Hong Kong banks' lending to Qianhai to grow gradually in the first 3 years

They are likely to be selective in their lending decisions.

Moody's Investors Service says the Chinese government's move to allow Hong Kong banks to make direct offshore RMB loans to enterprises registered in Qianhai in southern China will create a new outlet for their surplus offshore RMB funds, as well as expand their presence in the Mainland.

Here's more from Moody's:

"Given the limited pool of RMB funds in Hong Kong, we expect Hong Kong banks to be selective in their lending decisions and maintain good asset quality on loans to Qianhai," says Sonny Hsu, a Moody's Vice President and Senior Analyst.

"We expect Hong Kong banks to mainly lend to borrowers they are familiar with, such as subsidiaries of well-established Chinese companies, multinationals, and long-standing Hong Kong customers," he adds.

Hsu was speaking on a just-released Moody's report titled, "Qianhai Special Economic Zone Opens Business to Hong Kong Banks: Frequently Asked Questions."

According to the report, Hong Kong banks can demand credit guarantees from the corporate parents of borrowers or secure their loans with high quality collateral to mitigate credit risks on loans to borrowers in Qianhai.

Mainland authorities currently have in place strict capital controls on cross-border fund transfers for purposes other than trade, and require extensive approvals for any cross-border investments and financing.

Hong Kong banks would only need to fulfill two conditions to extend such loans to Qianhai: (1) the borrowers should be Qianhai-registered entities; and (2) the proceeds should be used in Qianhai. The banks and borrowers are free to determine the terms and conditions, including amounts, tenors and interest rates.

"The Mainland's decision is a step towards the relaxation of China's capital account and interest-rate regulations," says Hsu.

"This move will allow Mainland authorities to monitor the progress and development of liberalized cross-border lending on a very small scale before making a decision on whether to apply similar relaxations to the rest of the country," adds Hsu.

On 28 January 2013, a total of 15 Hong Kong and Chinese institutions became the first batch of banks allowed to make offshore RMB loans.

"Based on the balance of RMB624 billion in RMB customer deposits in Hong Kong at end-January 2013, we expect the banks to lend out at most half of such deposits, or RMB312 billion, as loans in Qianhai, which would be equivalent to 2.5% of overall banking system assets in the territory," Hsu says.

Because RMB will remain non-convertible through the capital account -- with the exception of Qianhai -- Moody's expects Hong Kong banks to maintain ample liquidity buffers in the currency.

In view of current market conditions, assuming that Hong Kong banks enjoy a yield pick-up of 200 basis points on such lending, they can expect an increase of 5 basis points in their aggregate return on assets.

The banks' profitability would further improve if tighter liquidity conditions in offshore RMB lead to wider offshore lending spreads.

For the Mainland's banking system, the impact will be minimal, given the small pool of available offshore RMB funds in Hong Kong relative to the total loans and deposits in China.

According to Moody's calculations, even if Hong Kong banks lent out their entire current RMB deposit stock as loans in Qianhai, it would amount to only 1% of total system loans in China.

"We expect the banks' lending to Qianhai to grow at a gradual pace, at least for the first two to three years, which will provide them with ample time to build-up experience in this new environment," Hsu says.