Banking shares in the region may look cheap but they are no bargain, Merrill Lynch says. Many Asian banks were trading at valuations close to historic lows, but the increased risk in the region justified the low valuations, analyst Keith Irving cautioned in a report. Some banks have lost their access to cheap foreign capital and still more face the risk of greater corporate defaults in the year ahead. Banks with a significant foreign currency component in their balance sheets will be hit hard by the currency depreciation and withdrawal pains of relatively cheap foreign credit. At the same time, higher interest rates would slow lending growth and lead eventually to increased provisions, the report said. South Korean banks have the highest proportion of non-performing loans in their portfolios but Mr Irving has forecast Thailand to surpass Korea by next year. Thai banks might eventually have to consider writing off 17.5 per cent of their loans outstanding by next year, the report said, compared with an estimate of 13.7 per cent for their Korean counterparts. Higher interest rates could give an immediate boost to some of the region's banks but in the long run margins would tighten. Over the short term, many banks will benefit from being able to charge more for their loans, while most of their deposit base - an average of 80 per cent - is tied up in time savings accounts paying last month's, last quarter's or last year's rates. But the report said: 'The longer that high market rates are sustained, the greater the proportion of the deposit base which will reprice at higher rates.' Less money will be borrowed at the higher rates, eroding loan growth. Banks with high loan-deposit ratios, such as in Korea and Thailand, will be squeezed more quickly by high market rates.
