Hong Kong banks among world’s most profitable thanks to low costs, better asset quality

Tight cost control along with better asset quality has allowed Hong Kong’s biggest banks to offer shareholders the highest returns in the region

PUBLISHED : Sunday, 20 August, 2017, 2:58pm
UPDATED : Sunday, 20 August, 2017, 10:08pm

The large banks in Hong Kong are some of the most profitable in the world, partly due to their low costs, according to industry experts.

Banking analysts say this is partly a result of market fundamentals, but also comes down to cost control decisions taken by the banks themselves. In this regard, HSBC Hong Kong, Bank of China Hong Kong and Hang Seng Bank have performed much better than Standard Chartered and Bank of East Asia.

Other factors driving the sector’s profitability include high loan growth and few substantial problems with asset quality.

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Morgan Stanley analysts calculated that Hong Kong banks’ have offered returns with a compound annual growth rate of approximately 14 per cent over the past five years, the strongest performance among all the Asia Pacific ex Japan MSCI country bank indices for the period.

Their performance can also be seen in Hong Kong’s contribution to the results of the large global banks with a presence in the city.

HSBC Group as a whole made pre tax profits of US$10.2 billion in the first half of this year; HSBC in Hong Kong alone made nearly half that figure – US$4.6 billion.

Standard Chartered announced first half pre tax profits of US1.91 billion at a group level; Standard Chartered Bank Hong Kong made just over a third of that – US$662 million.

“[This] offers a reminder of the dominance of Hong Kong, despite the fact that Standard Chartered’s recent growth in Hong Kong has been ‘soft’ relative to peers,” Ian Gordon, head of bank research at Investec, said in a report.

Anil Agarwal, head of Asia ex Japan banks research at Morgan Stanley, said profitability of the largest banks in Hong Kong was “partly the nature of the beast”.

“For banks the largest cost is on the liability side, actually raising the assets to lend. But in Hong Kong, if you have consolidated market share, you need a lot fewer branches to raise a deposit base,” he said.

In Hong Kong, deposits per capita are over US$200,000, the highest in Asia. To take an example at the opposite end of the spectrum, in India they are 80,000 rupees (US$1,200).

Consequently, large banks in Hong Kong can raise a lot of money more cheaply than their competitors overseas, and gain greater returns when they lend it out.

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However, Agarwal said the low cost base of the largest Hong Kong banks was also a result of actions taken by the banks themselves.

Morgan Stanley analysts, including Agarwal, said in a report that of the top five banks in Hong Kong, the three largest (HSBC Hong Kong, Bank of China Hong Kong and Hang Seng) were much more efficient from a cost perspective than the other two (Standard Chartered and Bank of East Asia).

The first three had a cost to income ratio of under 40 per cent in 2016, as opposed to one of about 60 per cent for BEA and Standard Chartered.

BEA is in the middle of a three year cost cutting programme, although Standard Chartered says it has completed its attempts to cut costs.

“The three largest banks are absolutely great in terms of cost control,” said Agarwal.

“It is easy for banks to fritter away cost advantage by spending more on staff costs or expansion, but the largest Hong Kong banks have been very disciplined in keeping a tight leash on cost income ratios.”

As for profits, loan growth has been strong in Hong Kong, and across the sector loans in the first six months of this year were up 15 per cent compared to the same period last year.

One reason for this was policies on the mainland. Deleveraging means that mainland banks are less willing to lend to corporates, who instead look to Hong Kong banks. Yue Yi, chief executive of Bank of China Hong Kong, said in June that capital controls on the mainland had driven more Chinese corporates to borrow in Hong Kong.

However, even loans for use in Hong Kong were up 14 per cent year on year, as the economy has performed well.

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As for asset quality, analysts have two major concerns for Hong Kong banks – mainland lending, and mortgages – but neither offer a major threat at this stage.

“China-related lending, undoubtedly, will remain the biggest concentration risk for Hong Kong banks. However, the way it is managed and supervised is evolving and we have been seeing corrective actions from some banks or in other cases just a sensible slow-down which supports their loan quality,” said Sabine Bauer, senior director at ratings agency Fitch.

As for property, this is a concern but residential mortgages made up just 5 per cent of the banking systems assets at the end of 2016, and since then the HKMA has taken repeated action to limit banks’ exposure to the property sector.