Uncertain China reopening threatens Hong Kong banks in 2023

BANKS OUTLOOK Uncertain China reopening threatens Hong Kong banks in 2023

Banks’ performance will be impacted amidst benefits from interest rates.

As growing interest rates continue to uplift the profitability of banks in Hong Kong, financial institutions are expected to be hit by the consequences of indecisiveness regarding China’s border reopening.

In the APAC Developed Market Banks Outlook 2023 report, Fitch Ratings reported that the wider net interest margins (NIMs) in 2022 from increasing interest rates will extend further next year, which will back the earnings growth of banks in Hong Kong.

Amidst macroeconomic woes, Hong Kong’s banking system benefits from a healthy liquidity buffer. But the sector outlook could face downside risks if there is a drop in liquidity buffers. This includes renewed market concerns on the market’s status as a global financial centre to significant capital outflows.

The Hong Kong SAR government is already on top of this by convincing international financial institutions to increase operations in Hong Kong as well as raise hiring financial talent in the market. Financial Secretary Paul Chan recently revealed that more senior global executives will also be deployed in the market.

Government data showed that 77 of the top 100 global banks are in Hong Kong. As of the end of August 2022, the banking system in Hong Kong was holding assets worth approximately $27t, which is about 9.5 times the size of Hong Kong’s gross domestic product (GDP) in 2021.

But these benefits will be mitigated by property stress and stringent travel rules that continue to weigh on Hong Kong’s economic prospects. As a potential border reopening is currently still in limbo in China, property risks will continue to fall on the market by next year.

Boosting the sector

As of September 2022, residential property costs declined by 9% but these risks remain manageable due to measures over mortgage lending, healthy property loan‑to‑value ratios, and strong household affordability despite the serviceability of newer home transactions being threatened by the hike in interest rates. But a sudden decrease in property prices may affect the bank’s outlook as 32% of loans are connected directly to the domestic real‑ estate sector. Of the percentage, 17% are residential mortgage loans.

If businesses start reopening from loosened cross‑border restrictions, it could boost an improving outlook for the banking sector.

The revival of businesses could increase profitability, higher‑volume loan growth, and better fee prospects, which will surpass funding‑cost pressures and credit costs.

With these factors, Hong Kong’s real GDP will soar by 3.5% in 2023, after shrinking by 0.5% in 2022.

China policy

China’s growth continued to be impacted by the domestic property market and weak consumer demand as an unintended consequence of stringent health measures to combat the pandemic.

Signs of policy support for the property industry and gradual progress in loosening health measures are starting to emerge but it is too early to conclude if these changes are enough to shift the economic fortunes of the region.

Growth and risk appetite for Japanese and Singapore banks

Banks in Japan and Singapore, which have a history of expanding offshore in emerging markets, have limited headroom within their current capitalisation and leverage scores.

Japanese banks already see their Common Equity Tier 1 (CET1) strained by the weakening yen versus the US dollar.

There could be a material rise in Japanese banks’ risk appetite in search of higher profit opportunities such as inorganic overseas investments as there are lower interest rates in Japan.

Common Equity Tier 1 ratios for Singapore banks have limited headroom within their “aa‑” capitalisation scores and could be strained if more adverse scenarios materialise or if banks make further acquisitions.

Pressure on Singaporean banks’ CET1 ratios may be reduced by slower loan growth and higher profitability but equally, a large‑scale acquisition in emerging markets would have the potential to weigh on their blended operating environment scores and also their Viability Ratings (VRs).

Unlike Japanese banks, Singapore banks will experience upside risks from higher interest rates.

More senior global executives will also be deployed in the market

Amidst macroeconomic woes, Hong Kong’s banking system benefits from a healthy liquidity buffer

APAC DM Banks - Rating Changes

Source: Fitch Ratings

Singapore banks will be amongst the top beneficiaries of higher lending rates in Asia and the Pacific, NIMs will expand significantly in the near term, given the prevalent use of floating rates and the high proportion of low‑cost deposits.

South Korean banks’ resiliency

Even as there is a slowing global and domestic economy, the South Korean banking system’s overall financial profile will stay resilient.

Profitability and loss‑absorption buffers for the market’s banks are expected to stabilise but credit costs may rise as non‑performing assets rise.

In 2023, lower loan growth is expected to reduce the need for banks to raise additional debt, and deposits are seen to persist in the tighter monetary environment.

Capital buffers at banks should remain steady, but there is little room for growth due to the need to contribute to market‑stabilisation funds and banks’ focus on corporate loans.

The country’s economic growth is expected to decelerate to 1.9% in 2023 from 2.6% recorded in 2022. This projection could change to deteriorating if there is a further decline in the employment rate and other economic growth prospects due to sluggish global demand, supply‑chain shocks, and high inflation.

Highly leveraged households, self‑ employed residents, and small and medium‑sized enterprises that rely on global demand are likely to be the most vulnerable in this environment.

Australian banking sector ‘steady with high inflation’

The banking sector in Australia will remain steady with high inflation resulting in the Reserve Bank of Australia raising interest rates.

It will likely decelerate the market’s economic growth and adversely affect the highly‑indebted households.

There are no large losses anticipated for the banking system due to low unemployment and solid underwriting.

Loan growth in Australia is expected to slow next year, following a softening GDP outlook and lower credit demand.

The system’s loans and deposit ratio will remain broadly around the current level but below pre‑pandemic levels.

A decline in the liquidity coverage ratio to more normal levels is likely but driven by banks running down excess liquidity built up in 2020 and the phasing‑out of the committed liquidity facility at the end of 2022.

Steady loan growth for Taiwanese banks

The profitability of banks in Taiwan will be backed by steady loan growth and widening NIMs. But this will offset potential investment losses due to expected market volatility and a modest rise in credit costs in 2023.

The disruptions from the pandemic have also ended and should have a limited effect on the market’s economic growth.

Amongst risks to the bank’s outlook include a prolonged global recession, a sharp correction in housing prices, excessive risk‑taking or growth in high‑risk emerging markets, aggressive growth and dividend payouts, and industry consolidation.

Taiwan’s relatively steady economy and housing market, as well as its prudent regulatory oversight, could boost the bank sector’s resilience despite global challenges that may subdue demand for high‑tech exports.

Taiwan’s GDP is expected to grow by 3.2% in 2022 and 2.8% next year.

Warning for housing markets

Prices in housing markets have declined in Australia, New Zealand, Hong Kong, and South Korea after several years of continuous increases due to low mortgage rates.

Whilst moderate declines would likely be welcomed by policymakers who tried to address affordability and increasing risks, a sudden drop in market confidence could grow systemic risks.

Factors such as healthy LTV ratios, mortgage insurance, and debt serviceability limits should mitigate the risks of asset‑quality deterioration.

Overall APAC woes

The banking sector in developed markets in APAC will see a neutral outlook. They can still be more resilient in the macroeconomic challenges than other countries in the region. However, most economies are not safe from the pressures of inflation. Loan growth in other markets will also be

Key Developed Markets Outlooks at a Glance

Source: Fitch Ratings