Hong Kong banks' mainland loan exposure drops for the first time in a decade

But bad loans remain a key risk.

Hong Kong banks' mainland China exposure (MCE)dropped to 27.3% of system-wide assets as at the end of 2015, a far cry from 32.8% a year earlier.

Although this marks the first decline in MCE in a decade, Fitch cautions that shaky mainland loans remains a significant concentration and source of risk for Hong Kong-based lenders.

"Hong Kong still accounts for nearly half of foreign banks' claims on mainland China, however, and the still-large MCE makes Hong Kong banks vulnerable in the event of a sudden deceleration or hard landing in China," said Fitch.

Locally incorporated authorized institutions (AIs) and branches of foreign banks still account for a large majority of non-bank lending gross MCE, at over 80%. Mainland Chinese subsidiaries of local AIs account for the remainder.

When broken down by borrower, Hong Kong banks' MCE is mostly to state-owned entities (42% of non-bank loans) and non-mainland entities (38%).

Fitch expects lending to onshore Chinese borrowers to increase as banks, including HSBC, focus on that segment for expansion.