OREANDA-NEWS. Foreign banks' mainland China exposure (MCE) is declining alongside the slowdown in economic growth, but it remains a significant concentration and source of risk for several banking systems including Hong Kong, Macao, Singapore and Taiwan, says Fitch Ratings.

Fitch's updated and relaunched MCE Data File, published on 7 June, shows foreign banks' claims in mainland China declining to USD1,585bn by end-2015, down from USD1,831bn a year earlier. Exposures at European, UK, North American and Hong Kong banks showed double-digit percentage declines, while APAC MCE fell by 7%.

Hong Kong banks' MCE had declined to 27.3% of system-wide assets at end-2015, down from 32.8% a year earlier. This marked the first decline in MCE in a decade, and was driven especially by a decline in claims on mainland banks. As a result, the breakdown of Hong Kong banks' gross MCE shifted in 2015, with non-bank loans accounting for a much greater proportion of the exposure relative to claims on banks.

Locally incorporated authorized institutions (AIs) and branches of foreign banks still account for a large majority of non-bank lending gross MCE, at over 80%. Mainland Chinese subsidiaries of local AIs account for the remainder. When broken down by borrower, Hong Kong banks' MCE is mostly to state-owned entities (42% of non-bank loans) and non-mainland entities (38%). Fitch expects lending to onshore Chinese borrowers to increase as banks, including HSBC, focus on that segment for expansion.

Hong Kong still accounts for nearly half of foreign banks' claims on mainland China, however, and the still-large MCE makes Hong Kong banks vulnerable in the event of a sudden deceleration or hard landing in China. Such a deceleration is not our core scenario, but Fitch maintains that banks' asset quality and liquidity would be significantly tested if such a risk-event were to occur. Fitch estimates the Hong Kong banking system's China NPL ratio to rise to 1.5%-2.0% by end-2016, up from below 1%.

There are significant disparities and divergences between Hong Kong banks regarding their MCE and its composition. Continued aggressive expansion into the mainland over the medium term, at a time of decelerating growth and reduced exposures for most other banks, could affect a lender's credit profile. Changes in the composition of borrowers from banks and state-owned firms to private entities in China could also be an important driver of credit profiles in future. As shown in the MCE Data File report, there have been notable changes in lending composition in several Hong Kong banks.