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Friday, August 21, 2020, 11:23
SAR banking resilient in pandemic
By Oswald Chan
Friday, August 21, 2020, 11:23 By Oswald Chan

HK’s banking system is expected to weather the tough times even though the COVID-19 outbreak has had a negative effect on banks’ bottom lines. The prospects of the lenders’ profitability and asset quality have been dimmed by the pandemic, but the banks remain competitive. Oswald Chan reports from Hong Kong.

US-based credit rating agency Fitch Ratings has painted a negative outlook for Hong Kong banks’ earnings and profitability to reflect the risks associated with the coronavirus pandemic and the city’s prolonged social unrest.

In a research report in June, the agency warned that low interest rates and weak market sentiment could affect revenue, as could a pickup in bad-debt provisions that it believes will persist well into next year.

It sees Hong Kong banks’ impaired loan ratios and average credit costs rising, and net interest margins and fee incomes dropping. However, Fitch expects Hong Kong banks’ financial profiles to remain resilient despite the economic shock, and capital buffers should remain sufficient relative to banks’ rating levels even if they maintain dividend payout ratios.

The Hong Kong Monetary Authority — the city’s banking industry regulator — said the SAR’s banking sector had been resilient in the first quarter of this year although lenders’ profitability has fallen and asset quality has deteriorated compared with a year ago.

Close monitoring

“The capital adequacy ratio currently stands at 20 percent, which is more than double the international standard of 8 percent, while the liquidity coverage ratio is at 160 percent — much higher than the international requirement of 100 percent. This provides a strong buffer against possible asset quality deterioration and, more broadly, the ongoing economic downturn,” an HKMA spokesperson told China Daily.

With lower interest-rate levels, retail banks’ net interest margin narrowed to 1.51 percent in the first quarter of this year from 1.58 percent for the same period in 2019. Banks also expect their asset quality to deteriorate in the coming quarters because of COVID-19’s adverse impact on borrowers’ repayment ability, and therefore the banks’ provisions for potential bad loans may go up further, according to the HKMA’s June quarterly bulletin.

“The HKMA has been closely monitoring banks’ asset quality, and has required banks to uphold their loan classification standards to reflect any changes in asset quality in a timely manner. Reflecting the prudent credit risk management adopted by banks in Hong Kong, the banking sector’s classified loan ratio has continued to stay at low levels in recent years,” the HKMA spokesperson added.

Besides good asset quality, as well as adequate liquidity and capital adequacy, the total deposits of Hong Kong banks remained stable in the first quarter of this year, with fluctuations within normal ranges, and with no noticeable outflow of funds from the banking system.

In late May, US President Donald Trump said he will revoke Hong Kong’s special status that treats the SAR as a customs region separate from the Chinese mainland. In mid-July, Trump signed into law the Hong Kong Autonomy Act, laying the groundwork for sanctioning Hong Kong financial institutions.

Market rumors have it that US economic sanctions against Hong Kong banks will trigger capital outflows from the SAR, and the local currency will weaken. 

However, the Hong Kong dollar had traded strongly in recent months, sparking intervention by the HKMA to absorb Hong Kong dollar inflows and drive up the aggregate balance of the city’s banking system due to strong capital inflows into the equity market, a robust initial public offering pipeline, and listed companies’ dividend payouts.

The HKMA has injected more than HK$109 billion (US$14.1 billion) to prop up the Hong Kong dollar since April. The aggregate balance rose to HK$187.7 billion as of Aug 6, the highest since 2017, versus HK$54.1 billion on April 21.

“Hong Kong’s highly efficient and well-regulated financial system has proven its robustness and resilience amidst multiples challenges in the past months. Our financial sector, including banking, has strong fundamentals to remain stable and capture the many growth opportunities on the Chinese mainland and within the region in the years ahead,” an HKMA spokesperson told China Daily on whether it’s prepared for US sanctions against Hong Kong banks.

“The HKMA is closely monitoring developments and maintains a close dialogue with banks to address any inquires or issues regarding their business operations,” the spokesperson said.

Looking ahead, however, the Hong Kong dollar may wane as the effect of these cyclical factors fade, although the local currency has been trading on the strong side of the band.

“The Hong Kong dollar may fall versus the US dollar floor rate of HK$7.75 in the third quarter, even though US President Donald Trump now appears to be against the idea of undermining the currency peg as a way of punishing the mainland. A decreasing yield appeal amid a larger aggregate balance may be the main drag for the currency,” said Stephen Chiu, forex and rates strategist at Bloomberg Intelligence.

Carie Li, an economist at OCBC Wing Hang Bank, echoed Chiu’s sentiments. “In the absence of liquidity draining events or strong equity inflow, we don’t expect the USD/HKD spot to touch 7.75. As such, the downside of HIBOR may be capped by the stabilized aggregate balance,” she said. 

However, in the medium term, another busy round of IPOs — led by the expected listing of Alibaba Group-affiliated Ant Group, which aims to raise up to US$30 billion — and another wave of strong equity inflow are poised to trigger the Hong Kong dollar to trade at its strong trading band again. The aggregate balance is expected to grow further to HK$200 billion, pushing down the Hong Kong dollar rates to the level of or even below that of US dollar rates, she said.

Not completely immune

In the worst-case scenario, if the currency peg were to be attacked, Hong Kong has an adequate financial arsenal to defend the currency peg. The HKMA has US$450 billion in foreign exchange reserves and access to US$57 billion in People’s Bank of China’s reserves under the present swap arrangement. The HKMA also has a liquidity buffer of HK$1.2 trillion to absorb capital outflow shock.

“As long as outflows do not exceed US$153 billion, any pressure on the peg, Hong Kong dollar liquidity, and interest rates should be manageable, ” said Kevin Lai, an analyst at Daiwa Capital Markets.

However, Hong Kong’s banking system is not completely immune from global financial shocks. 

“Because the Hong Kong dollar and US dollar interest rates have been so low for so long, leverage is a lot higher now than it was in 1997. In case market participants rush to switch Hong Kong dollars to US dollars, we believe the HKMA would defend the peg, but eventually, Hong Kong dollar interest rates would have to go up, thus putting real pressure on banks and both Hong Kong dollar and US dollar debt exposure in Hong Kong,” Lai said.

Oxford Economics Lead Economist Tommy Wu agreed. “There are clear risks that Hong Kong’s role as special gateway in and out of the mainland, as well as a global financial hub will be eroded,” he said. “The biggest risk factor is probably the overall development of China-US relations. Foreign investors and corporates may also hedge their exposures to the city. As such, foreign investment in Hong Kong will likely be affected to some degree by these uncertainties.”

Contact the writer at oswald@chinadailyhk.com

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