Downside risks to the banks' balance sheets loom.
According to BMI Research, the slower loan growth to mainland SOEs compared with that to the private sector has allowed the share of SOE loans to fall to 41.7% in September 2016 (from 47.5% in March 2014), but this still represents a significant share of loans, and therefore, poses downside risks to the balance sheets of Hong Kong banks.
Here's more from BMI Research:
The Chinese government is likely to continue to gradually allow more inefficient and loss-making SOEs to exit the market in an effort to reduce the potential financial burden on local governments, whose fiscal positions are already rapidly worsening.
While it is likely to be a last resort, the fact that bankruptcies have been highlighted as part of the State Council's plan to reduce corporate leverage in its October 10 announcement is a sign that the government will slowly remove its support and allow the market to play a greater role in determining the survival of firms.
We therefore believe that asset quality in the mainland will continue to worsen, and that the HKMA is concerned about the potential negative impact on the financial stability of Hong Kong banks.
Indeed, in its Half-Yearly Monetary & Financial Stability report released in September, the HKMA stated that: 'in view of possible further slowdown of the mainland economy and the risk of excessive credit, as revealed from the rising trend of the credit-to-GDP ratio, banks should remain attentive to the credit risk management of their Mainland-related lending'.
Moreover, the classified loan ratio of mainland-related lending of the territory's retail banks rose to 0 .9% in June 2016 , from 0.8% in December 2015.
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