Worries over funding costs in Hong Kong loom in 2012

Given the challenges in credit growth and deposit, Fitch warns of some increase in funding costs.

“Yes, we do expect continued pressures in funding in 2012. But to draw that directly from the European banks retreating out of this part of the world, we wouldn’t necessarily say so. Once the competition on credit growth and the competition on the deposit side of things continue to play out, then yes, we would expect some increase in funding costs,” an analyst from Fitch said in a teleconference.

Here’s more from Fitch Ratings:

Key Risk Factors: Fitch identifies concentration on real estate; a volatile operating environment; and opportunistic expansion to China as key risk factors for the Hong Kong banks. Strong collateral, liquidity and capital buffers are substantiating the relatively high rating levels that the Hong Kong banks retain, despite moderate market positions in the case of most banks.

Expansion into China: Fitch expects the growth of Hong Kong banks to be tied to expansion into mainland China - which could, if successfully executed, boost revenue and broaden loan diversification. Related risks stem from a weaker operating environment, untested collateral recoveries, and more prevalent corporate governance and transparency issues. Hong Kong banks. mainland exposures have often been short-term, trade-related and collateralised.

Strong Capital: If Basel III had to be implemented right now, Fitch.s simulation indicates that Hong Kong banks would encounter very little difficulty in meeting a conservative implementation of the more stringent requirements. The agency believes that the Hong Kong banking system qualifies for a counter-cyclical buffer set at the maximum 2.5% level, and accordingly expects that the banks will increase their regulatory reserves further.

Vulnerable to Bank Risk: Credit risk remains balanced between corporate and bank lending (mostly to UK and Asia Pacific banks), at 36% and 33% of consolidated assets, respectively, at end-November 2011. Adding in their substantial holdings of securities - at 20% of consolidated assets, and which are weighted more towards bank debt - indicates that Hong Kong banks are vulnerable to deterioration in bank credit and a widening in credit spreads.

Liquidity Pressures Manageable: Funding benefits from established deposit franchises despite most deposits being short-term. The risk of sudden withdrawals in bank and deposit funding is counterbalanced by substantial liquid assets (cash, bank deposits, securities), amounting to 54% of system-wide assets at end-November 2011. Fitch anticipates that Hong Kong banks would eventually cut back their expansion to China if liquidity tightened drastically.

Contagion Risk: In Fitch’s view, Hong Kong banks remain vulnerable to waning investor confidence - in global growth in general, and China in particular. The banking sector is dependent on foreign bank funding, which amounted to 28% of total liabilities at end- September 2011 (2010: 26%). The five largest funding providers (Japanese, Singapore, US, Chinese and UK banks) accounted for a stable 17% of total liabilities, and western European banks 9%. That said, Hong Kong banks have made insignificant use of capital markets funding.