One of the main concerns for Chinese banks is that a loss of access to dollar finance could hamper their ability to lend to corporate customers that rely on USD financing.
The impact of US sanctions imposed under the Hong Kong Autonomy Act (HKAA) is likely to be muted for now, but they could be damaging to Chinese banks and the Hong Kong financial sector if strictly enforced, the IIF (Institute of International Finance) says in a new China Spotlight note.
The note follows US State Department’s release of a report to Congress earlier this month naming ten individuals – including Hong Kong’s Chief Executive Carrie Lam – who are liable for sanctions under the HKAA, which was passed by the US Congress in early July.
The State Department had said it would identify the foreign FIs that conduct “significant transactions” with the sanctioned individuals within 60 days. If named, the FIs could face mandatory secondary sanctions, though the HKAA gives them a 30-day window to take remedial action, and up to one year to take corrective measures to avoid the implementation of sanctions.
With respect to foreign FIs, the HKAA specifies ten measures, including denial of access to loans, foreign exchange, banking transfers or payments, properties, financial technologies, and equity or bond financing from US institutions.
According to the IIF, large Chinese banks are expected to sacrifice individual customers if they are sanctioned under the HKAA, while small local banks with limited exposure to the US financial system or the US dollar “may not follow HKAA sanctions to the letter”.
“The most significant threat to Chinese FIs will be their loss of access to loans, dollar transactions, and banking transfer and payment services by US banks,” the note says, citing USD 965 billion of global banking claims on China.
While Chinese banks’ reliance on US dollar funding and their business in Hong Kong are still small relative to their balance sheets, the IIF says the decision to comply with sanctions under the HKAA will be more complicated if corporate or banking clients are the targets.
The State Department report only named individuals, not corporate entities. But the concern is that Chinese banks’ loss of access to dollar finance could hamper their ability to lend to corporate customers that rely heavily on US dollar financing. Non-financial corporates account for USD 102 billion of total international banks’ USD claims on China.
Meanwhile, FIs in Hong Kong are expected to reduce their dependence on US banks for loans, payments, and dollar transactions in the medium term, the IIF says, noting that some may migrate to places like Singapore or Shanghai “to avoid sanctions and their uncertainties”.
The power of US sanctions in Hong Kong lies in the preeminence of the US dollar in the city, where it accounts for over half of China’s offshore financing and over one-third of the total deposits, the IIF says. FIs could try to transact in dollars or seek dollar funding from non-US banks, but such transactions are ultimately settled via a US bank.
US sanctions under the HKAA may deal a material blow to Hong Kong’s financial sector if “strictly enforced”, but the impact will not be fatal, the IIF says. “HK’s financial industry has proven innovative and resilient since the Asian Financial Crisis in 1998. So far, there is no visible stress, even after sanctions were announced.”
Yet, another concern relates to the potential conflict between Hong Kong’s National Security Law with US sanctions against Hong Kong or Chinese FIs under the HKAA. The IIF says it is still unclear whether such sanctions would be automatically considered a sanction against Hong Kong or China itself – which would be considered an offence.
“The impact of HKAA seemed relatively muted for now,” the note says. “However, HKAA’s language is vague and subject to interpretation. The scope of escalation and damaging power should not be underestimated.”
“Should the conflict escalate, we worry about unintended consequences for global markets.”