bodyType

customContents

entityId

entityUuid

articlePageQuery

filter

article

articleBaseAdvertisingInfoArticle

articleListArticle

articleSeoArticle

helpersCheckIsPostiesArticle

hooksArticleAcknowledgementGateOverlayArticle

hooksTrackPageViewArticle

hooksContentInterestArticle

articleLinkingDataContent

articleSchemaContent

liveArticle

advertZone

sentiment

contentLock

topics

types

sections

moreOnThisArticles

urlAlias

commentCount

sponsorType

authorLocations

authors

paywallTypes

corrections

displaySlideShow

multimediaEmbed

printHeadline

seriesContainer

socialHeadline

headline

flag

firstTopic

glossary

flattenTypeIds

publishedDate

additionalInfoBoxes

images

image

relatedLinks

relatedNewsletters

__typename

createdDate

sponsor

factSheets

series

disableOffPlatformContent

published

updatedDate

summary

subHeadline

body

keywords

copyrighted

customTimezone

liveContents

Neal Kimberley

At the root of the Hong Kong dollar’s recent weakness is a tightening of US dollar funding conditions that has worked in the greenback’s favour. Yet, higher US dollar funding costs don’t apply to Hong Kong alone. Globally, these may be uncomfortable times for non-US banks that have ramped up US dollar lending in recent years. 
 “The pressures that have built since the start of this year on the Hong Kong dollar are reminiscent of what happened 11 years ago,” wrote Simon Derrick, chief currency strategist at US bank BNY Mellon last week, when there was also a widening of the spread between the Hong Kong and the London interbank offered rates. 
What has been seen recently in Hong Kong is “a further echo of market behaviour a year before the global financial crisis”, Derrick said. That is not to say that the BNY Mellon strategist is arguing that history will repeat itself but just that the resemblance to prior events is worthy of note. 
Hong Kong dollar spikes as short positions cut on expectations of higher rates


Explainer: What ails the Hong Kong dollar? It is the carry trade
With that in mind, at the very least it’s worth exploring whether any specific parts of the global financial system could be particularly vulnerable if a more elevated cost of accessing US dollar funding persists or if the pool of greenbacks available to borrow was to shrink. 
Aggressive expansion of their US dollar loan books could leave Japan’s banks exposed if US dollar funding conditions continue to tighten
 If tighter US dollar funding conditions are to persist or worsen, it might prove uncomfortable for Japan’s banks. Indeed, a piece in February from financial research group TS Lombard was pointedly titled “Is the Next Lehman Japanese?” 
 While “European banks played a decisive role in the subprime crisis,” TS Lombard wrote, Japan’s banks “may have taken over as the main systemic vulnerability”, having greatly expanded the size of their US dollar loan books in recent years, leaving themselves with huge US dollar funding needs, reminiscent of European banks in 2007. 
 That doesn’t mean there’s a Japanese Lehman just around the corner, far from it, but aggressive expansion of their US dollar loan books could leave Japan’s banks exposed if US dollar funding conditions continue to tighten. 
 A Bank for International Settlements working paper last month noted that “non-US global banks collectively hold US$12.6 trillion of dollar-denominated assets – rivalling those of US banks” and, strikingly, that while in the 2007-17 period, the global US dollar assets of European banks have shrunk by 42 per cent, those of Japanese banks have increased by 88 per cent to above US$2.5 trillion. 
 Additionally, the working paper notes, Japanese banks’ US dollar exposures have not only become the largest in size among non-US banks, but are also longer term and harder to scale back. 
Could this 73-year-old become Bank of Japan’s longest-serving chief?

Bank of Japan’s stance makes yen a sitting duck
Last week, the International Monetary Fund wrote that US dollar-denominated loan book expansion by Japan’s banks has led to “a rise in interbank liabilities used to fund an increase in loans and securities” that has affected the Japanese banking system’s US dollar liquidity ratio as a whole. 
While “overall, US dollar liquidity ratios have improved since the global financial crisis” the IMF stated that “the Japanese banking system’s liquidity ratio declined over the same period” even if “it currently stands at about 100 per cent”. 
 And while such a lending strategy can be perfectly viable as long as markets function smoothly and access to US dollar liquidity is cheap and plentiful, times change. 
 Commenting on the importance of swap markets, the IMF wrote that “the yen-dollar market – a crucial source of bank funding – may have become more pro-cyclical because of changes in market structure”. 
The IMF noted that US banks’ dollar swap supply has not kept pace with the growing demand for swaps, with the result that non-traditional lenders, such as hedge funds and sovereign wealth funds, have stepped in to meet demand. These institutions now account for about 70 per cent of the supply of foreign currency derivatives to Japanese financial institutions. 
 It could be problematic for Japan’s banks if those non-traditional lenders prove unable or unwilling to continue filling that role.
Can Japan claw back the ¥1.4 trillion it sent to North Korea?


 In the meantime, even without such a development, US dollar funding conditions are already tightening. The jump in the London interbank offered rate since the beginning of 2018 has already had an impact on Hong Kong’s linked exchange rate system. Globally, it has materially increased costs for those who have to borrow dollars. 
 At the very least, the rising cost of borrowing the greenback to fund their greatly expanded US dollar loan books may well erode the profitability of the Japanese banks involved, even if market functionality remains unimpaired. 
 But, if events in Hong Kong are more than just an echo of 2007, the implications for Japan’s banking system could be much more serious.
Neal Kimberley is a commentator on macroeconomics and financial markets


China won’t be the only Asian economy in Trump’s sights

5 reasons Hong Kong’s property sector will weather the Trump shock

Trump’s tariff weapon may amount to little in a changed world

Trumponomics 2.0 is fraught with danger

Macroscope

Forget the Hong Kong dollar, it’s Japanese banks that may crack under US dollar funding strain 

A businessman looks at a screen displaying a photo of US dollar bank notes in Tokyo in 2013. Japanese banks have steadily expanded their US dollar loan books. Photo: Reuters 

Bank of Japan (BOJ) Governor Haruhiko Kuroda (L), Japan's Prime Minister Shinzo Abe and Deputy Prime Minister and Finance Minister Taro Aso attend a lower house budget committee session at the parliament in Tokyo, Japan, February 13, 2018. REUTERS/Toru Hanai

Hong Kong Monetary Authority bought HK$51 billion during 13 interventions to stabilise currency against US dollar

Intervention within expectations, says deputy chief executive Howard Lee

The Hong Kong Monetary Authority. Photo: Nick Bevens

Don’t worry about the Hong Kong dollar but watch out for higher rates, city’s financial chief says

In his blog, Financial Secretary Paul Chan says the city’s monetary body is well-placed to deal with a weaker currency after spending almost HK$10 billion to prop it up

Financial Secretary Paul Chan Mo-po attends a Joint business community luncheon in Wan Chai. 28MAR18 SCMP / Edward Wong

The Hong Kong Monetary Authority spent the equivalent of just over US$1 billion to prop up the Hong Kong dollar. Photo: Jonathan Wong

Opinion

Comment

Business

Neal Kimberley says the aggressive expansion by Japanese banks of their US dollar loan books puts them in a vulnerable position as the cost of borrowing rises


The aggressive expansion by Japanese banks of their US dollar loan books puts them in a vulnerable position as US interest rates rise.
