product and customer experience, arming them with accelerated innovation that is key to building tomorrow s bank. For more information, contact finacleweb@infosys.com www.infosys.com/finacle 2012 Infosys Limited, Bangalore, India, Infosys believes the information in this publication is accurate as of its publication date; such information is subject to change without notice. Infosys acknowledges the proprietary rights of the trademarks and product names of other companies mentioned in this document.