Guess which Hong Kong bank is the most defensive to liquidity tightness

It's also positively geared to rising benchmark rates.

According to Barclays, it believes the market has underappreciated Hang Seng Bank’s core business which should generate an attractive ROE of 20.5% for 2014E, and will improve as interest rates normalize. Hang Seng Bank is most defensive among its Hong Kong banking peers to liquidity tightness in the event of tapering and is most positively geared to rising benchmark interest rates in the medium term.

Here's more from Barclays:

The potential disposal of its 10.9% stake in Industrial Bank would remove the drag on capital and dividends. HSB is now one of our top picks among the local Hong Kong banks.

The Business Drivers We believe HSB’s core business, compared with peers’: 1) has the strongest deposit franchise (67% CASA mix) and is most defensive to liquidity tightness in the event of tapering; 2) is most positively leveraged to rising benchmark interest rates (click here);

3) is relatively less exposed to mainland China-related lending; and 4) has a stronger risk management record with lowest average long-term credit cost. Moreover, it appears less affected than BOCHK by a potential downturn in commercial property prices (click here).

The potential disposal of HSB’s stake in Industrial Bank (IB) represents a big upside catalyst for HSB’s stock, in our view, as the drag on ROE, capital and dividend outlook would be removed.

The CEO of parent HSBC has previously commented that HSB’s management intends to sell the stake, although the timing is uncertain. If the IB stake were sold, we believe a special dividend could be paid as CET1 would rise to 17%, on our estimates (vs. reported 13.6% and fully loaded Basel III CET1 of 10.3% for 1H13).

Upside/Downside Scenarios Our upside case of HK$222.50 is based on ROE normalising back to its long- term average when benchmark interest rates normalise upwards. This would result in a higher margin and greater net interest income for Hang Seng Bank. The sale of Industrial Bank would also boost capital, dividend payout and reported ROE.

Our downside scenario (HK$82.10) is based on a greater-than-expected slowdown in economic growth, slower loan growth and sharp deterioration in asset quality.