| HONG KONG, March 25
HONG KONG, March 25 In just a few years, Hong
Kong banks have ramped up lending to China from near zero to
$430 billion, fuelling concerns about their credit exposure to
the mainland at a time when sliding economic growth and defaults
are making investors nervous.
Even a modest increase in non-performing loans would have a
significant impact on Hong Kong bank profits, suggesting the
sector will be a sensitive indicator of China's debt markets in
the year ahead.
A landmark domestic bond default earlier this month and
headlines of bankruptcies - highlighted last week by Zhejiang
Xingrun Real Estate Co - have underscored concerns that an
unprecedented surge in company debt in China is now showing
signs of unravelling.
"The quality of these loans extended by Hong Kong banks to
Chinese companies has not been tested," said Mirza Baig, head of
foreign exchange and interest rate strategy at BNP Paribas in
Singapore. "That is a concern in the backdrop of the rapid rise
Foreign bank claims on China hit $1 trillion last year, up
from nearly zero 10 years ago, and the biggest portion was
provided by Hong Kong, Bank of International Settlements data
shows. The $430 billion in loans outstanding represents 165
percent of Hong Kong's GDP, BIS figures show.
Data from the Hong Kong Monetary Authority (HKMA), the
city's de-facto central bank, showed a similar astonishing rise.
By the end of 2013, Hong Kong banks' net claims on China as a
percentage of their total loan book was nearing 40 percent,
compared with zero by 2010.
The rival financial centre of Singapore has also ramped up
its China loans as well, but its exposure is the equivalent of
15 percent of its GDP, figures from its monetary authority show.
Local banks in both these centres have taken over lending
that foreign banks once dominated, drawn by cheap funding rates
following the global financial crisis, a voracious appetite from
Chinese borrowers and healthy growth in the world's
"Hong Kong banks have pounced on arbitrage opportunities
between on-and offshore renminbi funding rates," said Cathy
Holcombe, a strategist at Gavekal Dragonomics in Hong Kong.
There is no breakdown of the type of loans behind the $430
billion figure. But Stephen Long, managing director of financial
institutions at Moody's Investor Services, said "a substantial
part" is in lower-risk categories such as trade finance. This
would include loans to Hong Kong blue-chip companies operating
on the mainland or loans supported by guarantees from Chinese
However, trade finance may also hide speculative flows that
bet on a rise in the yuan - a popular trade encouraged by the
currency's 2.9 percent rise against the dollar last year. In
this trade, investors and companies falsify trade receipts to
convert foreign currency into yuan and avoid capital controls.
This year's slide in the yuan may also pinch debtors'
ability to service their loans. The yuan has dropped nearly 3
percent, wiping out its 2013 gains, putting it on track for its
worst March quarter since 1992.
"Most of these loans are not hedged completely on a currency
basis even if they are collateralised and the currency
volatility means some of these banks may be sitting on large
currency losses," said a trade banker at a large European Bank.
He declined to be identified because he was not authorised to
speak openly to the media.
Stock and credit analysts also say a big chunk of the loans
has ended up in China's property and financial sectors, as well
as industries with surplus production capacity, such as steel -
all areas where regulators are trying to control lending.
To be sure, capital buffers at Hong Kong banks are much
higher than minimum international standards and the central bank
has not shown any alarm about the lending.
The HKMA said it has been "closely monitoring" the sector's
credit exposure and it expects banks "to maintain sufficiently
robust system of controls to manage the specific risks that they
Investors are showing more concern though. An index of
financial stocks in the main Hong Kong bourse had
fallen by more than 13 percent this year through to the end of
last week. It perked up on Monday on hopes for government
stimulus to support the Chinese economy.
Analysts said Bank of East Asia and Bank of China
(Hong Kong) have the biggest exposure to China among
the lenders based in the territory, at 46 percent and 27 percent
of their loan books, respectively. The latter is also the
clearing bank for all yuan-related transactions appointed by the
China's central bank. The banks did not return calls seeking
Hong Kong's non-performing loans (NPLs) ratio is currently a
record low of 0.5 percent. But if it returned to the long-term
average of 3.5 percent, it would cut nearly 20 percent off
current expectations for local bank pretax profits for the
financial year starting this April, Barclays Capital said.
Larger global banks in Hong Kong, such as Standard Chartered
Bank and HSBC are less at risk because of
their big balance sheets.
Under a scenario whereby NPLs return to 3.5 percent, Bank of
East Asia would take a 10 percent hit to its pretax profit,
while Dah Sing Financial Group and Wing Hang Bank
could lose nearly a sixth, Barclays says. Dah Sing and
Wing Hang did not return calls seeking comment.
Sharnie Wong, a banking analyst at Barclays, said the two
biggest risks to asset quality of Hong Kong banks are a sharp
downturn in China's economy and a rise in U.S. interest rates.
The first factor could reduce the ability of borrowers to
service their loans and the second point would raise bank
funding costs, squeezing profit margins.
Although China's official NPL ratio is 1.0 percent, bankers
estimate the real figure is anywhere between 5 percent and 10
Wong and other analysts argue that interest rates, and with
them NPLs, are set to rise as rates globally increase, partly in
response to healthier U.S. and European economies.
That means Hong Kong banks will have to put more aside to
offset debt risks and so readings on their NPLs and provisions
against bad debt will provide a window on the state of China's
(Additional reporting by Michelle Chen; Editing by Michael
Flaherty and Neil Fullick)