Published October 1, 2008
Storm clouds gathering over banks
By SIOW LI SEN

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LOCAL banks normally make money from gapping operations, that is, lending on the interbank market. So the silver lining - as some see it within this awful mess - is that the three local banks can earn profits from deploying funds on the wholesale interbank market as local interest rates spike up.
But talk to any veteran banker from any of the three banks - DBS, United Overseas Bank and OCBC Bank - privately, they are likely to tell you that they'd rather not earn this kind of profit because what caused the spike is the contagion of fear which has now landed on our shores. Risk aversion of lending to other banks and customers, which has caused global financial markets to seize up since last year, has caught up with bankers here, as no one knows which institution may be hit next. This caused short-term interest rates, or the three-month interbank rate, to more than double from one per cent in August to 2.23 per cent last Friday before the Monetary Authority of Singapore (MAS) injected money into the system and the rate eased back to 2 per cent. Yesterday, the rate fell to 1.85 per cent.
The interest rate trend over the next few weeks is far from clear though some are even betting that the US Fed will reduce its rate to one per cent from the current 2 per cent in the near term. Local rates will follow. In the meantime, many central banks including the MAS will continue to inject funds into the system to ease market funding pressures. MAS said last Friday that it was prepared to inject additional liquidity, if required.
What's becoming increasingly likely is that we are headed for a recession and things will get very tough. MAS could loosen monetary policy to help exporters and increase our competitiveness vis-a-vis regional rivals. But that means a depreciation of the Singapore dollar. As MAS moves on the Singapore dollar, asset values such as property and stocks will be hit further because of capital outflows.
Part of Singapore's attractiveness has been its strong dollar over the past three years and foreign investors invested here to enjoy currency gains as well as asset appreciation. The Singdollar has since fallen about 6 per cent from its July high of $1.345 to one US dollar. Some predict that the Singdollar could drop to $1.50 by the year-end though others say the fall will be capped by it being regarded as a safe haven currency within the region.
Downward spiral
A note from Citi yesterday commenting on the failure of the US rescue plan said that it will accelerate the downward spiral in global financial markets, as markets are dragged into a new vicious cycle of losses and accelerated deleveraging. 'Asset prices in Singapore will not be spared, as downside risks to earnings, heightened risk aversion, and a flight to quality could accelerate outflows of foreign portfolio capital,' it said. In August, Singapore's foreign exchange reserves fell by US$4.86 billion to US$170.1 billion.
Citi banking analyst Robert Kong thinks that based on history, the STI can fall by more than 50 per cent from its peak during prolonged downturns. At yesterday's close of 2,361, the STI had corrected around 40 per cent from its peak in October 2007. He said that depending on the depth of a possible recession, an STI of 1,800 by mid-2009 is no longer unrealistic. Citi also expects a longer export slump than originally expected, and domestic demand - which has held up relatively well so far - could weaken substantially as well. 'Although job creation has held up remarkably well in the current downturn, this is likely to slow substantially, and mass retrenchments cannot be ruled out.'
Citi property analyst Wendy Koh thinks that sentiment in the property market, already fragile, would be dented further, while job losses in the financial sector could add to housing woes.
High-end residential property is expected to decline a further 25 per cent, while prices in the mid-market could fall another 15 per cent, and the mass market could decline 5-10 per cent. Ms Koh had earlier predicted that high-end prices would fall 20-30 per cent from their recent peak.
She expects office rentals to halve by end-2010 and capital values to fall some 38 per cent from current levels. Apart from oversupply, there is a risk of rapidly falling demand and potential withdrawal of office space amid the financial crisis.
Whatever gapping margins the three local banks will enjoy could be more than offset by upcoming problems in the wider economy.