Hong Kong banks well prepared for coming downturn

A stress test by Fitch ratings said that the city’s banks have sound capital positions and earnings buffers.

PUBLISHED : Tuesday, 07 June, 2016, 3:52pm
UPDATED : Tuesday, 07 June, 2016, 3:52pm

Hong Kong banks are well prepared to withstand challenges from a downturn in the credit cycle because of their sound capital positions and earnings, according to a recent stress test of 13 Hong Kong banks conducted by the Fitch Ratings agency.

A slowdown in the Chinese economy and turmoil in the Hong Kong property market were considered in the stress test.

In recent years, Hong Kong banks have increased their exposure to mainland China. Fitch said that the direct impact of a slowdown in the Chinese economy on Hong Kong banks would include higher borrower default rates and difficulties in collateral enforcement and disposal.

“We would also expect spillovers from slower loan growth, a possible recession, a sudden shift in market confidence coupled with fund outflows,” the report said.

Domestic property exposure has been a traditional area of risk in the Hong Kong banking system.

Fitch’s stress test consisted of two scenarios, a base case and a more severe case.

Bank of China Hong Kong emerged the strongest from the base case scenario and Hang Seng from the severe scenario.

Sabine Bauer, senior director financial institutions, at Fitch said: “Our base case, the scenario that we consider most likely, is that the banks would all remain profitable and their average non-performing loan ratio would stay below two per cent at the end of 2018.”

The non performing loan (NPL) ratio compares of the amount of loans in default with the total number of outstanding loans given by a bank.

Bauer said that Fitch’s extreme case was possible but less likely as it assumed a shock caused by various negative events.

In this more extreme and less likely case, “we would see a more serious deterioration in asset quality over the three-year stress period with average NPLs of eight per cent at the end of 2018,” she said.

Nonetheless, “under this scenario, capital buffers are depleted but we believe that systemic stability can be maintained,” Bauer said.

Capital buffers are funds banks are required to hold in addition to minimum capital requirements.

The single biggest risk in both scenarios was the banks’ exposure to mainland China.

“The extent of asset deterioration will vary subject to banks’ exposure [to the mainland]” the report said. Fitch’s findings showed that Bank of East Asia, China Citic Bank International, and China Construction Bank Asia were the most vulnerable to losses in this regard.

“We are mindful about greater cyclical volatility. Hong Kong banks’ risk profiles have evolved, with their exposure to China [now] much larger than in the last downturn. We expect this trend to continue over the long term,” Bauer said.

“This higher risk could justify banks maintaining greater absorption buffers and capital ratios above global standards, in our view,” Bauer said.

The report found that the potential losses arising from banks’ domestic property loans would be moderate as this lending was tightly supervised. Hang Seng Bank, DBS Hong Kong, and Shanghai Commercial Bank were most exposed to a domestic property correction, the test showed.

“Hong Kong banks are quite resilient, and have sufficient capital to weather the problems,” Sherry Zhang, an analyst at Moody’s said. “In comparison with their international peers, banks in Hong Kong have plenty of capital and ample liquidity.”

Nonetheless, since 2013, Moody’s has given Hong Kong’s banking sector a negative rating, which remains unchanged and Zhang said that the operating environment for banks in Hong Kong was continuing to deteriorate

“There are two reasons for this, deteriorating external macro-economic conditions and tightening interest rates,” she said.