HONG KONG: The profitability of banks in Hong Kong is expected to improve further in 2010 amid the local economic recovery, but narrow net interest income margins will still remain a constraint for the sector, international credit rating agency Standard & Poor's said yesterday.

Standard & Poor's, meanwhile, maintains a stable outlook on the city's banking sector, saying that banks in Hong Kong remain well supported by strong capital and liquidity.

The rating agency suggested that non-interest income of local banks may continue to improve this year, as both fees and trading income hinge on external economic conditions and investment sentiment.

However, the current low interest-rate environment is likely to continue trimming down the non-interest income of the banking sector.

Standard & Poor's also estimates that Hong Kong banks' loan exposures to mainland entities will grow 30 to 40 percent in the next few years, taking advantage of the strong growth momentum of the country's economy.

The huge economic stimulus package and abundant liquidity on the mainland were part of the reasons for local banks' having maintained good asset quality in 2009.

But Terry Sham, Credit analyst at Standard & Poor's, said a different payment culture and legal framework between Hong Kong and the mainland may present a few potential challenges to banks in Hong Kong.

"As Hong Kong banks continue to expand their businesses beyond their core Hong Kong customer base and move more widely into the mainland, in our opinion, they are likely to face a high level of credit risks, stemming from policy risks and a developing credit culture," Sham said.

Given the saturated domestic market on traditional banking products, Standard & Poor's expects Hong Kong banks to continue to expand their business scope on the mainland and explore new opportunities in wealth management.

Meanwhile, the expansion in scope for offshore renminbi business will present Hong Kong banks with potentially lucrative opportunities, the agency added.

Despite an expected economic recovery, Standard & Poor's believes owners of smaller independent banks in Hong Kong will find increasingly compelling financial reasons to sell their stakes, as pressure on net interest margins and profitability has a bigger impact on the smaller lenders.

The ability of smaller banks to expand their business scope is also constrained by their size and financial resources.

"Banks in Hong Kong, or existing banking operations of foreign banks in Hong Kong, are likely to remain a possible stepping stone for sizeable mainland banks to expand internationally," Standard & Poor's said.

Given the flexible economic structure and sound regulatory environment, Hong Kong will also serve as an attractive gateway for foreign financial institutions entering the Greater China markets, it said.

(HK Edition 02/24/2010 page2)