The UK has significant financial ties to Hong Kong, and the recession and correction in house prices we are forecasting there will put the territory’s financial sector under pressure. However, only a couple of UK banks are vulnerable. And as they appear well capitalised, even a much worse economic downturn than we expect in Hong Kong should not undermine UK financial stability.
- The UK has significant financial ties to Hong Kong, and the recession and correction in house prices we are forecasting there will put the territory’s financial sector under pressure. However, only a couple of UK banks are vulnerable. And as they appear well capitalised, even a much worse economic downturn than we expect in Hong Kong should not undermine UK financial stability.
- The political protests in Hong Kong have an economic significance too. Hong Kong GDP fell by 0.3% q/q in Q2 and as the protests continued in July and August we have pencilled in a sharper fall in GDP of 0.8% q/q in Q3. Housing in Hong Kong is clearly overvalued, so the downturn is likely to trigger a correction in house prices, perhaps of 15% or so. And were there to be significant capital outflows, Hong Kong’s central bank would tighten monetary conditions to maintain the currency peg to the dollar. Put that all together and there is little doubt Hong Kong’s banks will come under pressure in the coming quarters.
- While most countries have very limited exposure to Hong Kong’s banking sector, the UK stands out like a sore thumb. UK-headquartered banks have outstanding claims on counterparties in Hong Kong of £426bn, equivalent to 16% of UK GDP. (See Chart 1.) Given UK banks’ collective common equity tier 1 capital is only a little larger than that, at £439bn, if a large proportion of UK bank loans in Hong Kong were to go bad it could have significant ramifications for UK financial conditions.
- However, there are three reasons why we doubt UK banks’ activities in Hong Kong will destabilise the UK’s financial sector. First, bank loans in Hong Kong are reasonably safe. Mortgage loan-to-value ratios are low, and for new loans have recently fallen below 50%. Only a much larger correction in house prices than we expect would push many borrowers into negative equity. Meanwhile, only 0.4% of all loans were non-performing in June. The upshot is that we aren’t expecting a banking crisis in Hong Kong. (See our China Economics Update, “Hong Kong’s banks can weather the storm”, 10th September.)
- Second, only two UK banks would be implicated if there were a banking crisis in Hong Kong. Chart 2 shows banks’ risk-weighted credit exposures to Hong Kong. For most of them, China and Hong Kong don’t even merit their own category! As HSBC was founded in Hong Kong before the headquarters moved to London in 1993, the bank still has a huge presence in the area. Standard Chartered is also notably exposed.
- Third, both HSBC and Standard Chartered have enough capital to withstand a full-blown UK financial crisis. Last year the Bank of England found that even in a situation equal in severity to the global financial crisis (which would be far worse for UK banks than a banking crisis contained in Hong Kong), the resulting fall in both banks’ capital ratio did not take them below their minimum capital requirements.
- Overall, while the economic fallout of the Hong Kong protests will put banks there under pressure, high credit quality means it shouldn’t turn into a Hong Kong financial crisis. If it did, a couple of UK banks would be badly affected. But strong capitalisation across UK banks and the fact the majority wouldn’t be directly affected mean it shouldn’t lead to a substantial tightening of financial conditions in the UK.
Chart 1: Banks’ Foreign Claims on Hong Kong (% of Reporting Country’s GDP, 2018)
Chart 2: Credit Exposure to Hong Kong (£bn, 2018)
Sources: BIS, Refinitiv, Capital Economics
Sources: Banks’ Pillar 3 Disclosures, Capital Economics
Andrew Wishart, UK Economist, +44 20 7808 4062, firstname.lastname@example.org