Financial experts gathered last week for FinanceAsia’s China Fixed Income Summit in Hong Kong.
The discussion was dominated by debate over unpredictable regulatory shifts, the coming of virtual banking and outsized demand for funds from large Chinese lenders as they seek to meet global capital adequacy requirements.
Virtual banks
With a wide range of innovative offerings and fewer expenses, the sudden arrival of virtual banking is expected to disrupt the traditional financial services industry in Hong Kong.
“The Hong Kong Monetary Authority (HKMA) hasn’t issued a banking license for more than 40 years and then all of a sudden they issued eight virtual banking licenses in Hong Kong this year,” said Frederic Lau, vice chairman of AMTD Group.
Lau estimates that virtual banks will soon be hungry for fresh funding as they acquire more customers and gear up to go head-to-head with banking sector incumbents. “In the near future [virtual banks] will provide more services to customers and for doing that, they will need more capital.”
The HKMA has imposed strict capital requirements, demanding that firms seeking virtual banking licences maintain a minimum capital of HK$300 million ($38.3 million). “We hope also to see innovation on the investment side through virtual banks,” Tim Fang, head of global markets with AMTD, explained. “We are developing products to reach investors we can’t reach right now.”
Firms leveraging tech to explore new avenues of liquidity include Hong Kong-based Futu Securities. Backed by mainland tech conglomerate Tencent, online brokerage service Futu accessed Chinese retail money for equity, according to an example cited by Fang.
Applications of virtual banking tech extend beyond simple retail financial services, the commentators pointed out. Nonetheless, in its 2019 Hong Kong Banking report, consulting firm KPMG foresees the enduring primacy of brick-and-mortar banks as “virtual banks [win] over a considerable number of customers, but only a minor share of banking assets.”
Regulatory woes
Heightened uncertainty around regulatory moves emerged as the primary source of unease among market observers, with the issue eclipsing concerns from the long-simmering trade dispute between the US and China. “We see more material impact from regulatory trends or policies rather than from the trade war because the impact of the trade war is more indirect,” said David Yin, a vice president for ratings agency Moody’s.
The trade war, on the other hand, affects importers and exporters, which in turn is reflected in financial institutions’ balance sheets, he said. “Despite negative trends, we still see strong insurance pipeline from a number of financial institutions in China,” he added.
In the aftermath of the global financial crisis of 2008-09, central banks in the West undertook monetary expansion to shore up their economies. After nearly a decade of zero or near-zero interest rates, the US Federal Reserve sought to reverse the policy, hiking interest rates.
Slowing growth in the US, however, has prompted another about-face by the regulator. It reverted and trimmed rates in both June and September. Fluctuations in monetary policy have become a regular feature in the operations of major central banks, triggering rapid depreciation or appreciation in their widely traded currencies.
During the sustained period of low-interest rates, several emerging market businesses became reliant on offshore debt, usually denominated in dollars or euros. The sudden strengthening of the currencies in which they borrowed makes servicing or refinancing those liabilities more expensive.
That borrowing spree notwithstanding, low interest rates did little to stimulate corporate investment, observed economist Charles Goodhart. Here too, heavier regulation was the culprit.
“What has been remarkable over the last decade has been the continuing low level of corporate investment, despite exceptionally low-interest rates and continuing high profitability,” wrote Goodhart, formerly a member of the Bank of England, in a paper last year.
“Bank regulation has been toughened at a time when bank profitability has remained low. Partially as a result, banks have found it easier to meet the higher CARs [capital adequacy ratios] by reducing leverage, rather than by raising new equity."
“Regulation is always, and almost inevitably, procyclical. Regulation is enhanced after a crisis, when bankers are, in any case, more risk-averse,” said Goodhart.
But easing financial regulation may also not be good news, as that tends to happen after the crisis has passed and there is a widespread perception that the economy is back on track, which generally precedes another period of financial hardship. “Financial crises tend to occur just after periods of greatest economic expansion and optimism. Such optimism and confidence will lead most people to think that the previous tough regulations were otiose. Attempts to ease financial regulation may themselves be a leading indicator of [a] future financial crisis,” he noted.
TLAC roll-out continues
While the rising burden of regulation was top-of-mind for the panellists, the upcoming spate of Total Loss-Absorbing Capacity-related issuances by Chinese banks was another element that figured high on their agenda.
Four Mainland Chinese banks – Agricultural Bank of China, Bank of China, China Construction Bank and Industrial and Commercial Bank of China – are classified as globally systemically important banks (G-SIBs). G-SIBs must comply with measures on capital adequacy, of which TLAC is a part, implemented by the Financial Stability Board in 2015.
TLAC is an international standard under which G-SIBs must hold a preset proportion of equity to reduce the risk of a government bailout. The move is, in part, a response to insufficient insolvency regimes exposed after the 2008 financial crisis when banks dubbed “too big to fail” received considerable government support.
To qualify, China’s largest state-owned banks have issued billions of dollars worth of offshore bonds. “The size of capital needed once TLAC comes through, they talk about a trillion [Rmb] needed by Chinese banks,” AMTD’s Tim Fang explained. “That’s a huge development over the next three years.”
The final deadline for Chinese TLAC adoption is 2025 when TLAC should comprise 16% of the bank’s risk-weighted assets or 6% of the Basel III leverage ratio denominator. “The first issue will be what form TLAC takes in China,” said Terence Lau, a partner at Linklaters. “For structural reasons, it is more likely that they will go for banks issuing TLAC directly.”
Chinese and Japanese G-SIBs must issue far more debt instruments than their European and American counterparts to bridge the current funding gap. This hasn’t slowed down implementation and so far China’s financial institutions are three years ahead of schedule, according to a recent DBS Asian Insights report.
Still, the TLAC requirements pose a particular challenge for Chinese banks, which operate in a shallow market with little variety of investors and a tendency for financial institutions to buy each other’s debt. Moreover, the largest banks in China are state-owned and the government would likely bail them out despite TLAC stipulations.
The HKMA has already launched its own TLAC rules. Because Chinese G-SIBs have until 2025 to implement TLAC, Hong Kong currently treats them equal to non-G-SIB institutions.
