DWS balances GEM bank opportunity against exposure to economic conditions
Not all global emerging market banks are equally capable, or able to provide investor returns, says DWS’ Martin Rother.
Due to their high gearing, global emerging market (GEM) banks are heavily exposed to changes in economic conditions and are affected by monetary policy.
Slowing GDP growth puts pressure on loan growth and increases risk of asset quality deterioration while monetary easing, which stimulates the economy and should support asset quality, could put pressure on net interest margins. Interest income for GEM banks accounts for more than 70% of total income compared to less than 60% for developed market (DM) banks.
Many GEM banks still have a business model focusing on deposit gathering and lending with little capital market-related businesses. Structurally, return on equity, which is on aggregate 18%-19% but with significant dispersion between different banking markets, is likely to come down a few percentage points.
Structurally, the attractiveness of GEM banking models has increased versus DM banks, as most have a stronger funding base through customer deposits, solid capital ratios and superior growth prospects driven by lower banking penetration and more favourable demographics.
This does not necessarily translate into superior investment returns however, as not all banks are able to maximise shareholder value. Additionally, GEM banks are trading at a premium in terms of price to book but not in terms of price earnings multiples.
Contagion risk facing DM banks has the potential to spread to GEM banks. Emerging economies are dependent on European banks largely for trade finance, yet, trade finance represents only around 5% of total domestic loans. The GEM banks are experiencing reduced funding although most GEM banks are not reliant on cross-border flows to fund domestic lending.
Moreover, the deleveraging by European banks has, for the most part, been compensated by other banks stepping in.
GEM banks would not be immune from global credit market dislocations and, as they are high beta stocks, they tend to perform poorly if global risk aversion increases. East European banking markets through their strong links to European banks are probably most affected by crisis.
Within the GEM banking universe we would recommend banks with robust domestic deposit funding, stable asset quality and strong capital base. These banks should be able to cope with market uncertainties better than their more leveraged peers and be equipped to fund future growth.
Some of the Asian banks offer an attractive structural growth story. In contrast we would be cautious on banks facing funding constraints (high loan to deposit ratios).
Banks operating within an economy which has a current account deficit such as India and Turkey may also be more vulnerable to global shocks.
Martin Rother (pictured) is senior emerging markets fund manager at DWS Investments