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Faster growth in the US should be a good thing for the global economy. However the benefits for Asian banks may be less pronounced than in the past. Fiscal stimulus in the US is welcome but is dwarfed by the credit creation required to keep China's GDP growing at 6-7% range. After a decade of rapid debt accumulation we also question the ability of many of Asia's most indebted markets to cope with rising domestic rates. If US rates continue to rise, absent tighter capital controls, we would expect liquidity to continue to leak out of Asia's banking systems pressuring not just the traditional current account deficit markets but also eventually Chinese & Australian banks.

Since the introduction of “zero rate policies” as a result of the GFC we have now had 4 periods where the US 10 year government bond yield has risen sharply from lows. Each time Asia’s EM focused banks have significantly under-performed global peers. In this report we look at 4 key metrics that we believe make certain Asian banking markets more vulnerable than others. This includes current account surplus/deficits, net international investment positions, FX reserves & the pace of credit growth into the rate shock. Whilst still vulnerable to short-term portfolio outflows we think Indonesia is in better shape than in 2013, Malaysia however looks vulnerable (as does Australia).

After a decade of rapid debt accumulation we are not sure that many of Asia’s most indebted banking system’s can cope with a rise in rates without triggering a sharp slowdown in domestic growth and/or asset quality problems. If US rates rise and Asian rates do not follow (or rise at a slower rate) we think concerns over capital outflows will remain elevated. The scale of capital flowing across Asia’s borders we believe is already unprecedented with China over the past 12 months seeing cUS$500bn leaving its financial system (vs inflows of US$300-400bn just 2-3 years ago). A key question is where will this capital go? In the short term it is unlikely to replace the rapid withdrawal of “portfolio” flows from western markets. In the medium to long-term however the sheer scale of Chinese ODI has the potential to benefit the banking systems across many of the ASEAN “One belt, one-road” markets.

Looking at the sector on an implied cost of equity basis it now in aggregate looks 8-9% expensive to us relative to its 5 year average. Despite under-performing the MSCI World banks index by c13% since the end of Q3 (when US rates started to rise in this cycle) we remain cautious. We would be particularly cautious on the North Asian banking sectors post their recent moves with those markets that have traditionally enjoyed “positive carry” relative to the US looking increasingly vulnerable if US rates keep rising (China & Australia). We are inclined to see the pull back in Indian private banks and Indonesian banks as an opportunity to build positions given the scarcity of banking systems globally that can offer high RoAs & asset compounding.