Financial institutions feeling the squeeze as economy slows
Financial institution sectors globally are facing deteriorating credit conditions as slower economic growth, higher living costs and rising unemployment put pressure on asset quality, according to Fitch Ratings.
The rating agency has stated that several key bank, non-bank financial institution (NBFI) and insurance sectors that had ‘neutral’ sector outlooks in mid-2022 now have ‘deteriorating’ sector outlooks for 2023, reflecting the weaker macro-economic environment. Rating Outlooks are still predominantly Stable in most FI sectors, largely due to rating headroom, but headroom could be eroded if macro-economic conditions worsen beyond our expectations.
Bank sector outlooks are mostly ‘deteriorating’, except in the Asia-Pacific region. Many banks benefited from widening net interest margins linked to higher interest rates during 2022, while impaired loans remained close to historical lows.
However, Fitch expects the spotlight to be on asset quality in 2023 as pressure on borrowers starts to translate into higher credit losses. If the economic downturn becomes more severe, spillover and contagion risks could worsen, particularly for emerging market economies, where changes in sovereign credit profiles could affect banks’ Issuer Default Ratings.
Half of NBFI sector outlooks are ‘deteriorating’, a material increase from mid-2022. NBFIs, like banks, will face increasing pressure on asset quality in 2023. In addition, their access to funding will be costlier and, in some cases, constrained.
Finance and leasing companies and business development companies are likely to be particularly challenged except in the Asia-Pacific region, where strong product demand and relatively wide margins will help to protect earnings. NBFIs with balance-sheet-light business models are likely to be less affected by the macro-economic pressures.
Insurance sector outlooks are mixed. Non-life insurance sector outlooks in many developed markets are ‘deteriorating’ as market competition may prevent insurers from raising premiums enough to compensate for increasing claims costs due to high inflation.
This could lead to significant erosion of underwriting margins.
In contrast, the outlooks for non-life sectors in emerging markets, and for life sectors, are predominantly ‘neutral’. Non-life insurers in emerging markets typically have more scope to increase premiums to offset inflationary cost pressures as pricing competition is less intense.
Life insurers are less exposed to inflation as claims amounts are typically fixed or linked to market values of underlying assets. Moreover, life insurers generally benefit from higher interest rates given their high investment leverage, although higher investment yields could be marginally offset by an increase in credit costs.
The key downside risk to Fitch’s FI sector outlooks is a worsening of global macro-economic conditions materially beyond our expectations. In particular, higher central bank policy rates to combat persistently high inflation could significantly hinder economic growth and increase unemployment. This could lead to credit losses exceeding our baseline forecasts.
