Moody's: Outlook for Hong Kong's banking system remains negative

Moody's Investors Service says that its outlook for Hong Kong's banking system is negative, as it has been since June 2013, reflecting an operating environment with notable systemic imbalances and loose monetary conditions.

"Specifically, unfavorable trends, including a further appreciation in property prices, rising private sector leverage and the banks' growing exposure to Mainland borrowers, have persisted over the past 12 months," says Sonny Hsu, a Moody's Vice President and Senior analyst.

"The government's proposed revision for the local bank resolution regime, slated to be implemented by early 2016, is also a driver for the negative outlook," adds Hsu. "The revised regime will allow the authorities to impose losses on the creditors of distressed non-viable financial institutions; and we expect that public support from the Hong Kong government, which we now incorporate in seven out of 17 rated banks' ratings, would be less forthcoming."

Hsu was speaking on the release of Moody's "Banking System Outlook: Hong Kong". Moody's rates 17 banks in Hong Kong.

Notwithstanding the negative outlook, Moody's expects Hong Kong banks to mostly retain their sound credit profiles over the outlook horizon.

Partially mitigating Moody's concerns over the banks' risk profile is the moderation in their overall loan growth since second half 2014 and Moody's expectation that loan growth will remain modest in 2015 as banks take a more cautious approach in their loan underwriting amid challenging credit conditions on the Mainland.

Hong Kong's currency peg implies that local interest rates will likely rise in tandem with those in US, where Moody's expects hikes in the second half. Nevertheless, the potential impact on local borrowing costs should be modest over the outlook horizon of 12-18 months. Any deterioration in banks' loan asset quality should remain manageable.

Hong Kong banks' capitalization will benefit from a slower pace of loan growth and high profit retention. Banks are also bolstering capitalization as the authorities raise minimum capital requirements.

Moody's stress tests suggest that rated banks would maintain sufficient capital even in a scenario of adverse shocks, which supports their current ratings.

The expected resilience in the banks' asset quality and their good capitalization explain why they continue to have high credit ratings. They have among the highest baseline credit assessments on a weighted average basis in Moody's rated universe.