Moody's Investors Service has issued a negative outlook for the city's banking sector for next year, citing further volatility in the global economy, aftershocks from the Lehman Brothers minibond saga and poor earnings prospects in a saturated market. The ratings agency said yesterday that Hong Kong banks had emerged from the financial crisis relatively unscathed, with healthy balance sheets and strong capitalisation. However, it said a difficulty in growing profits could lead banks to take 'unnecessary and unjustified risks', such as unsuitable and aggressive acquisitions of overseas assets. Banking shares dropped earlier in the day but ended the session slightly up. Dah Sing Banking Group fell 2.79 per cent at one point before finishing 0.17 per cent higher, while Bank of China (Hong Kong) closed flat. 'It's true that growth potential in Hong Kong is low, so the mainland market is really the only way out for a lot of banks,' said analyst Tony Tong of Everbright Securities. 'For example, Bank of East Asia and Wing Hang Bank are both aggressively pursuing this strategy.' But he added Hong Kong banks were unlikely to make unnecessary overseas acquisitions. Moody's stressed that Hong Kong banks did not suffer from a liquidity problem. Banks had exercised caution in safeguarding their portfolios with a flight to quality to more secure assets. Moreover, the total loan-deposit ratio continued to fall, standing at 45.6 per cent at the end of June. The report also highlights the Lehman minibond saga as an 'expensive lesson' for the banking sector. It brought massive negative publicity to banks, sending investors to look for other platforms to invest in. Bank capital bases were not affected by their investments in collateralised debt obligations and structured investment vehicles, Moody's said. But the minibond problem served to highlight a lack of understanding of investments on behalf of these banks and an inability to contain 'reputational' risk. 'People are good at forgetting - if they weren't, people wouldn't be buying so heavily into Bank of China (Hong Kong) stocks, as shown by the increase in fee income in the bank's first-half results,' said analyst Steven Chan of Daiwa Institute of Research. BOCHK reported a fall in net profit in the first half of this year of 5.6 per cent as a result of compensation to buyers of Lehman-linked minibonds, but recorded an increase of 1.7 per cent in net fee income. Moody's warns that the city's economy remains extremely vulnerable to external shocks. This echoed remarks made by Chief Executive Donald Tsang Yam-kuen on Tuesday that a new slump could hit Hong Kong in the middle of next year. Leo Wah, a senior analyst at Moody's, said the impairment loan ratio would continue to rise next year due to a time lag. Despite this, Hong Kong banks are well capitalised enough to absorb any possible impairment losses even in a severe downturn, in line with the results of the Monetary Authority's stress tests.