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China resistance is futile for HKMA

Hong Kong central 230px
By Rashmi Kumar
13 May 2014

The Hong Kong Monetary Authority is cracking down on the rapid growth of loan books caused by the rise in lending to Chinese names. While trying to insulate its banking system from too much exposure to the increasingly troubled mainland economy is understandable, it is fighting a losing battle.

Life has been good for Hong Kong banks over the last few years. The tightening of onshore liquidity and the easy access to US dollars in Hong Kong has driven many Chinese corporates to the Special Administrative Region for funding. Hong Kong's banks have reaped a windfall.

But now the party is over — or at least it will be if the Hong Kong Monetary Authority (HKMA) has its way. It has put in place new rules that require banks to increase their deposit base if their loan book rises by more than 20% per year, in what the HKMA calls the Stable Funding Requirement.

Not only that, but the authority has also decided to increase its scrutiny of how banks are managing their lending risk through the introduction of regular onsite examinations and stress tests.

Its goal is simple: to ensure that US dollar liquidity is not under pressure as banks in Hong Kong continue to increase their exposure to Chinese credits. That looks like a laudable aim: gross mainland China exposure to Hong Kong banks (including local branches of international banks) has increased from about 19% in 2010 to almost 40% by 2013, according to data from Fitch and the HKMA.

The HKMA frets that some of that exposure is looking decidedly risky. Earlier this year Labixiaoxin Snacks Group failed to meet some of the covenants on a $75m loan it took in 2013, and is said to be one of the cases that has spurred the regulator to act. Add to that the fact that the Chinese economy is seeing a gradual decline in its overall rate of growth, and the prognosis is not good.

The new HKMA rules mean local lenders are expected to manage their loan books in line with their deposits. That's tough for international banks, owing to their limited access to shore up retail deposits — a factor that the HKMA is hoping will limit their lending.

Foreign banks are speaking out about this, although they have already found a loophole. By simply booking China loans through their loan desks in other countries they will be able to stay within the limits imposed by the HKMA while also profiting from new business.

That makes the new restriction look toothless. But even without the loophole the HKMA plan was surely doomed to fail. Hong Kong’s economy is so highly leveraged to China that any serious economic problem on the Mainland will have serious consequences for Hong Kong, regardless of whom the banks lend to.

In any case, there can be few Hong Kong companies that do not have a substantial business operation in the Mainland, meaning that banks still remain highly exposed even through their lending to local Hong Kong names.

All of which means the problem is not really that Hong Kong banks have too much loan exposure to Chinese issuers, but that Hong Kong itself has too much exposure to Chinese volatility. The HKMA’s actions are in keeping with those of a responsible regulator. But as King Canute once showed his 11th century subjects, it is impossible to hold back the tide. 

By Rashmi Kumar
13 May 2014