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MARKETS & INVESTING | Staff Reporter, Hong Kong
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Hong Kong’s golden age of banking is officially over

It used to be APAC's banking darling.

Over the past decade, Hong Kong has been the darling of the Asia-Pacific in banking, but a perfect storm has shut the door for more growth. 

When China began its aggressive expansion about a decade ago, Hong Kong was a direct benefactor, as hundreds of industrial goliaths and banks started to tap the territory’s financial services firms for their financial know-how, as well as billions worth of debt and share issues. This fuelled robust growth not only in Hong Kong’s banking sector, but also in tourism and luxury goods.

But as quickly as Hong Kong rose from the Chinese expansion, it is also swiftly losing its banking lustre as the mainland enters into a phase of drastic slowdown. According to a report by McKinsey and Company, margins and returns on equity are shrinking. “For instance, the Asia Pacific banking industry’s ROE slipped to 14% in 2014, from 15% a year earlier,” the report says. McKinsey says the region, along with its financial industry, is undeniably settling into a new era of slower growth and greater challenges in generating economic profit.

McKinsey notes that initial symptoms of a decline started manifesting themselves in 2015, when Asia Pacific profit pools, led by Hong Kong, started edging lower. “Even as profits have grown, in half the Asia-Pacific markets studied, ROE declined between 2005 and 2014. Throughout the region, squeezed margins put pressure on bank profitability, although other factors, such as the cost of risk and taxes were also culpable,” the report notes.

Ranking agencies have also been taking notice. Rankings firm Moody’s, for instance, has recently changed the outlook of DBS Bank Hong Kong as well as OCBC Wing Hang Bank from stable to negative due to expectations of a more challenging operating environment for Hong Kong’s banks. “DBS Bank (Hong Kong) and OCBC Wing Hang Bank’s long-term deposit ratings incorporate multiple notches of uplift based on Moody’s assessment of a very high level of affiliate support in times of need. The outlook on their ratings is therefore affected by the change in outlook for DBS Bank’s and OCBC’s ratings, respectively,” Moody’s says.

HK’s new resolution laws

Meanwhile, Hong Kong’s banks are also currently pressured by the territory’s new resolution law, which throws a wrench into the financial institutions’ recovery and resolution plans. According to a report by Fitch Ratings, the new law closes the gap between Hong Kong’s limited power to intervene in financial institutions and the Financial Stability Board’s key attributes for effective resolution regimes. Fitch says Hong Kong is one of the few Asian jurisdictions to have implemented resolution laws that specifically allow for bail-in. Cross-border resolution plans are particularly important because the bulk of banks operating in Hong Kong are owned by foreign groups and resolution of a foreign parent could have spillover consequences for the Hong Kong subsidiary.

Fitch Ratings expects that local banks forming part of larger international groups, such as HSBC and Standard Chartered, will be able to draw on their group’s resolution plans.
“Foreign parents may position their subsidiaries for resolution by the Hong Kong host regulator and plan for external loss-absorbing capital issuance, while others may look for resolution at the parent level by the home regulator, intending to upstream potential losses through issuing loss-absorbing capital to their parent,” Fitch Ratings says.
Additionally, Fitch says authorities will also have to seek reassurance that continuity of critical financial services will be preserved at the Hong Kong banks. “We also expect the HKMA to publish comprehensive guidance on how they will determine the point of non-viability for banks. The law links non-viability to a breach of a financial company’s authorisation and licensing criteria and also provides flexibility, enabling resolution authorities to exercise judgement depending on prevailing circumstances,” Fitch says.
Staff turnover is also a major challenge for Hong Kong’s financial institutions as an uncertain economic outlook and regulatory pressure cause investment banks to be more cautious in their approach to hiring, according to Robert Walters. “Larger banks have sought to address this in recent months by increasing base salaries and fast-tracking better performers to improve staff retention. We anticipate that more banks will follow suit during the year, reflecting new market norms,” a report by Robert Walters says.

New entrant challenges

“New entrants to the asset management market will continue to drive salaries upward in 2016 by paying above-market rates for top talent, particularly for those in senior sales roles,” the report adds.

Meanwhile, due to increased job insecurity, housing transaction volume has dropped by 38% in Hong Kong, according to OCBC, causing the number of approved mortgage loans to dip by 34% to 26,276 over the first five months. In order to attract more applications for loans, OCBC says several banks in Hong Kong further cut the mortgage rates from 1-month HIBOR plus 1.6% to 1-month HIBOR plus 1.5%.

“The Fed’s likelihood of slowing rate hike pace post Brexit is the main support for the banks to offer lower mortgage rates. The Fed’s slower tightening will also ease the capital outflow from Hong Kong, allowing HIBOR to stabilise at an historical low for some time,” OCBC notes. “As such, borrowing costs might remain low and in turn underpin a rebound in housing transactions which rose for the third straight month on monthly basis.”

However, with the housing cooling measure in place, OCBC says the upward risks on the housing market are little or none. “Instead, as the Fed may still continue to tighten its policy albeit at a gradual pace, coupled with more housing supply ahead, renewed downward risks are expected to drag down the housing market again after recent short-lived pick-up,” OCBC adds.

On the other hand, McKinsey adds that the rapid rise of an affluent middle class in Asia-Pacific presents a significant opportunity for Hong Kong’s banks. “By 2020, we estimate that 14% of the global assets held by affluent households, those earning $100,000 to $1 million a year, will be in Asia-Pacific, excluding Japan. The region will become the world’s largest affluent market, easily surpassing North America,” the report says.

McKinsey says assets held by China’s affluent class, for instance, will likely grow by a whopping $3.4 trillion by 2020 and will account for most of the region’s growth and benefiting its banks handsomely. “By 2020, revenues from affluent class households are expected to reach $141 billion, about 12% more than the revenues brought in by serving high-net worth households,” the report says.  

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