Fitch Ratings says in a special report that prospects have improved for most emerging market (EM) banks in recent quarters as the global economic recovery gains momentum and many EMs are forecasted to return to solid growth in 2010. However, Fitch has significant asset quality concerns about banks in China in the medium term, following recent rapid loan expansion in that market, and many banking systems across Central and Eastern Europe (CEE) and the Commonwealth of Independent States (CIS) are still working through asset quality problems and adapting to funding constraints which have emerged during the crisis.

In most EMs, particularly in Latin America and Asia, banks have weathered the crisis better than was anticipated 18 months ago, and positive rating actions exceeded negative ones in H209 and Q110. Bank upgrades in Turkey (Q409) and Indonesia (Q110) have followed sovereign rating actions, and most Russian privately-owned banks were placed on Rating Watch Positive/Evolving in Q110, reflecting the sector's better than expected performance during the crisis. Even in markets worst affected by the crisis, such as Kazakhstan, Ukraine and the Baltics, any further negative rating actions are likely to be limited given significant downgrades to date, potential parent bank support and some signs that recessions are starting to bottom out in these countries.

Loan growth in China in 2009 far outpaced that in other EMs, and by year-end Chinese banking assets exceeded those of the other 23 systems covered in Fitch's report, combined. Although Chinese loan growth is likely to slow in 2010, and reported asset quality remains sound to date, such a rapid expansion gives rise to significant asset quality concerns in the medium term, in Fitch's view. On a global basis, loan to GDP ratios look high in China, Taiwan, Latvia, Estonia and Ukraine relative to sovereign rating levels, while penetration is moderate in Mexico, Peru, Indonesia and Colombia.

Asset quality deterioration has been particularly sharp during the crisis in the CIS and the Baltics, driving large sector losses in 2009 in these markets, with the exception of Russia. Risk charges were also significant in Brazil and Mexico, reflecting a combination of loan impairment, in particular on high-margin/high-loss retail portfolios, and prudent provisioning/write-off policies. However, charges in these two markets were offset by good revenue generation and are expected to moderate in 2010.

Margins remained healthy across LatAm and in Indonesia and Turkey in 2009, while spreads were tighter in CEE and the rest of Asia. Cost/income ratios were globally in the sound 40%-60% range, with lower ratios in LatAm and some CEE markets. Overall, solid 2009 results in Turkey and across LatAm suggest a robustness of banks' business models in these regions, while Asian markets also remained profitable.

Foreign-currency lending is high in many CEE markets, Kazakhstan, Ukraine and Peru, reflecting dependence on cross-border funding and/or high shares of FX deposits, as well as lower FX loan rates. However, FX lending is moderate in Asia and elsewhere in LatAm. Loan/deposits ratios are high across much of CEE and CIS, and at the top end of the scale this is highly correlated with asset quality deterioration during the crisis, with Ukraine, Kazakhstan and the Baltics topping both charts.

Capital ratios are solid in Turkey, Brazil and Indonesia, given quite robust balance sheets in those markets, while Russian banks' significant loss-absorption capacity has helped institutions navigate asset quality problems during the crisis. China, Taiwan and India operate with tighter capital ratios than most other EMs, increasing exposure to any future increase in loan impairment.

State ownership remains considerable in the seven largest EM systems, and this has helped support loan issuance during the crisis in several other markets in addition to China. High foreign ownership in CEE and parts of LatAm may reduce contingent sovereign liabilities, but can also make local economies dependent on parent bank policies.