Hong Kong Builds a Bubble

Hong Kong likes to lay the blame for its escalating property prices on the influx of mainland money, particularly into high-end apartments. However the latest evidence from the HK Monetary Authority suggests that Hongkong is doing much to help the process along. Meanwhile the territory's lending institutions are helping mainland firms avoid the rather modest efforts that China has been making to rein in credit growth.

How much the Hong Kong lenders know about the quality of their loans to mainland companies may be debatable. But add domestic and foreign lending together and for the first time in years there may be some cause for concern at the potential losses to Hong Kong institutions when the credit cycle finally turns from a period of excess ease and negative real interest rates.

Over the past year to end-February loans for use in Hong Kong rose by 26.8 percent compared with nominal GDP increase of around 6 percent. The pace of growth accelerated in the most recent months. For sure, the 26 percent number came after zero growth in lending in 2009 and a modest 10 percent in 2008. Nonetheless it is a huge increase at a time when interest rates, even in a Hong Kong dollar pegged to the anemic US currency, may well start to rise soon and put pressure on some borrowers. Some of the loans which appear as trade-related credits may also be for asset purchases – there was a 48 percent rise in Hong Kong loans for trade finance, which appears out of all proportion to actual trade volumes and may be funding commodity stockpiling.

Another fast growing sector has been exposure to non-bank mainland entities – up 47 percent to HK$440 billion and now representing almost half of all loans for use outside the territory. Whether most of this increase is accounted for by mainland-controlled banks in Hong Kong or by others is not clear. But it indicates how far the mainland is now a source of loan business for Hong Kong even at a time when mainland credit remains fast-growing and mainland foreign currency reserves continue to grow apace.

The banking data also shows the gradual decline of the Hong Kong dollar in intermediation. Hong Kong dollar money supply rose only 7.7 percent in the 12 months to February compared with a rise of 12.9 percent in foreign currency deposits. Yuan deposits continued to rise but at HK$407 billion are still only 12 percent of non-Hong Kong dollar deposits. The bottom line of all this is that a growing proportion of loans are being financed by foreign currency and that the loan to deposit ratio for Hong Kong dollars has risen steeply, albeit from a low level.

There remain many obstacles to the wider use of the yuan offshore and there is no sign yet that the government, which finds decisions on even minor matters such as tunnel tolls, very difficult is contemplating a change of currency regime. But clearly the complexion of banking in Hongkong is changing as a result of the mainland impact and very gradual liberalisation of the yuan.

Meanwhile the Hong Kong Monetary Authority has not only indicated its concern at the pace of loans growth and promised to monitor it more closely it is to tighten its grip on new entrants into the retail banking business. In future, however large such entities may be they will have to set up a separately capitalized Hong Kong subsidiary subject to local regulation rather than that of the parent’s country. This could slow the entry of foreign banks still eager to get to Hong Kong and, they hope, a piece of the China action. In one way its provides extra protection for Hongkong retail customers. However, to the extent that such banks aim mainly at the mainland market, the HKMA may not find it easy to monitor asset quality.