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Why We Prefer EM Banks Over Their DM Peers

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Sr. Research Analyst

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In light of the recent developments with Silicon Valley Bank and Credit Suisse, many clients have asked us if emerging markets banks have exposure to similar risks. The answer, as we explain in this and a related article, Why Leading EM Banks Don’t Present the Same Risks SVB and Credit Suisse, is a resounding “No.” Emerging markets banks, in fact, have more growth opportunities and less risk exposure than many of their developed markets counterparts, including those that do not face the challenges confronted by Silicon Valley Bank and Credit Suisse.

May 2023

Overall, banking is not an industry in which we see sizable growth opportunities for long-term investors. In general, banking, or any lending business based on leverage, is fraught with credit, liquidity, and regulatory risks. Substantial credit or asset impairment losses, for example, can wipe out a bank’s equity or capital. That can make the business unsustainable unless there is a substantial capital injection. Overall, these risks make banks relatively unattractive compared with the other sectors in which Sands Capital has historically invested. Still, there is a considerable difference between the growth prospects of emerging markets (EM) versus developed markets (DM) banks.

In the developed markets, banking is mostly a mature industry that sells commoditized products and services. In most emerging markets, however, the very low rates of penetration for financial services create secular growth opportunities for banking and other financial services firms. A disproportionate share of the value created tends to be captured by a select number of leading institutions that have superior brands, strong distribution capabilities, a diverse array of products, significant capital, and high-caliber management teams. All these advantages have, over a long period, generally delivered above-average growth for the banking industry in emerging markets, with sustainable competitive moats for the region’s leading banks.[1]

The Persistent Challenges for DM Banks

In developed markets, the combined effects of slow gross domestic product growth and high credit penetration now limit the growth opportunities for many banks’ lending operations. The maturity of the financial systems in developed countries also creates substantial room for competitors to offer some of the core services that banks have traditionally offered. Loans can be acquired from the bond market, shadow banks, and other financial intermediaries, while deposits can be directed to money market funds, investment assets, or insurance products. The result of these combined factors is that DM banks do not have an underlying secular growth trend that can support their businesses. Instead, DM banks rely more heavily on financial engineering to drive their growth.

The Benefits of a Less Mature Banking Sector in EM

The situation is far different for banks in emerging markets. In many EM countries, the baseline economic growth rate exceeds 5 percent annually, and credit penetration is often substantially below the level seen in DM countries (see exhibit below.) The opportunities to provide access to basic financial services—such as credit, savings, payment mechanisms, and wealth management—can deliver secular growth for the banking industry in these markets. The fact that these markets are still in the early stages of access to financial services can create a foundation for sustainable earnings growth because, as the leading EM banks are likely to grow by simply focusing on the core banking functions of taking deposits and issuing credit.

Much Lower Levels of Debt Penetration in Emerging Markets

Source: World Bank as of December 31, 2022. https://data.worldbank.org/indicator/FD.AST.PRVT.GD.ZS?most_recent_value_desc=true, Bank of International Settlement (BIS) https://www.bis.org/statistics/totcredit.htm?m=2669 as of Feb. 27, 2023.

In India, for example, even after decades of double-digit retail loan growth, household credit penetration, as a percentage of GDP, is just 35 percent, compared with about 75 percent in the United States. Additionally, in emerging markets, there are very few alternatives to the major banks that can meet customers’ savings and borrowing needs. This concentrates the secular growth opportunity into the hands of the leading banks, which are able, in turn, to leverage their superior scale, brand equity, and capital to benefit disproportionately from these markets’ growth potential. The result is often a set of large banks with significant profitability and growth relative to their DM peers. These large EM banks can also take less risk. They do not need to expand into complex and esoteric financial activities to create long-term value for their shareholders.

Related: Why Leading EM Banks Don’t Present the Same Risks SVB and Credit Suisse Did

[1] Source: RBI Database, HDFC Reporting, as of December 31, 2022.

Disclosures:

The views expressed are the opinion of Sands Capital and are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. The views expressed were current as of the date indicated and are subject to change. This material may contain forward-looking statements, which are subject to uncertainty and contingencies outside of Sands Capital’s control. All investments are subject to market risk, including the possible loss of principal. Readers should not place undue reliance upon these forward-looking statements. There is no guarantee that Sands Capital will meet its stated goals. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase.  

Silicon Valley Bank and Credit Suisse were not held in any Sands Capital strategies and is referenced for illustrative purposes only.

References to “we,” “us,” “our,” and “Sands Capital” refer collectively to Sands Capital Management, LLC, which provides investment advisory services with respect to Sands Capital’s public market investment strategies, and Sands Capital Ventures, LLC, which provides investment advisory services with respect to Sands Capital’s private market investment strategies, which are available only to qualified investors. As the context requires, the term “Sands Capital” may refer to such entities individually or collectively.

As of October 1, 2021, Sands Capital was redefined to be the combination of Sands Capital Management, LLC and Sands Capital Ventures. Both firms are registered investment advisers with the United States Securities and Exchange Commission in accordance with the Investment Advisers Act of 1940. The two registered investment advisers are combined to be one firm and are doing business as Sands Capital. Sands Capital operates as a distinct business organization, retains discretion over the assets between the two registered investment advisers, and has autonomy over the total investment decision-making process.

Information contained herein may be based on, or derived from, information provided by third parties. The accuracy of such information has not been independently verified and cannot be guaranteed. The information in this document speaks as of the date of this document or such earlier date as set out herein or as the context may require and may be subject to updating, completion, revision, and amendment. There will be no obligation to update any of the information or correct any inaccuracies contained herein.

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