SINGAPORE banks are in for tough times in 2016, but a collapse of the banking sector is unlikely, despite alarmist calls from a few hedge funds in recent weeks. Investors who fear a banking crisis should take heart that Singapore banks follow stringent and unique domestic standards when setting aside reserves for bad loans.
All banks create reserves, known as allowances or provisions, for lending that is under stress. This is reflected on their income statement, and is a drag on earnings. There are two forms of provisions. One is known as a specific provision that, as the name suggests, is a portion of earnings set aside for specific loans that are under stress.
The second is known as a general provision, which is an overall cushion against loans that may, even in the ordinary course of business, come under stress. To do this, banks typically look at historical loan loss data to estimate how much to set aside, and correspondingly, to deduct against operating profit.
Over the three months that make up a reporting quarter, banks try to recover portions of a non-performing loan, typically by restructuring the lending terms or by selling collateral that the loan is secured against. (The simplest example is that of a housing loan. If a borrower defaults on payments, the bank has the right to take possession of the property to recover its loan.)
At the end of the three months, the banks make provisions for new or existing non-performing loans, but also return to this reserve the funds that they have recovered from errant borrowers, in the form of writebacks. The quarter-end figure reported is the net result of such work behind the scenes. This process goes on in perpetuity for a well-functioning bank, but intensifies in an economic downturn.
In Singapore, the central bank has gone further to ensure domestic banks keep enough of a cushion, by its standard, for both good and bad times. Under MAS rules, Singapore banks must always maintain a general provision of at least one per cent of loans and receivables after accounting for collaterals and deducting any specific provisions made. For most international banks, there are hardly such prescribed thresholds specified by regulators for general provisions, given worries by accounting bodies that banks would smoothen out their earnings, and avoid paying taxes on higher income, observers told BT.
The regulator here also expects Singapore banks to set aside specific provisions of at least 10 per cent, 50 per cent, and 100 per cent, for loans graded "substandard", "doubtful" and "loss", respectively, on the portion not covered by amounts that can be recovered from collateral.
This explains the provision levels of Singapore banks today, which are more than one time of bad loans that are backed by collateral.
In announcing its results in February, Standard Chartered - an international bank - said it has provided for 0.7 time of bad loans, after including collateral value. Analysts whom BT spoke with said a like-for-like comparison between StanChart's provisioning and that of the Singapore banks would be unfair, despite similar exposures to Asia.
StanChart itself said that its provisioning standards are based on historical recovery percentage levels of "mid to high 60s". StanChart's reasoning is certainly kosher. But there is also room to say Singapore banks have - by force - held provisions that are over and above that of international peers. In uncertain times, this offers comfort.
Meanwhile, international accounting rules are shifting to effectively push banks to create more provisions. Currently, most international banks make allowances on its loans based on an "incurred loss" model. By 2018, banks should be making provisions based on "expected loss" on loans. The hope is that if banks make greater contingencies, they would hold off the temptation to lend too much during the good times without a suitable buffer - with the view of bumping up earnings significantly - only to be met with large losses in a cyclical downturn.
Large losses will hit hard on retained earnings that, together with share capital, make up the banks' core capital. If banks cannot rejig its capital ratio adequately to meet regulator's requirements - by selling more shares at a discount, cutting dividends, or reducing assets - they run the risk of going bankrupt, and losing most of depositors' money. Even after taking conservative provisions into account, Singapore banks are more capitalised than what their strict regulators require from them.
No doubt, banks' earnings over the next few years will mirror the bumpy ride of Singapore's - and Asia's - economy, and especially with added stresses from low oil prices, and uncertainty over China. After all, part of the attraction in a bank stock is the chance to invest in a share of regional growth and capital liberalisation.
But the "neurotic" ways of Singapore - as one observer put it - mean that savings of average salarymen are not left to the conscience of bankers. By the same token, then, Singapore banks are on solid ground. Rumours of their death are grossly exaggerated.
This article was first published on March 1, 2016.
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