Shareholder support key for Hong Kong virtual banks to weather failure risks

Six out of the eight virtual banks in the city reported narrower losses in 2022.

Continuous shareholder support should help Hong Kong’s virtual banks weather initial losses in the path to growing their business, says Fitch Ratings.

Six out of eight virtual banks in Hong Kong reported narrower losses in 2022 amidst a moderation in operating cost growth and expansion in higher-yielding lending, the ratings agency noted, the ratings agency said. 

However, as they stand, the nascent banks remain vulnerable to higher failure risks than traditional banks due to a limited record in terms of customer loyalty, economies of scale and risk management. 

“Virtual banks are more reliant on costlier deposits than traditional peers due to their nascent franchises,” Fitch said in a report. “These higher funding costs drive virtual banks’ risk appetite, evident from their lending to higher-risk segments, such as SMEs and unsecured borrowers, and investing in higher-yielding corporate debt securities.”

Investment securities and corporate debt accounted for 36% of virtual banks’ total assets on average as of end-2022.

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Their loans to higher-risk borrowers expose them to potentially higher credit costs in an economic downturn. This also renders them more susceptible to potential market confidence issues in the event of stress, especially since their depositor loyalty is unproven and easy transfers make the deposit base vulnerable to flight risk, Fitch warned.

The shareholders of these virtual banks are key for virtual banks as they establish their foothold in the industry. As most of these shareholders are established corporates or incumbent banks themselves, they provide the necessary capital and funding support to help virtual banks weather initial losses and support their growth momentum.

“We believe ongoing ordinary support from their shareholders, mainly established corporates or incumbent banks, remains critical to their continued business growth and helps mitigate their higher standalone risks. However, the shareholders’ willingness to continue injecting capital could be tested if losses at these banks persist,” Fitch Ratings said.