Hong Kong banks to be barely hurt by Chinese liquidity squeeze

How long will it stay safe?

According to Fitch Ratings, the spillover of risks from China's tight interbank market to Hong Kong banks is initially limited as long as the Chinese liquidity squeeze does not intensify and is not sustained.

The offshore renminbi (CNH) market - unlike the onshore renminbi interbank market - is experiencing only moderate volatility, and the small extent of Hong Kong banks' renminbi exposure means the impact should be manageable.

Here's more from Fitch Ratings:

We expect some outflows of renminbi deposits from Hong Kong banks. But the bulk are not being deployed, due to the limited opportunities to use this funding, leaving the system-wide renminbi-denominated loans/deposits ratio at a low 13% at end-Q113. These deposits could decline substantially before the Hong Kong banks encounter any meaningful CNH liquidity stress, especially as the renminbi deposits make up less than 10% of system-wide deposits.

Competition in Hong Kong's CNH deposit market is likely to rise as the branches of mainland Chinese banks pay aggressively, especially ahead of end-June - the first-half reporting date. Hoarding offshore customer deposits could benefit Chinese banks' interim results since deposit positions would be reported on a consolidated basis.

HK dollar and US dollar liquidity are more important for Hong Kong banks, as their balance sheets are denominated predominantly in these currencies. These markets have so far suffered only limited contagion from the Chinese situation.

We do not expect the Chinese liquidity squeeze to escalate, especially after yesterday's announcement by China's central bank that it would guide market rates to reasonable levels and that it expects a gradual fading-out of the seasonable factors that caused the recent spike in interbank rates. However, tighter interbank liquidity may persist.

Sustained stress in the Chinese interbank market would raise counterparty risks for Hong Kong banks' exposure to mainland banks - that arises mainly from interbank placements and from guarantees on trade finance. At 13% of banks' assets at end-March 2013, any increase in the claims on mainland banks could put pressure on the asset quality of Hong Kong banks.

Surges in CNH borrowing costs are unlikely to be as extreme as for onshore renminbi, where flows are restricted by capital controls. Even though there are some channels for transferring offshore renminbi to onshore, these are subject to constraints that limit the repatriation of funds to trade-settlement transactions. The one-week CNH Hong Kong interbank offered rate (HIBOR) rose to 6.0% on 25 June, compared with the Chinese interbank rate of 7.6% and the CNH deposit rate of 5.6%.

Hong Kong banks could take the opportunity to expand lending to Chinese corporates while their mainland counterparts are constrained. This could kick-start a second wave of corporate loan growth. But many Hong Kong banks have strict underwriting criteria to maintain quality control on China-related lending, which stood at 18% of system-wide assets at end-2012.