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Published: 09:43, April 03, 2023 | Updated: 09:44, April 03, 2023
HK safeguarded from banking turbulence in the Western systems
By Li Chen
Published:09:43, April 03, 2023 Updated:09:44, April 03, 2023 By Li Chen

Since the collapse of Silicon Valley Bank, the United States and Europe have been going through banking turmoil, with the effects rippling across global financial markets. As a global systemically important financial institution, Credit Suisse reached a crisis point. Backstopped by the Swiss government, the Swiss Financial Market Supervisory Authority and the Swiss National Bank, Credit Suisse was acquired by UBS for 3 billion Swiss francs ($3.28 billion). To support the deal, the Swiss National Bank agreed to provide 100 billion Swiss francs in liquidity assistance, and the Swiss government provided up to 9 billion Swiss francs in loss guarantees to help UBS take over Credit Suisse’s assets.

Once again, this round of banking turmoil has revealed the inherent contradictions in the development model of the US and European banking sectors. The modern banking industry has inherent instability and cyclicality. The basic function of banking is to meet the real economy’s demand for liquidity and credit. In order to transform savings into investments, and mobilize short-term funds for long-term uses, banks will inevitably bear certain degrees of maturity mismatches (borrow short and lend long), liquidity risks, and credit risks.

However, in a loose monetary environment with abundant liquidity and low interest rates, banks are prone to excessive maturity mismatches and high leverages, taking on excessive risks. When the macroeconomic policy environment undergoes major shifts, with liquidity tightening and interest rates moving up sharply, asset prices will fall, and the hidden risks in the banking sector will be exposed.

Over the years, the evolution of the US and European banking sectors have been characterized by deregulation and financial disintermediation. The intertwining of the banking system and capital markets has become increasingly complex. The 2008 global financial crisis did not change these structural features. The subsequent ultralow interest rates and quantitative easing policies have further bred complacency and increased the risk appetite of the banking industry.

Since 2022, against the backdrop of high inflation, the Federal Reserve and the European Central Bank have sharply raised interest rates and tightened liquidity. The dramatic change in the macro-policy environment has progressively exposed the hidden risks within the US and European financial systems. Drawing a lesson from financial history, it is not surprising to see a new wave of banking crises occur in this process. The collapse of Silicon Valley Bank was triggered by depositor panic and a bank run, caused by an asset price fall and liquidity shocks under the pressure of interest-rate hikes. The crisis of Credit Suisse was more complex, reflecting its accumulated operational problems and risk management failures.

Banking turmoils tend to bring systemic risks to the economy. In resolving risks and maintaining financial stability, the government faces a fundamental dilemma. Not to intervene in times of crisis may result in the self-destruction of financial markets, but to intervene would exacerbate the problems of “moral hazards”, worsening perverse incentives in the banking sector to take on excessive risks without being held accountable.

Since the 1990s, the mainstream economic policy ideology in the US and Europe has been to advocate for a free market, financial liberalization, and deregulation. Paradoxically, in terms of their actual policies dealing with major financial crises over the past decades, the US and Europe have often ultimately relied on direct official intervention to bail out the markets. This time, the governments and central banks in the US and Europe responded rather promptly in handling this wave of banking turbulence, which helped to stabilize the markets, but also brought to light their banking system’s fragility and degree of dependence on public-sector backstopping.

The current landscape of the global political economic environment is very different from that of the 2008 financial crisis. Against the backdrop of high inflation, growing debt burdens, ongoing geopolitical conflicts and supply-chain restructuring, the policy space for the US and Europe to stabilize the economy has shrunk substantially. It has become increasingly difficult to balance the multiple policy goals of taming inflation, maintaining financial stability, and avoiding economic recession at the same time. If the banking turmoil in the US and Europe escalates further and spreads, the risks of recession will rise sharply.

For Hong Kong’s financial industry, the direct impact of the current banking turbulence in the US and Europe has been limited. As an international financial center, Hong Kong has the unique advantage of “one country, two systems” in maintaining financial stability and promoting financial sector development. With solid foreign exchange reserves, a robust linked exchange rate system, and a sound local banking sector with adequate liquidity, Hong Kong is well-positioned to navigate the potential global repercussions caused by the ongoing banking turbulence in the US and Europe.

In recent years, the Chinese mainland has strengthened and improved financial regulation, deepened its financial sector reform and opening-up, and effectively resolved the risks of some high-risk small and medium-sized financial institutions. The mainland’s financial stability has provided a solid foundation for Hong Kong’s financial stability.

Hong Kong and the mainland have continued to strengthen the development of financial sector connectivity mechanisms, such as the Shanghai-Hong Kong Stock Connect, Shenzhen-Hong Kong Stock Connect, Bond Connect, and the Cross-boundary Wealth Management Connect. The offshore renminbi business in Hong Kong has witnessed a healthy development. In particular, the enhanced currency swap agreement signed between the Hong Kong Monetary Authority and the People’s Bank of China will facilitate further development of Hong Kong’s offshore renminbi market.

Moreover, Hong Kong is actively exploring the development of the Central Moneymarkets Unit, a critical financial infrastructure serving Hong Kong’s financial industry for over 30 years, into a major international central securities depository platform in Asia, providing safe, reliable and efficient services to support cross-border transactions, clearing, settlement and custodian operations.

For the global financial system, the most profound challenge going forward is that financial market risks and geopolitical risks may exacerbate each other. In the current geopolitical environment, global finance is being increasingly politicized and weaponized. In this context, Hong Kong should stay vigilant for the potential risks, effectively coordinating financial development and security.

With unique strategic roles in China’s “dual circulation” development pattern as a “superconnector” between the domestic and international circulations, Hong Kong should further promote connectivity with the mainland’s financial market, take full advantage of the new opportunities brought about by the Belt and Road Initiative and the Guangdong-Hong Kong-Macao Greater Bay Area development, and further promote yuan internationalization. As the global order further shifts toward multipolarity, Hong Kong’s status as an international finance center will become even more important in the future.

The author is an associate professor at the Centre for China Studies at the Chinese University of Hong Kong, and a research fellow (by courtesy) at the Lau Chor Tak Institute of Global Economics and Finance.

The views do not necessarily reflect those of China Daily.


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