Jun 23 2008 Trond Vagen in Hong Kong
The Hong Kong Monetary Authority, the territory's de facto central bank, has developed an early warning model that it hopes will facilitate early detection of systemic banking distress in the Special Administrative Region. In its latest quarterly bulletin, the HKMA said that the model identifies a set of leading indicators for impending banking problems and is capable of estimating banking distress probability.
These indicators include macroeconomic fundamentals, currency crisis vulnerability, credit risk of banks and non-financial companies, asset price bubbles, credit growth, and the occurrence of banking distress in other Asia-Pacific economies, the HKMA said. Testing its model on historical data, it said that it could have raised the alarm three quarters before the Asian financial crisis hit in 1998.
While the current risk to Hong Kong of a systemic breakdown in the banking sector seemed contained, the monetary authority did note that a number of indicators have recently shown some unfavourable movements. These included a recent spike in real estate prices and the rate of change of real GDP per capita.
"The estimated probability of banking distress continuing to fall within the range of the lowest fragility category," the HKMA said. It added, however, that the recent deterioration in the index highlights the latest market views on the risk of banks, reflecting the current tight credit conditions in international financial markets and the uncertain global economic outlook.
"Prevailing global financial instability and the unsettled subprime crisis, coupled with the increased credit risk of corporate exposures and possible further rises in operating costs, may continue to pose challenges to banks," it said.
Other risks
Amid tightening regulation and falling stock markets in mainland China, one of the main risks facing the banking sector in Hong Kong is the level of lending to mainland enterprises. Over the past year, many mainland Chinese companies have opted to borrow money in Hong Kong rather than in China as mainland authorities have tightened the purse strings.
"The default risk of non-financial Chinese companies needs to be watched closely. This is particularly so given that the ongoing monetary tightening on the mainland may undermine companies' liquidity and growth capacity, and thus increases their default risk," the HKMA said.
It found that the aggregate default probabilities of the Chinese corporate sector have been increasing since 2006, reaching nearly four per cent in March 2008 because of higher stock market volatility. This suggests that banks in Hong Kong involved in lending to China may be exposed to increasingly high credit risks, the HKMA said, noting that how this affects the asset quality of the non-bank Chinese exposure of banks in Hong Kong needs to be monitored.
The banking sector's exposure to mainland Chinese non-bank entities rose by 58.7 per cent to HK$890.8bn ($1.14bn) at the end of March from September last year, according to HKMA's figures. This accounts for nearly eight per cent of banking sector assets.
Elsewhere, the banking sector in Hong Kong seemed well protected against liquidity risk, the HKMA said, noting that the average liquidity ratio of retail banks in the territory stood at 47.7 per cent in the first quarter of 2008. Although this was a marked decline from the 51.9 per cent recorded in the fourth quarter of 2007, it was still substantially higher than the regulatory minimum of 25 per cent, it said.
