Asia Pacific banks' cyclical pressures finally easing

But high private sector debt still a key risk.

Some of the cyclical pressures faced by Asia Pacific (APAC) financial systems are beginning to ease, owing largely to a revival in global trade and a strong start to the year in China. However, Fitch Ratings says high private-sector debt remains a risk to financial system stability and bank performance across much of the region, particularly with US interest rates likely to continue to rise over the next few years.

Here's more from Fitch Ratings:

A synchronised improvement in advanced and emerging economies is driving a stronger recovery in global GDP growth and trade volumes. The pick-up in trade has been particularly robust in APAC, led by the policy-driven rise in Chinese demand.

Commodity prices have recovered since early 2016, reducing strains in resource-linked sectors, while currencies and asset prices have held up well amid US rate hikes. These trends have helped support bank performance across most of the region. Asset quality, for example, has remained healthier than we had expected.

Fitch's sector outlook is still negative for 10 of APAC's 17 rated banking systems, but that is down from 13 at the start of the year. We have removed the negative sector outlooks on Hong Kong and Macau - two economies with particularly close links to China. Our sector outlook on Japan has also been moved to stable from negative, which mirrors a similar change in the sovereign rating.

Nevertheless, the build-up in private-sector debt and the rise in property prices over the last decade of ultra-loose global monetary policy have created financial risks that could still be tested by US rate hikes. Thailand, Malaysia, Korea and Singapore stand out as economies where household debt has risen strongly, while corporate debt has soared in Hong Kong and China.

Several factors mitigate the risk of an outright financial crisis in China, but a sharp slowdown in its economy is one of the key potential risks facing other APAC banking systems.

New and evolving regulations could add to pressures on banks, but will ultimately strengthen financial systems. The main changes will be the agreed phase-in of higher capital requirements and - in Japan's case - higher total loss-absorbing capacity (TLAC) requirements. Fitch expects APAC banks to issue new loss-absorbing capital and debt instruments totalling USD200 billion by end-2018 to meet the requirements.

Banks in China, Japan and India will account for most of this issuance. A focus on risk-weight calculations and robustness of models will also keep banks in the more developed markets busy over the next few years. More jurisdictions are likely to implement bail-in legislation, but support is unlikely to disappear in most markets as the authorities remain reluctant to impose losses on senior creditors.

Most APAC banking systems are well-positioned to cope with pressures, but the potential for rating changes stemming from asset-quality issues is highest in India and China.

In India, where problems are concentrated among state banks, the government appears to be willing to provide capital to stronger banks to support growth, while providing weak banks with only the capital needed to meet minimum requirements - in order to encourage them to downsize and/or consolidate.

In China, risks are highest at second- and third-tier banks, which have weaker capital, larger exposure to shadow banking and higher reliance on short-term wholesale funding than the much stronger state banks.