Uncertain operating environment could increase exposure to toxic assets: Report

Fitch Ratings said in a new report released on Monday that the uncertain operating environment on the mainland is increasing the risk profile of Hong Kong banks and raising the prospects of negative rating action.

"Hong Kong's banks will likely cede some of their historical strengths of robust capitalization and low risk appetite if rapid growth on the mainland causes them to lower their underwriting standards," said Sabine Bauer, director of Fitch's financial institutions team.

Fitch estimated gross mainland exposure could rise to about 35 percent of local banking assets by 2012, up from 24 percent at end-June 2011 and 10 percent at end-2008. To date, the mainland credit exposures of Hong Kong banks have often been short-term, trade-related and collateralized.

However, the operating environment is weaker, and corporate governance and transparency issues are more prevalent on the mainland, the report claimed.

Hong Kong lenders have been creating more mainland-related credit since the city became the country's center for offshore yuan business. Their loans to mainland non-bank companies jumped 47 percent last year while total lending grew 29 percent, the Hong Kong Monetary Authority said in an April circular asking banks to review their business plans and funding strategies.

The report noted that the Hong Kong banking sector still maintains adequate liquidity, and the agency is not expecting near-term systemic liquidity pressures. However, Hong Kong banks' liquidity could tighten suddenly, as the banking sector is sensitive to investor confidence in the "China growth story", global risk aversion, and tight liquidity in the advanced economies. Banks in Hong Kong benefit from substantial foreign-currency funding from foreign banks although this has proven volatile in the past.

However, one local banker who spoke to China Daily wasn't worried.

"Most of the local banks' loans made on the mainland are mainly of the trade finance type, which is usually guaranteed by their mainland counterparts. Therefore the chance of a default is very small," said Hang Seng Bank Executive Director Andrew Fung.

"Local banks are seldom engaged in mainland mortgage loans or in lending to small and medium-sized enterprises, so an economic slowdown or asset price slump on the mainland shouldn't have too much of a negative effect on local banks," he added.

Fitch sees the larger Hong Kong banks, and those which belong to international/mainland banking groups, as best positioned to maintain or expand their market share, as competition will remain fierce in servicing the larger companies with stronger credit profiles.

The limited competitiveness and scale of the smaller Hong Kong banks may tempt them to expand into riskier segments. In addition, those banks which have experienced rapid growth over the last two years, and those most exposed to the mainland may find it most challenging to maintain solid asset quality in a weaker environment, the Fitch report said.

"The usual high loans-to-deposits ratio of local smaller banks and the usually higher exposure ratio to mainland assets mean that the business risks among local medium-sized banks will be higher," Core Pacific-Yamcichi senior banking analyst Timothy Li told China Daily.

Fitch added that the local subsidiaries of the mainland banking parents may be lax in their risk management standards, which could pose a problem in the future.

"Fitch is seeing signs of the increasing influence of mainland banking parents on Hong Kong subsidiaries, which could negatively influence efficiency or even reverse progress in key areas including risk management."

Bloomberg and Reuters contributed to this story.

oswald@chinadailyhk.com

China Daily

(HK Edition 10/25/2011 page2)