Moody's Investors Service says in a new report that the profitability of Asia-Pacific banks will deteriorate over the next few years as the coronavirus outbreak accelerates structural changes.

"Lower-for-longer interest rates, rising credit costs and operating expenses, and in some countries aging populations will on weigh on the profitability of APAC banks in coming years, with many of these trends exacerbated by the coronavirus outbreak," says Rebaca Tan, a Moody's Assistant Vice President and Analyst.

"While the region's banks are all facing a growing need to change their business models to overcome these challenges, laggard institutions are at a greater disadvantage," adds Tan.

Banks' return on assets (ROA) already declined in 12 out of 17 APAC banking systems between 2014 and 2019, and is likely to remain weak at least through 2020-21. Among other factors, deflationary pressure from a reduction in aggregate demand and low oil prices will keep interest rates low for a prolonged period, leading to declines in interest income and NIM compression to levels that can only be partly offset by reductions in funding costs.

Another drag on profitability is likely increases in credit costs as asset quality weakens, while the accelerating shift to digital banking services will push up operating expenses.

To reduce their dependence on net interest income from domestic markets, banks will increasingly pursue other revenue sources or expand overseas while continuing with digitization. However, these options have their own challenges, especially for laggard banks that lack the vision or resources to overhaul their business models.

The gap between agile large and laggard banks in their ability to tackle profitability challenges means the former will widen their competitive edge. In the long term, laggard banks that fail to change their business models will become acquisition targets or will have to merge to survive.