Mainland China’s debt risks pose an increasing threat to Hong Kong’s banking system, with analysts fearful that the exposure could have serious implications.
The Hong Kong Monetary Authority (HKMA) is looking further into how the lenders are exposed to China because the city’s bank are lending increasingly to mainland companies.
Hong Kong banks lent a total of HK$2.867 trillion ($370 billion), including trade finance, to mainland companies during the first quarter, according to a June report by the HKMA.
The figure means Hong Kong banks were 10.8% more exposed to the mainland in the first quarter, compared to end-2013’s HK$2.59 trillion. Last year, the bank’s mainland exposure grew 29% and accounted for 20% of their total assets at end-2013 versus 16% at end-2012.
For the first time in its quarterly report, the HKMA disclosed a detailed breakdown of China-related lending, highlighting how the authority is closely monitoring the cross-border lending market.
According to the report, China’s private sector borrowed 8.2% more than the year before and the public or state-owned entities 12.6% more; trade finance increased 30% while bank loans rose 8.1%.
Moody’s said its outlook on Hong Kong’s banking sector remains “negative” over the next 12 to 18 months, considering the worsening credit situation on the mainland. It cited the country's slowing growth, increasing corporate debt, especially in property and infrastructure, and potential risk of debt default.
The International Monetary Fund and rating agency S&P this year also warned of Hong Kong banking risks in terms of their increasing lending to China.
“The key risks that underpin the negative outlook are the banks’ growing exposures to mainland China, deteriorating credit conditions in the mainland, asset market imbalances in Hong Kong’s economy, and the government’s proposals on revised bank resolution regimes,” said Sonny Hsu, a senior analyst with Moody’s.
Potential risks for HK banks
Hong Kong banks have evolved as an important offshore financial conduit for the mainland.
They can offer low-cost funds to mainland groups compared with their Chinese rivals, and companies in China have in any case found it difficult to borrow from the domestic market due to the tight liquidity conditions.
Also, there has been an increase in cross-border trade and investment activity between Hong Kong and the mainland.
But the strong growth in lending by Hong Kong banks to mainland borrowers will put pressure on the banks’ liquidity profiles and capitalisation levels, according to analysts.
According to the HKMA, Hong Kong retail banks posted a non-performing loan ratio (NPL) of 0.46% in the first quarter, a relatively low level compared to mainland banks’ average of 1%. In March, the HKMA said Hong Kong banks’ China-related NPL was 0.25%.
However, if Hong Kong banks continue to increase exposure to China, and China’s economic growth slows down significantly, the banks’ NPL could rise close to 1% and might have bad loans of HK$28.7 billion, based on the total China-related loans of HK$2.867 trillion.
About 60% of Hong Kong bank loans to China companies have underlying collateral, according to a HKMA officer in April.
But usually the Chinese borrowers’ collateral is in the mainland and sometimes it is not easy for Hong Kong banks to claim the collateral, analysts said.
There have already been cases where Hong Kong-listed mainland companies had gone bankruptcy but investors still have difficulties in tracing the companies' mainland assets.
“Hong Kong banks may need more time to evaluate the borrowers’ assets and liabilities. They also need to face a different legal and regulatory environment if the debtors can’t pay,” said Liao Qun, chief China economist with Citic Bank International.
China debt risks accumulating
Meanwhile, risks are still accumulating in the mainland credit market.
China has overtaken the US as the world's largest issuer of corporate debt with $14.2 trillion outstanding as of the end of 2013, according to S&P.
There are also signs that Chinese banks are borrowing record amounts from international bond investors to meet Basel III global banking regulations, while Hong Kong banks are one of the major investors in these bonds, according to analysts.
Chinese financial institutions issued $14 billion offshore bonds this year, compared to last year’s year-to-date amount of $2.7 billion, according to Dealogic. The markets Chinese banks are tapping include Hong Kong, Taiwan, Singapore and the Europe.
The key drivers behind the strong growth in the banks' mainland exposure are mainland and overseas corporates' expanding cross-border trade and investment activities, relatively low funding costs in Hong Kong compared to China, and credit demand diverted to Hong Kong from within China due to tighter liquidity conditions on the mainland.
Adding to fears is that China is seeing more problem debt products in the domestic market. This year, the country’s first corporate bond default – by solar-cell maker Shanghai Chaori – occurred, suggesting the government is less willing to bail out troubled firms.
Chaori was sued by one of its creditors last week and was asked by a local court to go into the bankruptcy process. The company said that it could only pay Rmb4 million of a Rmb89.8 million coupon due in March.
Risk contagions
Will China’s onshore debt risks spread to the Hong Kong banking system? Investors have already started to think about the questions.
Moody’s answer is that the Hong Kong banks have so far maintained conservative credit standards on their mainland-related lending and report good asset quality metrics.
One major determinant factor is China’s economic growth.
“If China can remain a growth rate at above 7%, there is little chance that the domestic debt problem leads to systematic massive defaults and exerts on overseas markets like Hong Kong,” said Liao Qun.
