Fitch Ratings, based in Hong Kong, has indicated that banks in South and Southeast Asia are likely to face significant credit risks due to an ongoing conflict in the Middle East. However, the adverse effects are expected to unfold gradually through individual credit profiles, according to the agency.
The anticipated rise in energy costs, disruptions in supply chains, and diminished remittance flows are expected to exert considerable pressure on banking systems in emerging markets. These systems typically exhibit lower borrower resilience and are more susceptible to inflationary pressures and external shocks. The primary concern for credit analysts is not whether banks will experience immediate difficulties, but rather which banking systems and loan sectors will be affected first if the conflict continues.
Asset quality is likely to come under strain initially in the more vulnerable segments, including retail loans, micro-enterprises, and small and medium-sized enterprises (SMEs). Fitch’s projections for the banking sectors in various Asia-Pacific markets already take into account anticipated asset quality declines. However, an extended conflict could exacerbate challenges in countries that are particularly exposed to fluctuations in commodity prices and trade disruptions, such as the Philippines, India, and Thailand, with Singapore being slightly less affected. In the Philippines, the impact may be more significant than in past crises due to a recent shift in loan growth towards micro, SME, and consumer segments, as banks have reduced their reliance on large conglomerates.
The individual profiles of banks in several emerging markets in the Asia-Pacific region could face increased pressure, as the Viability Ratings (VRs) for these institutions are generally more susceptible than those of banks in developed markets. A decline in VRs could occur if the operating environment worsens beyond Fitch’s current forecasts, particularly if rising fuel costs and supply chain disruptions diminish borrower cash flows, leading to an increase in impaired loans and credit costs.
Industries that are most vulnerable include those with limited pricing power and higher energy demands, such as refining, chemicals, energy-intensive manufacturing, and certain retail sectors. SMEs are generally more exposed to economic downturns compared to larger corporations, although support for state-owned or strategically significant borrowers in some regions may help mitigate bank losses indirectly.
The potential impact on Issuer Default Ratings (IDRs) would be generally constrained in most markets where ratings are supported by government or shareholder backing, though this can vary by country. Approximately two-thirds of IDRs for banks in emerging markets across Asia-Pacific are influenced by such support, meaning that weaker standalone credit profiles do not automatically lead to downgrades in IDRs.
This dynamic is particularly relevant in China, where all bank ratings are driven by support, and in India, where nearly all ratings are similarly influenced. Consequently, while a prolonged crisis could pressure VRs or individual assessments, it might not lead to immediate IDR downgrades. In contrast, in Indonesia and Thailand, IDRs reliant on support are more vulnerable, particularly since their sovereign ratings have a Negative Outlook.
Indian banks seem to be in a better position than many of their regional counterparts to withstand a moderate deterioration in their operating environments. Recent positive rating developments and current asset quality indicators suggest that Indian banks are entering this phase from a relatively strong VR position, with Fitch already factoring in expectations for some weakening in its outlook and rating evaluations.
Nonetheless, the impact is likely to build gradually over time if rising energy costs, a decrease in external demand, or prolonged supply chain disruptions begin to undermine borrowers’ ability to repay. This underscores the importance of the speed and extent of stress transmission, which may be more critical than the initial shock itself.
