Ongoing global economic malaise and a benign investment market, has led to slowing activity and an uncertain outlook for Hong Kong's banking sector, according to KPMG's latest annual report.
KPMG's 24th annual publication of the sector, notes that banks face pressures on revenue, on new liquidity regulations as well an increasing need to manage costs better.
The report highlights low Net Interest Margins (NIM), which is likely to continue principally due to ongoing economic issues. Non-operating income also saw limited growth during 2011, as fund raising activities were quiet and total stock market turnover remained flat in 2011, compared to 2010. When looking at licensed banks, the increase in revenue came principally from net interest income, due to growth in lending volumes.
Rita Wong, Partner, KPMG China, says: "The key narrative on NIM for 2011 was one of rising deposit costs as banks had to increase rates to attract, or in many cases, retain deposits, particularly in the fourth quarter of 2011. The increase in rates was due to keen competition in the market, particularly for fixed term deposits. Our analysis shows that banks need to mitigate NIM compression from higher deposit costs and to improve the proportion of income which is non-interest income, albeit in a controlled manner."
KPMG research shows that only three banks, HSBC, Standard Chartered and Wing Lung reported increased NIM and for HSBC this was due to the performance of its significant operations outside Hong Kong. Within Hong Kong, HSBC bank's NIM dropped slightly by three basis points.
Paul McSheaffrey, Partner, KPMG China, says: "Inherent operational risks for banks are increasing, in part due to the complexities in the regulatory environment and pressure to increase revenues. In addition we also see a need for banks to continue to invest to improve their capability and competiveness. To offset increasing revenue pressures and to remain competitive in a challenging environment, we have seen an emphasis on cost control by many banks. Banks are adopting different strategies but some common themes include outsourcing various back office functions, very tight management of discretionary spending with approval often required from senior management and lastly, setting of new target operating models, which often includes reducing or redeploying headcount to align with the current revenue streams of the bank."
In terms of the credit environment, the report notes that overall credit quality remained strong in 2011, with no indications of a systematic increase in impaired loans in the system. Mortgage and credit card delinquencies stayed at very low levels throughout the year, indicating that customers’ ability to repay their loans remains robust. However, there are concerns that the benign credit environment will not be sustained in the medium term, especially with key macro-economic indicators pointing to slower growth globally, inflationary pressures in many economies and generally lower consumer confidence.
Liquidity is becoming increasingly important, and therefore having a strong customer deposit base from which to fund lending is vital for a bank to be successful. In particular, retail banks, which do not have a strong base of 'sticky' current and savings accounts and instead rely predominantly on fixed term deposits to fund themselves. They will be susceptible to increasing deposit costs if the intense demand for liquidity of Q4 2011 is repeated, the report states. Banks will also be implementing new liquidity requirements from Basel III which emphasise the importance of a stable funding base. This will likely lead to further price led competition for deposits and further margin compression for a number of banks.
Total bank assets increased by HKD2.2 trillion, or 15 percent, to HKD16.9 trillion during 2011. With total customer deposits growing by 11 percent, the loan to deposit ratio increased from 68 percent to 73 percent. The ranking of licensed banks by total assets remains unchanged from 2010 and there is one new entrant (Wing Lung Bank) to the top ten rankings by net profit after tax.
Paul concludes: "Looking ahead, if revenue pressures remain we expect a number of banks to reassess their size and offering in Hong Kong, particularly in light of restrictions on capital in home countries. Banks who are likely to remain are those with a strong franchise amongst retail and corporate customers, and those who are considered to have market leading product capability."
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KPMG China has 13 offices (including KPMG Advisory (China) Limited) in Beijing, Shanghai, Shenyang, Nanjing, Hangzhou, Fuzhou, Xiamen, Qingdao, Guangzhou, Shenzhen, Chengdu, Hong Kong and Macau, with around 9,000 professionals.