UK bank stress tests do not clear fog over China risk

December 22, 2015

British banks survived the Bank of England’s 2015 stress tests largely unscathed, but the assessment published earlier this month also underscored the vulnerability of the UK banking system to China.

Key to the tests was a check of the resilience of UK banks to an emerging markets crisis scenario in which Chinese growth falls to 1.7 percent, effectively a screeching halt from nearly 7.5 percent in 2014 and 6.9 percent at last measure.

While BoE Governor Mark Carney concluded “the UK banking system would have the capacity to continue to lend to the real economy even under such a severe scenario,” some of the numbers are striking, especially in the context of Britain’s push for closer economic ties with the Asian superpower.

UK bank exposure to China and Hong Kong, which was handed back to Chinese authorities in 1997 after over 150 years under British control, is high by international comparison:

  • Claims of UK banks on China and Hong Kong represent around 153 percent of their high-quality or Tier 1 capital, far above Germany’s 39 percent, Australia’s 44 percent and the United States’ 16 percent, according to the BoE’s December Financial Stability Report.
  • British banks account for about 36 percent of all foreign bank claims on China and Hong Kong, according to the Bank for International Settlements (BIS). That is far higher than 11 percent for the United States, nearly 10 percent for Japan and 5 percent for France. Analysts say the bulk of that exposure lies with HSBC, which passed the BoE’s stress tests, and Standard Chartered, which only passed after taking remedial action.
  • China represents 15 percent of British banks’ foreign claims, compared with 4 percent for Japan, 5 percent for the U.S. and 2 percent for Germany, according to Morgan Stanley.

China graphic

The concern is that slump in China would lead to a rise in corporate defaults. Chinese private sector debt has reached nearly 200 percent of annual economic output, up from around 120 percent in early 2008.

The BIS warned in September of early signs of banking stress in places with strong credit growth. The credit-to-GDP gap – a proxy for how fast credit is growing – was above 25 percent in China, higher than the 10 percent level which is often followed by serious banking strains within three years, the BIS said.

Another concern is that Chinese authorities may be underplaying the extent of the debt risks. Fathom Consulting estimates that around 15 percent of loans made by China’s banks were non-performing by the end of last year, far higher than the official estimate of 1.6 percent.

HSBC, which has 96 billion dollars worth of assets in mainland China and 635 billion dollars worth of assets in Hong Kong, seems aware of the potential problems.

The bank has reduced gross exposure to Chinese financial institutions by more than $30 billion over the last two and a half years, according to its group finance director Iain Mackay.

— Graphics by Vincent Flasseur

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