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Full pockets

Ratings agency Fitch believes the city’s lack of diversification beyond ‘gaming-related tourism and consumption sectors’ makes it ‘vulnerable to policy changes in China and shifts in consumer sentiment’

In a global growth environment which ratings agency Fitch predicts is ‘likely to pick up’ this year despite a ‘long’ list of variables, the outlook for the banking sector of the MSAR ‘remains negative’ for 2017, according to the group’s Financial Institutions 2017 Outlooks Compendium.
The ratings agency notes that the region’s outlook carries a rating of ‘stable,’ the same as at the end of 2015, whereas the sector outlook for the banking industry is ‘negative,’ given the city is seeing an ‘enduring impact from a slow recovery in the gaming sector, the effect of a China slowdown and property-price corrections on banks’ credit profiles.’
In particular, the group calls the current framework in place for the MSAR as ‘weaker-than-peer’ opining that this ‘leaves banks underprepared to withstand risks.’
Late last year the MSAR underwent an audit by the Asia/Pacific Group on Money Laundering, which examined its financial and business sectors, their vulnerabilities and possible points of exploitation, with particular attention to regulatory framework; audit results are currently being prepared. One of the heads of the local banking institutions has described the audit to Business Daily as “a challenge to all of us.”
An overall expansion to the MSAR’s ‘volatile’ Gross Domestic Product, coming on the back of consecutive contractions of 3 per cent (2016 estimate) and 20.5 per cent (2015), is expected to ‘add stability’ to the operating environment of the financial sector.

Diversify, man
The group points out that the city’s lack of diversification beyond gaming-related tourism and consumption sectors makes it vulnerable to policy changes in China and shifting consumer sentiment, and points out that the system has a high risk of systemic stress.
However, the gaming exposure the group classifies as ‘manageable’ – noting that the ‘quality of gaming-associated exposure including restaurants and retail sectors will be supported by a rebound in gaming-sector revenue.’ This leads the group to forecast mid-single-digit growth for gaming revenue in 2017 ‘due to new casino openings and mass-market visitors.’
With regard to banks’ exposure to the Mainland, classified as MCE, the group sees it ‘continuing to expand, driven by cross-border financing needs of Chinese and foreign institutions and banks’ deepened business integration with these Chinese bank parents.’
In particular, two of the banks ranked by Fitch with a ‘stable’ outlook are due to the fact that ‘parental support drives ratings,’ notes the agency.
Domestic loans by local banks are expected to pick up this year in the domestic retail, hotel and property sectors, according to the report.
‘We think banks’ profitability will hold up, but a reliance on interest income may constrain the upside as loan spreads could narrow on low aggregate loan demand,’ notes the report.
‘The steadily growing share of higher-yielding securities will support earnings but also adds market risk,’ says Fitch, believing that liquidity will be backed by the ‘large deposit base, moderate loan growth and access to liquidity support from parents.’
The group calls for the MSAR to ‘diversify and stabilise its economy through building up non-gaming sectors’ in order to limit its exposure to the Chinese economy and policy changes.

Working forward
A recent consultation by the International Monetary Fund of the MSAR resulted in a commendation by the institute for a ‘sound financial sector’ as well as ‘strong macroeconomic resilience’ noting a liquid and well-capitalised banking sector, prudent fiscal policy and flexible labour markets, pointing out its support for the MSAR to diversify in three main areas: VIP-focused gaming to mass market, gaming to non-gaming tourism and tourism to financial services.
These reflect the position taken in the MSAR’s five-year plan.
A recent ranking by the Heritage Foundation placed the MSAR 8th in Asia in terms of economic freedom, scoring 90 (out of 100) for trade freedom, 85 for investment freedom, and 70 for financial freedom, noting that ‘the small financial system functions without undue government influence’ and that ‘relatively sound regulation assures free flows of financial resources.’
A recent statement by the local monetary authority assures that ‘with Macau SAR’s sound public finance, stable balance of payments, credible linked exchange rate system and healthy financial system, the Government and local financial system are able to cope with volatilities in financial markets.’

Neighbouring Hong Kong received the same rating as the MSAR, with a stable overall outlook and a negative sector outlook, given the similar exposure to the Mainland ‘as Hong Kong banks become more sophisticated in their China-related activities – which should lead to a pick-up in the onshore activities of Hong Kong banks.’
Overall, the SAR has ‘sound intrinsic strength’ with Fitch opining the banks will ‘continue to maintain solid fundamentals amid tight regulatory oversight and macro-prudential measures.’
For China, the ratings reflect those of the two SARs, with the negative sector outlook due to ‘reliance on credit to support growth’, ‘increasing regulatory scrutiny’ and ‘rising interconnectivity with non-bank financial institutions.’
The group points out that China’s ‘credit problem’ is set to intensify this year due to, in addition to the previous points, ‘rapid growth in new mortgage loans’ and the ‘rise in system leverage.’
‘Household lending, in particular mortgages, should remain a key loan growth driver for 2017, in spite of further home purchase restrictions in the higher-tier cities being introduced to cool market prices,’ notes the report.
Regarding the increased regulatory scrutiny predicted for this year, the agency points out that ‘whether tighter regulations successfully contain systemic risks will depend on the implementation, as previous rules sometimes had the unintended consequences of reducing bank transparency.’

Wide world
Overall, Fitch points out a list of 10 main themes to keep an eye on in the coming year for the banking sector, led by macroeconomic drivers including fiscal easing, monetary tightening, investment and productivity levels’ influence on GDP and emerging market growth (which it notes should rebound somewhat from recent lows).
Other issues include political risks, mostly concerning Brexit and U.S. President Donald Trump but also encompassing ‘populist momentum’ and its effect on upcoming European elections (‘expect greater levels of economic nationalism and pressure on established norms and alliances’).
‘(De)regulation’ was also a major factor, with the report stating ‘expect a push to repeal or rework many parts of Dodd-Frank’ and ‘ongoing debates’ regarding Basel and its ‘continued role in the harmonisation of bank regulation globally.’
Among the top ten issues, the group’s Global Group Head of Global Financial Institutions, David Weinfurter, dedicates one each to Brexit, Italy and China, while pointing out further shifts will depend upon emerging markets (with negative outlooks for their banks increasing) and technology and FinTech competition (referring to interest in ‘disruptive technologies like blockchain’).
In addition, a ‘profits challenge’, in particular given that ‘equity remains under some pressure’ and the sluggish growth in over-banked territories, as well as an ‘investor appetite for loss-absorbing paper’, based on debt instruments, (noting that ‘additional issuance is forthcoming’), are pointed out as key themes the group will monitor this year.