Warning bells are sounding in several quarters as an explosion in the quantity of loans by Hong Kong-based banks to Chinese enterprises has left the territory's economy vulnerable to a downturn in China.
A report late last month by the International Monetary Fund (IMF) urged the territory's de facto central bank, the Hong Kong Monetary Authority (HKMA), to closely monitor and supervise its banks' exposure to mainland borrowers.
That exposure is about $430 billion in outstanding loans, representing about 160% of Hong Kong's gross domestic product.
The report echoes similar warnings recently by the credit rating agency Moody's and the Credit Suisse Group.
Moody's has gone so far as to issue a “negative” outlook for three of the five Chinese banks with subsidiaries in Hong Kong.
The IMF warned that under extreme circumstances, if the default rate in China's banking system interbank obligations hits 80%, all the capital in Hong Kong's banking system would be wiped out.
The IMF noted that Hong Kong has one of the best-regulated banking systems in the world, and the administration has a record of prudence and probity. But the fund urged the territory's monetary authority to work with Chinese regulators to plan an orderly resolution of non-performing loans, and to pay close attention to any weaknesses in the Hong Kong banks' balance sheets.
The demand from mainland China for loans from banks in Hong Kong has ballooned since the middle of last year, when the Beijing authorities started limiting access to credit.
To this drive has been added continued overseas expansion by mainland companies and the appreciation of the value of the Chinese currency, the renminbi. This has added to the attraction of loans in Hong Kong dollars, which are pegged to the United States greenback.
Moody's issued a “negative” outlook for the Hong Kong subsidiaries of the China Construction Bank, the Industrial and Commercial Bank of China and the Wing Lung Bank, which is owned by the China Merchants Bank, over concerns about the fast growth in their loans.
“These banks' future performance will be increasingly influenced by developments in the mainland economy and health of its corporate sector,” said Moody's.
One of the potential problems, said the ratings agency, is that lending to China by subsidiary banks in Hong Kong is a relatively new phenomenon and the system has not been tested.
Most of the lending by Hong Kong subsidiaries is backed by credit guarantees given by their parent companies.
“The use of these guarantees means that, in theory, the credit risk of these loans has been transferred back to mainland banks, though it should be noted that the enforceability of these structures has not been truly tested due to rare occurrences of default in recent times,” said the Moody's report.
The same point was made more broadly in March by the French bank and financial services company BNP Paribas.
Its head of foreign exchange and interest rate strategy, Mirza Baig, who is based in Singapore, told the Reuters news agency: “The quality of these loans extended by Hong Kong banks to Chinese companies has not been tested. That is a concern in the backdrop of the rapid rise in exposure.”
Figures produced by the HKMA say Hong Kong-based branches of foreign banks account for 43% of loans made to Chinese customers, Hong Kong incorporated banks represent 36% and subsidiaries of mainland banks hold the remaining 21%. Chinese state-owned companies have taken out half the loans, including borrowing trade finance.
Credit Suisse has pointed to the dangers in the increasingly popular practice by Chinese companies of borrowing money offshore at lower interest rates to invest back in China at much higher rates. •
China’s Communist Party leadership is so concerned about the flagging economy, it is reported to be bringing a key policy meeting forward in order to confront the problems.
The so-called Fourth Plenum would normally be held in November, but reports from Hong Kong say Prime Minister Li Keqiang wants it held perhaps as early as this month. The reports have given new impetus to the already widespread speculation that the Chinese economy is growing at a far slower rate than the official 7.5% growth forecast for this year, and may even be in recession.
Li appears to believe that the Chinese economy is approaching a crisis of confidence among the public. Unless confronted and reversed, the lack of confidence will gather steam and become self-fulfilling.
The performance of China’s banks is expected to be high on the agenda. The value and proportion of bad loans rose again in the first quarter of this year, the biggest increases since 2005, after rising steadily for 10 months.
However, although official statistics published in China are now a good deal more reliable than they were a decade ago, they are still doctored to meet political needs.
Some analysts believe Chinese banks use massive writeoffs to keep the apparent level of non-performing loans low. The slipping share values of some Chinese banks indicate the investing public believes bad loans could be five times higher than reported.
The bank loans problem is interwoven with China’s gathering property crisis. Much of the collateral lodged with banks to cover loans is property. According to China’s banking regulator, 38% of outstanding bank loans have real estate as collateral, representing about $4.6 trillion. But real estate prices are dropping, market activity is shrinking and supply of both commercial property and housing is outstripping demand.
