Despite a strong performance for 2010, Hong Kong’s banking sector faces liquidity and credit quality concerns as well as an impact from the current European debt crisis, according to KPMG’s latest Hong Kong banking survey.

KPMG’s 2rd annual report of the sector, notes that 2010 was characterised by sustained loan growth, rising asset prices, low levels of bad debts and significant increases in the sale of investment products.

However, while the first half of 2011 saw a continuation of these favourable conditions, continuing low interest rates have placed further pressure on net interest margins, making it difficult for banks to grow revenue to offset rising wages and other costs. Banks will increasingly focus on operational efficiencies, offshoring and managing costs.

“Banks face increasing regulations and compliance requirements. Basel III rules for example, will require them to raise their capital and meet new liquidity requirements," says Martin Wardle, Head, Financial Services, KPMG in Hong Kong. "In addition, regulators are requiring them to raise their regulatory reserve ratios. We are also likely see restructuring of bank balance sheets in order to meet these new requirements.”

The report notes that Hong Kong dollar liquidity is increasingly becoming a more pressing concern for banks. The growth in local currency deposits has lagged behind HKD loans as customers have favoured the appreciating renminbi. In turn, the tightening of liquidity has helped to bring some pricing power back to the banks and added to the upward pressure on deposit rates as lenders compete for funds.

Total bank assets increased by HKD1.7 trillion, or 15 percent, to HKD12.3 trillion during 2010, with gross advances to customers growing by a strong 29 percent.

With total customer deposits growing by a more restrained 7.5 percent the loan to deposit ratio increased from 52 percent to 62 percent.

The ranking of licensed banks by total assets remains unchanged from 2009 and there is only one new entrant to the top ten rankings by net profit after tax, demonstrating that well-established banks continue to dominate.

Licensed banks recorded better asset growth than during the 2009 recovery from the global financial crisis, with the Hong Kong operations of the large mainland banks generally growing their assets the fastest. Although most performance measures, including cost-income ratios have remained largely stable in 2010 when compared to 2009, customer loan to deposit ratios are the exception, having increased in most banks.