International Monetary Fund warns Hong Kong over mainland exposure

The mainland is now Hong Kong's most systemically important exposure in terms of a potential shock to interbank markets, the International Monetary Fund said yesterday, urging the city's de facto central bank to remain focused on mainland lending exposures.

Under an extreme scenario presented in the IMF analysis, if the default rate in the mainland banking system's interbank obligations hit 80 per cent, the losses because of Hong Kong banks' exposure to the mainland interbank market would wipe out all the capital in the city's banking system.

The IMF said the HKMA should work with mainland regulators to facilitate an orderly resolution of distressed assets and address any weaknesses in banks' balance sheets.

The exposure of Hong Kong's banks to mainland companies has soared since the middle of last year, when a tightening of onshore liquidity saw many mainland firms looking offshore for funding.

The Hong Kong financial system's external claims on the mainland are now about 160 per cent of the city's gross domestic product, with 120 per cent comprised of claims on banks and 40 per cent claims on non-bank institutions, the IMF said.

On the banking side, foreign bank lending accounts for around 40 per cent of the total because of mainland entities lending through their branches in Hong Kong.

The HKMA has stepped up its supervision of Hong Kong-based banks' credit risk management last month, asking them to show they had stable funding requirements and agree to regular stress testing and onsite examinations of credit underwriting processes.

A 44.5 per cent annual surge in total loans in the Hong Kong banking sector in January prompted the HKMA to introduce its Stable Funding Requirement, which requires banks to increase their deposit base if their loan book grows by more than 20 per cent per year.

While the global body acknowledged that soaring exposure to the mainland was a key risk factor for Hong Kong's financial stability and economy, the IMF said stress tests that they conducted on the city's banking system showed that the lenders were still "very well capitalised" to absorb a broad range of severe financial shocks, including a possible economic downturn that could generate significant losses in their exposure to mainland credit.

"These exposures are recognised by all of us as a key risk factor for Hong Kong," Allison Holland, deputy unit chief of the IMF's monetary and capital markets department, said in a conference call yesterday.

"The stress test confirmed the Hong Kong banking sector would be robust enough to absorb a range of severe shocks, including losses in credit exposure to mainland China.

"In addition, the effectiveness of the regulatory regime framework is very robust, providing comfort that any emerging risks will be identified early and closely monitored."