You won't believe how bad Asia's nonperforming loans are

Slower GDP, higher interest rates.

According to Moody's Analytics, nonperforming loan ratios have been trending lower in Asia for more than a decade, though the trend may reverse in coming years as economic and financial conditions shift.

Some Asian economies are likely to experience an environment of slower GDP growth and higher interest rates in coming years, which will make debt harder to repay. An increase in bad loans is also likely after Asia’s credit binge in recent years, which poses risk to the region's banking systems and real economies.

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Alarm bells might not be ringing just yet. Bad loans account for less than 5% of all loans across most of Asia, below the rate that caused significant financial problems in the U.S. and many European countries in 2009. 

This can be attributed to more prudent lending standards among Asian banks since the 1997 Asian financial crisis and 2008 global recession and efforts by authorities to increase credit ratings. Economic and financial conditions, including lower interest rates, steadily expanding economies, and rising asset prices have also helped ensure stability in credit markets.

Spotlight on India, Korea and China

That said, the problem is certainly festering for some. A deterioration in credit conditions is already being felt in India, where slower economic growth and rising interest rates have made it tougher for borrowers to repay debt. India’s nonperforming loan ratio increased from a low of 2.3% in 2011 to around 4% in 2013. 

Central bank data show publicly owned Indian banks, which account for about 75% of total lending, are behind the increase in nonperforming loans. 

The government has encouraged lending in an effort to support development of the country’s inadequate infrastructure, but although these intentions are positive, delays to projects and other regulatory issues have weighed on revenues, and thus, developers’ ability to repay debt.

Flash point coming?

Nonperforming loan ratios tend to be low during periods of strong credit and economic growth, as new loans have had less time to go bad. But after a prolonged period of debt accumulation, nonperforming loan ratios tend to rise.

Changes in private debt burdens across Asia and the U.S. in the precrisis years from 2004 to 2008 show a positive correlation with nonperforming loan ratios in the five-year period since 2009.

For instance, China's deleveraging in the lead-up to the 2008 crisis helped lower itsnonperforming loan ratio in the past five years, while India and Korea's leveraging led to a rise in its nonperforming loan ratio. 

Thus, the recent surge in bank lending across most of Asia leaves economies and financial systems at risk. China's massive stimulus and investment splurge has pushed its private credit-to-nominal GDP ratio up more than 60 percentage points since 2009, while debt burdens have grown 10 to 20 percentage points in most other Asian economies in the past five years. 

Some of this lending is likely to turn sour, and a period of slower growth and tighter monetary policy will compound the upward pressure on nonperforming loan ratios.