Hong Kong Banks Well Prepared For Credit Cycle Trouble - Fitch

Tom Burroughes

1 June 2016

Hong Kong banks are “well prepared” to cope with a downturn in the credit cycle because they have sufficient capital and earnings to act as a buffer, according to international ratings agency , which has cast its gaze over 13 lenders.

Fitch’s analysis of the banks involved testing them to a “mild” and “severe” scenario in which their average non-performing loan ratios reached 1.9 per cent and an unprecedented 8 per cent, respectively, over a three-year assessment period, it said.

The report comes at a time when concerns about decelerating mainland Chinese growth, and its impact on the wider region, has created more volatile equity markets and raised concerns about the robustness of a still relatively young banking system. In late March, US ratings agency Standard & Poor's cut its credit rating outlooks for China and Hong Kong from stable to negative, blaming this on increasing economic and financial risks to the mainland government's creditworthiness. The move suggests the agency may lower China and Hong Kong's ratings from AA minus and AAA respectively in the subsequent six months to two years (source: CNBC).

The banks' average Fitch core capital ratio had fallen to 11 per cent by the end of the test assessment period in the worse of the two scenarios created by the agency - from 15.9 per cent at the start - enough to ensure systemic stability, Fitch said.

A slowdown in the Chinese economy and turmoil in the Hong Kong property market are the central assumptions of this stress test, with the more severe of the two scenarios having more disruptive and lasting effects on banks.

Loan-impairment charges would rise to 6.9 per cent of loans under the severe scenario, and would be likely to lead to ratings downgrades if such a scenario were to materialise.

"Our assumptions lead to cumulative average LICs of 1.4 per cent of loans under the base scenario, a level we consider realistic, and against which we have been benchmarking our ratings," Fitch said.

Mainland China exposure is the single-biggest risk for Hong Kong banks, in Fitch’s opinion. In this exercise, such exposure accounted for on average 56 per cent of the samples' loan impairment charges in the severe scenario (base case: 58 per cent).

“Fitch acknowledges that the assumptions made in our severe-case scenario are very harsh, and likely to be beyond the expectations of most market participants. Our assumptions take into account historical episodes of system stress as well as Hong Kong banks' considerate underwriting policies and sound prudential supervision,” the agency said.

“However, they also reflect our view that the growing links between Hong Kong and China and the banks' expansion in the mainland Chinese market will potentially leave a more pronounced impact than the stress observed previously. We did not specifically adjust for banks' benefitting from guarantees from their (state-owned) parent entities due to limited disclosure,” it continued.