Banks in Asia's trade-dependent developed markets would face the most pressure on their credit profiles in the event of a sharp slowdown in the Chinese economy, Fitch Ratings says in a new report. Banks in these markets are among those with the strongest underwriting standards and risk controls in the region, but the downturn in economic conditions would test asset quality and add to their existing profitability challenges.
Fitch Ratings' hypothetical scenario models the economic impact of a sharp Chinese economic slowdown sparked by the US imposing additional tariffs of 25% on around USD300 bn of Chinese imports. The tariff impact is sharply amplified by a separate investment shock involving a substantial retrenchment in investment activity against the backdrop of corporates' need to ease balance-sheet pressure and preserve liquidity amid weaker demand. Chinese GDP growth would trough at 3.4% in 2020, compared with a base case of 5.9%, before recovering to 4.2% in 2021.
A severe slowdown in China would affect Asia-Pacific banks through three main channels - direct losses on mainland exposure, broader stress from a weaker regional economic environment, and market risks from a negative shift in global investor sentiment.
Outside of mainland China, Hong Kong banks have the most direct exposure to a Chinese slowdown, with claims on the mainland accounting for 30% of Hong Kong's system assets at end-2018. We cut our assessment of the operating environment for Hong Kong's banks to 'a'/stable from 'a+'/negative in 2018 due to the growing links between the territory and mainland China. Singaporean banks also have significant direct exposure.
Hong Kong and Singapore - along with South Korea and Taiwan - would also be hit the hardest through macroeconomic knock-on effects, given their close trade links with mainland China. A severe China slowdown could also undermine housing market sentiment and exacerbate home price corrections in markets where affordability is most stretched, most notably Hong Kong and Australia.
The region's emerging markets would generally be most exposed to a shift in investor sentiment away from risky assets and markets. Most Asian economies have low external financing requirements relative to their international reserves, giving them a buffer against market pressures, but Sri Lanka is a clear exception, while Indonesia also has some vulnerability on this metric. Banks in Sri Lanka and Indonesia also have a significant proportion of outstanding loans denominated in foreign currency, which could expose them to asset quality risks from currency weakness.