Asia-focused banks face capital squeeze due to inflation, bond turbulence

By Selena Li and Sameer Manekar

HONG KONG/BENGALURU, Oct 26 (Reuters) - A mix of volatile bond markets, sticky inflation and shifting foreign exchange dynamics is creating a risk to Asia-focused banks' profitability and strong capital positions as they prepare to announce their third-quarter earnings.

While the major Asia-focused lenders benefit from healthy deposit bases, rising long-end yields and macroeconomic pressures are exposing vulnerabilities, according to analysts.

Following an early October global bond rout where the benchmark 10-year US Treasury yield touched a multi-year high of 5.34% before stabilising around 5.11%, alongside a spike in Japanese yields, the lingering impact of higher borrowing costs continues to ripple through regional financial institutions.

"There is a liquidity impact, the capital impact, and there is a profit & loss impact," said Harsh Wardhan Modi, co-head of APAC financials and head of ASEAN research at JPMorgan, referring to the pressure from rising yields on Asia-focused banks.

Rising yields would weigh on profits and asset values, which would erode bank capital and limit their ability to raise new funds, and could lead to negative revisions of their earnings per share, a metric closely watched by investors, according to Modi.

Among major Asian and Asia-focused banks, British bank HSBC HSBA.L will kickstart the quarterly banking earnings parade on Tuesday, followed by peer Standard Chartered STAN.L on Wednesday and Singapore's DBS Group DBSM.SI next week.

HSBC is expected to post a 33% rise in pretax profit in the July-September quarter, while Standard Chartered should show a flat quarterly profit from a year ago and DBS a 3.2% decline in net profit for the same period, according to analysts' estimates.

Shares of HSBC and Standard Chartered suffered declines after the US Treasury rout earlier this month, dropping 3.8% and 9%, respectively.

Shares of Southeast Asia's largest lenders also fell, with DBS shedding 3.2%, and OCBC OCBC.SI seeing a near 9% drop during the same period.

The pressure on bond valuations and therefore book value of banks would potentially weigh on lenders' key capital ratios and, by extension, dividend payouts, Morningstar's equity analyst Kathy Chan said.

The full impact of that, however, can be mitigated by organic capital generation through their healthy earnings, she added.

PRESSURES IN JAPAN, SOUTHEAST ASIA

Moody's warned that Japan's rising government bond yields are inflicting large unrealised losses on lenders with long-duration assets, already triggering credit downgrades for select regional banks, including Norinchukin and Japan Post Bank 7182.T.

"We do think there's further upward pressure on the interest rates market there (in Japan)," said Alka Anbarasu, associate managing director, financial institutions group at Moody's Ratings.

Beyond broader balance-sheet headwinds, emerging market lenders in Southeast Asia are facing distinct local vulnerabilities, analysts said.

In economies like the Philippines and Indonesia, stubborn inflation and rising foreign exchange volatility are beginning to bite into asset quality and wholesale funding structures, according to Moody's analysts.

Regional banks are also bracing themselves for a slowdown in wealth momentum after robust gains driven by capital inflows from Chinese investors into Singaporean lenders, HSBC, and Standard Chartered.

"China's tighter offshore tax scrutiny may slow these flows near term, potentially showing up in third-quarter results," said Moody's Sally Yim, though she stressed the long-term wealth management growth story remains intact.