Weak Asset Quality Continues to Impact Profits of Philippines’ Digital Banks
The outlook for Philippine banks in 2024 appears promising, with expectations of earnings normalization and anticipated policy rate cuts in the latter half of the year, as assessed by S&P Global Ratings.
S&P Global Ratings credit analyst Nikita Anand expressed confidence in Philippine banks’ ability to capitalize on the country’s robust economic growth anticipated for 2024. Anand highlighted the potential for favorable growth opportunities alongside stable asset quality.
Anand further elaborated that as lower asset yields are foreseen due to expected policy rate cuts in the latter part of the year, earnings are anticipated to return to normalcy.
Maintaining a healthy funding profile, Philippine banks are expected to sustain a loan-to-deposit ratio ranging from 70% to 75%, with a substantial proportion of low-cost current and savings deposits, accounting for approximately 70% of total deposits.
Anand added, “There hasn’t been any sign of irrational deposit pricing in reaction to the competitive rates offered by emerging digital banks. These digital banks are still in their early stages and are grappling with initial challenges, holding a market share of only 0.4% of sector deposits.”
Steady Risks Ahead
In 2024, the outlook suggests that credit losses will maintain stability, ranging from 0.5% to 0.7% of gross loans.
As of the end of November 2023, the non-performing loan (NPL) ratio is anticipated to reach 3.5%, up from the previous 3.4%. This increase is attributed to the swift expansion in riskier sectors, particularly credit card loans and other unsecured consumer loans over the past couple of years.
Nikita Anand remarked, “As these segments mature, we anticipate a rise in consumer NPLs. However, we expect risks to remain manageable, given the Philippines’ low household leverage, accounting for only 10% of GDP, and the steady employment conditions.”
Challenges Persist for Digital Banks
Despite ongoing efforts, digital banks are projected to face continued losses in 2024, primarily due to persistently weak asset quality and substantial operational costs.
S&P Global Ratings highlighted that digital banks are anticipated to grapple with notably weaker asset quality compared to traditional banks.
This discrepancy stems from their significant exposure to unsecured consumer loans and the relatively unproven creditworthiness of their target clientele.
Furthermore, the banking sector as a whole, encompassing both digital-only and traditional institutions, is poised to maintain its focus on enhancing digital capabilities throughout the year.
This strategic emphasis aims to bolster operational efficiency and adapt to evolving consumer preferences.
Nikita Anand emphasized the role of digitization in reducing the sector’s cost-to-income ratio.
Notably, data from S&P indicates a decline in the banking sector’s cost-to-income ratio, dropping to 55%-57% by the end of 2023 from 64%-65% recorded at the close of 2016.
Projected Surge in Credit Expansion
The Philippine economy is poised for robust expansion, with real gross domestic product (GDP) anticipated to grow by approximately 6% in both 2024 and 2025.
This favorable economic outlook, coupled with subdued inflation and interest rates, is expected to stimulate demand for credit.
In light of these factors, S&P Global Ratings foresees credit expansion accelerating to double-digit growth rates, ranging between 10% and 12% throughout 2024.
This marks a significant uptick from the comparatively modest 5% to 6% growth observed in the preceding year.
“We anticipate the possibility of policy rate reductions in 2024, given the prevailing moderate inflationary conditions,” remarked Anand.
Nevertheless, the normalization of policy rates is projected to exert downward pressure on net interest margins.
Despite this, there are potential positive drivers for profitability.
These include anticipated reductions in operating expenses and a growing proportion of unsecured retail loans within banks’ portfolios, as highlighted by S&P.
