China loans grow along with vigilance at Hong Kong banks

Rising exposure to the property and manufacturing sectors in coastal provinces fuels default risks amid slowing growth across the border

PUBLISHED : Monday, 18 August, 2014, 4:01am
UPDATED : Monday, 18 August, 2014, 4:01am

A default at a small property developer on the mainland could spook bankers thousands of kilometres away in Hong Kong.

That is because the city’s banks are rapidly growing their exposure to the mainland at a time when its economic stability has come under pressure.

Lending to coastal provinces – an area that has already seen early defaults this year – was the riskiest bet, said Brian Li, an executive director at Bank of East Asia. During a press conference this month for the release of the bank’s first-half earnings, Li called Zhejiang province a “high-casualty area” for non-performing loans.

On-balance-sheet lending to non-bank mainland customers continued to grow rapidly in the first half of this year at several Hong Kong banks, interim earnings reports showed.

Hang Seng Bank ratcheted up its lending to mainland customers by 51 per cent year on year, while Standard Chartered Bank (Hong Kong) grew that exposure by 61 per cent.

Moody’s Investors Service expects banks to continue ramping up exposure through to the end of next year. The ratings agency maintained a negative outlook on the Hong Kong banking sector in June, citing both rising exposure and elevated economic risk on the mainland.

Hong Kong’s exposure to the mainland grew 29 per cent last year, accounting for 20 per cent of total banking assets, or HK$2.3 trillion, by the end of the year, a Moody’s report said.

The International Monetary Fund has warned twice this year that the city’s banks faced substantial risk if the mainland economy slowed rapidly.

Economic conditions on the mainland have shown signs of improvement after a slow start to the year but the spectre of defaults still haunts the property and manufacturing sectors in several coastal provinces.

“The riskiest investments we see here are in trusts that go into the property sector – speculative borrowers investing in shadow banking, trusts, that kind of thing,” said Eliza Liu, head of research at China Construction Bank International in Hong Kong, of the most worrisome spots for Hong Kong bankers.

In response to concerns, the Hong Kong Monetary Authority has said it is monitoring the situation closely but growing exposure is a “natural consequence” of economic growth on the mainland.

A still-high rate of economic growth is just one factor that has driven mainland-bound lending.

Higher interest rates on the mainland have also pushed companies there to search out loans in deposit-rich Hong Kong. The Hong Kong dollar’s peg to the US dollar, coupled with loose monetary policy in the United States and Europe, has kept the city awash with cash. A downturn in mortgage lending has led banks to focus on corporate business.

“Banks have a lot of liquidity and they need to lend it out,” said Paul McSheaffrey, head of banking at KPMG in Hong Kong. “If the loan demand isn’t here from Hong Kong corporates, then they are looking across the border at corporates, particularly in southern China.”

A large component of lending exposure to the mainland is not even going to mainland firms. Many loans on the mainland books are extended to Hong Kong-based firms that have boosted their presence on the mainland, said Stephen Sheung, head of investment strategy at SHK Private.

“A lot of these Hong Kong companies used to do a lot more business in Hong Kong,” Sheung said. “But now they’re increasingly on the mainland.” The uptick in cross-border lending was almost unavoidable, he said.

Some local banks, though, have figured out how to mitigate risk while continuing to lend to mainland firms, namely by financing those firms’ offshore operations and distancing themselves from onshore risk.

BEA said when announcing its first-half earnings that it was changing its focus towards lending to mainland firms offshore.

DBS Bank said much the same when it reported earnings.

“Our available position is to help these companies for their offshore needs,” Alex Cheung, managing director at DBS Hong Kong, said at the release of the Singaporean bank’s interim results.

That form of mainland exposure could decrease risk in Hong Kong, said Edmond Law, an analyst at UOB Kay Hian. 

he demand will still be there but I think banks will be more selective going forward,” he said. “I know that some banks are trying to lend to Chinese companies that are exposed in Singapore and London.”