Hong Kong banks saw a decline in profits compared to the previous year, mainly impacted by the economic slowdown, regulatory and cost efficiency pressures, according to KPMG’s latest annual report.
KPMG’s 27th annual publication of the sector provides an analysis of key performance metrics for the top 10 locally incorporated banks in Hong Kong.
“We see that 2014 was a more difficult year for the Hong Kong banking sector than 2013," says Paul McSheaffrey, Partner, Head of Hong Kong Banking, KPMG China.
"Regulations – and the continued intensity of regulation – continue to loom over banks, with a potential need for investment to be directed towards regulatory rather than growth projects. Also, China, one of the sources of growth in balance sheets in recent years, is experiencing an increase in bad debts.”
The report notes that overall, the surveyed banks’ total assets grew by 8 percent. However banks’ profitability dropped by 20 percent compared to 2013.
This decrease in profitability was due to the absence of a significant gain of HKD 34 billion recognized by The Hongkong and Shanghai Banking Corporation Limited (HSBC) in 2013 on the sale of its investment in Ping An Insurance. If this sale is excluded, overall profitability still dropped by 6 percent compared to 2013, the report notes.
On financial performance, there were few positive trends emerging. Net interest margin (NIM) remained stable, but at low levels.
Impact of interest rates
“The outlook for interest rate rises in the US remains uncertain and the prospect of a ‘lower for longer’ interest rate environment could have an impact on the growth prospects of the sector in Hong Kong," says Edwina Li, Partner, Head of Financial Services Assurance, KPMG China.
"Costs and cost-to-income ratios increased and this may be a sign that there are fewer areas for banks to easily cut costs in order to boost profitability. We continue to see areas where regulators are increasing the intensity of their supervision of banks and where investment will likely be needed to satisfy their demands.”
In general, revenue continued to be challenged as HKD and USD interest rates remained low. This was reflected in the NIM which fell slightly, although the higher asset base meant that absolute levels of interest income increased.
“While there is still some expectation of increasing interest rates, the prospect of ‘lower for longer’ interest rates would pose some strategic questions to certain players in the Hong Kong market around competitive positioning,” McSheaffrey notes.
Managing costs a key priority
Managing costs was again a key priority for the Hong Kong banking sector in 2014. The report finds that cost-to-income ratios increased slightly for the top 10 banks. This, coupled with an 8 percent rise in operating expenses, indicates that banks may find it more difficult to make further cuts to operating expenses than in recent years.
In addition, compliance costs are expected to rise and banks will face an increased need to invest in future growth, for example in new digital channels.
Rita Wong, Partner, Financial Services, KPMG China, says: “This trend is likely to continue as banks in the region continue to invest in more regulatory and compliance initiatives, while faced with growing wage and infrastructure costs in a highly competitive environment.”
Meanwhile, banks’ exposure to non-bank mainland China-related business continued to rise in 2014. Total reported non-bank mainland China exposure grew by 12.5 percent, while the top 10 locally incorporated banks experienced similar growth to 2013, at 12.2 percent.
On-balance sheet non-bank mainland China exposure of the banks surveyed grew by 16.1 percent over the same period, and represented 31.9 percent of the total gross loans and advances, a growth of 2.4 percentage points from 2013.
McSheaffrey concludes: “While the credit quality of the banks’ exposure to mainland China remains strong, the slowing of economic growth rates in mainland China remains an area of risk. In particular, some sectors such as real estate, iron and steel, and renewable energy remain troubled.
"As the authorities look to continue reforming the financial sector in mainland China, we expect to see more orderly defaults and restructurings, which, while still causing bad debts, should give banks some comfort regarding the recovery process going forward.”