Singapore’s economic recovery from the pandemic has been faster than what the economists predicted at the start of 2021. Even with the impact of the heightened alert measures in July and August, the economy expanded by 7.1% year over year and 1.3% quarter over quarter in the third quarter. Excluding any unforeseen circumstances, we can expect Singapore GDP growth for 2021 to be around 7%.
Singapore banks‘ earnings have risen as a result of this recovery as seen by their third-quarter results, and they have performed well as a whole in 2021.
Now, as this year comes to an end, what can we expect from our local banks in 2022? Will they continue to do well or will they start losing steam?
To answer these questions, we must evaluate two factors: the inflation and economic development of Singapore and China.
a) Inflation is real
This inflationary environment is unlikely to be short-lived. For the most part of 2021, Jerome Powell has put forth that the inflation environment is only transitory. However, this changed in his latest speech, stating that the inflation would no longer be transitory. The Fed has started its tapering in December and it would start accelerating from $15 billion a month to $30 billion a month. If everything goes according to plan, the Treasury purchase may be completed as early as March 2022, opening the path for rate hikes. At present, the Fed predicts three rate hikes next year, three more in 2023 and another two in 2024.
More than likely, you are beginning to feel the effects of inflation at home as well. With increased domestic demand for goods and services, as well as higher import costs caused by bottlenecks in the global supply chain, inflation in Singapore rose to a new high in November, breaking its previous peak record in October. Overall inflation increased to 3.8% in November, up from a more than the eight-year high of 3.2% in October.
For 2022, MAS has kept its overall inflation projection at 1.5% to 2.5%, though we should take this with a pinch of salt as things are still fluid and could change at any time.
Aside from this, we still have the GST hike, which was postponed due to the pandemic. While the exact time of the hike is uncertain, the economic recovery and falling unemployment rate present a great opportunity for a GST hike to be introduced in the Budget 2022. Another motivating factor for the government would be the fact that delaying this unpopular legislation much longer would bring it dangerously close to the impending Presidential Elections in 2023.
What has the GST hike got to do with the inflation? Well, there is a chance that if GST is raised in 2022, it will likely exacerbate the current level of inflation.
What does this mean for banks?
Banks profit from the money we deposit by lending it to businesses. The difference between the interest they pay us and the interest they receive from the borrower is the net interest margin, also known as the average interest margin. Because NIM (net interest margin) reveals the amount of money a bank earns on its loans, it’s a good indicator of its profitability and growth as we look ahead to 2022.
With rising inflation, interest rates are likely to increase to curb spending, inadvertently impacting banks’ NIM.
Conventional wisdom states that consumers are more likely to borrow money and less likely to save it when interest rates are low. With a higher demand for loans than savings accounts, a bank’s net interest margin will increase over time. Conversely, when interest rates rise, loans become more expensive, thus making savings a more attractive option. This consequently decreases a bank’s NIM.
However, in practice, this may not always be the case. Historically, when interest rates fall during a recession, it has frequently coincided with a drop in net interest margins. On the other hand, periods of economic expansion usually correlate with increases in interest rates and net interest margins.
As illustrated in the figure below, NIMs plummeted in the aftermath of the financial crisis, owing to asset yields falling considerably faster than banks could reprice term deposits (Similar to 2020/21). As the asset refinancing wave died down and banks were able to lower deposit rates, NIMs increased back up in tandem with rate hikes (equivalent to the present and possibly in 2022).
So, moving forward, what now? Well, three possible scenarios could happen.
Case 1: Inflation continues to increase but at a moderate pace
At the moment, DBS, UOB, and OCBC have seen their net income increasing, mainly due to decreased credit allowances and lowering of general provisions. This happened as its portfolio improved following the economic downturn last year and not due to the improvement of its net interest margin.
Moving forward, if inflation continues to rise at a moderate pace, allowing for a sustainable economic growth, an increase in interest rate could expand the NIM of our local banks. Thus, this would expand the banks’ earnings.
This is the best-case scenario, and it’s the one I am currently leaning towards to.
Case 2: Inflation continues while our economy slows down
However, if inflation increases too fast, it could spell disaster for the economy.
High inflation is often associated with high volatility, making people uncertain about the future. This uncertainty can hinder economic growth, which is bad for banks in general.
In this scenario, banks’ earnings may drop as their loan books become stagnant or are reduced.
Case 3: Inflation goes away by itself
In this scenario, we assume that consumer demand falls and that the supply chain bottleneck is resolved.
While I doubt it, the surge of the Omicron variant which is considerably more transmissible, could force countries around the world to seal their borders once more. This action could help alleviate the supply chain bottleneck by lowering customer demand.
In this scenario, inflation slows, causing the bank’s NIM and profitability to stay roughly the same.
b) Impact of China’s economic slowdown
Another factor to examine is the growth of the Singapore and China economies in 2022, both of which our local banks tie majority of their loans to. I’m not concerned at all about Singapore. Even though economists have forecasted a slower growth rate for Singapore in 2022, this growth is predictable and unlikely to deviate significantly from the forecast.
On the other hand, China continues to pose the greatest risk to banks due to its volatile growth. While the country continues to be a significant source of revenue for banks, its recent policy change against tech companies and emphasis on common prosperity has created a lot of uncertainty in the Chinese market.
Considering the power shortage and housing crisis, China’s economy and other economies that rely on it could slow down.
According to a report released earlier this month, Nomura’s chief China economist mentioned that due to deteriorating property markets, rising costs of China’s zero Covid strategy and widespread factory closures leading up to and during the upcoming Winter Olympics, GDP growth is expected to decelerate to 2.9% year on year in its first quarter of 2022, down from 18.3% the previous quarter.
Who knows what the second quarter will bring, given the predicted growth is relatively low for a country that has been growing at an average of 7-8%?
Will the Evergrande crisis have a domino effect that will influence the entire economy? Or will China’s economy suddenly soar as it successfully controls Covid or chooses to live with it?
Parting thoughts
All three Singapore banks are currently performing well and given the present inflationary climate, bank stock prices could climb up even more in 2022.
Nevertheless, the ability of local banks to maintain their growth momentum and thus their stock price, is still dependent on how the macroeconomic environment plays out.
- Supposing inflation rises too quickly, our economy could stall. In that case, gains in NIM will almost certainly not be enough to compensate for the revenue lost, owing to a reduction in the loan book.
- If China’s economy continues to slow down, local banks’ earnings growth will also drop (particularly DBS, which has the largest holding in China at 30%, followed by OCBC at 25.6% and UOB at 16%).
It is difficult to say, but I believe that 2022 will be the year in which banks continue to see revenue growth. Who knows? I could be wrong. What are your thoughts?