China, Canada, HK at Risk of Banking Crisis

China, Canada and Hong Kong are among the economies most at risk of a banking crisis, according to early-warning indicators compiled by the Bank for International Settlements.

Canada—whose economy grew last year at the fastest pace since 2011—was flagged thanks to its households’ maxed-out credit cards and high debt levels in the wider economy. Household borrowing is also seen as a risk factor for China and Hong Kong, according to the study, news outlets reported.

“The indicators currently point to the build-up of risks in several economies,” analysts Inaki Aldasoro, Claudio Borio and Mathias Drehmann wrote in the BIS’s latest Quarterly Review published on Sunday.

The study offered some surprising results: for example, Italy wasn’t shown as being at risk, despite its struggles with a slow-growing economy and banks that are mired in bad debts.

While China was flagged, a key warning indicator known as the credit-to-gross domestic product “gap” showed an improvement, said the BIS, known as the central bank for central banks. This may suggest the government is making progress in its push to reduce financial-sector risk.

The gap is the difference between the credit-to-GDP ratio and its long-term trend. A blow-out in the number can signal that credit growth is excessive and a financial bust may be looming. In China, the gap fell to 16.7% in the third quarter of 2017, down from a peak of 28.9% in March 2016 and the lowest since 2012, the study showed.

The narrowing gap in China “suggests the efficiency of financial intermediation is improving," said Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered Plc in Hong Kong. “This helps to slow the pace of the rise of the debt-to-GDP ratio, creating conditions for an eventual deleveraging of the economy,” Bloomberg reported.

China's Financial Crackdown

China is getting serious about dangers in its financial system. While derisking has been the government’s mantra since 2015, the country’s most powerful politicians have been ramping up directives on everything from shadow banking to stock-market speculation. Since April last year, financial regulators have targeted curbing the growth of wealth management products and interbank borrowings, with a more recent focus on reining in household debt.

The BIS is not the first international body to flag risks in China. The International Monetary Fund, in a report published in December, identified three "major tensions" in China's financial system that could derail the world's second-largest economy.

But Chinese authorities had acknowledged those risks and taken action to slow down debt accumulation even before the IMF report was released. China accelerated those efforts in 2017 by strengthening regulatory oversight and closed several loopholes in the economy.

Canada and Hong Kong

Risks are building in Canadian credit markets, BIS said. Canada's credit-to-GDP gap and its total debt-service ratio are coded red, meaning they exceed a threshold that points to a higher risk of a banking crisis in the coming years, the Edge Markets reported.

On two other measures–the debt service ratio for households and cross-border claims to GDP–Canada surpassed a lesser threshold, triggering amber alerts.

The latest BIS warnings come as Canada's household-debt levels remain at record highs, and housing prices continue to be elevated in cities like Vancouver and Toronto even as recent regulations dampen the rate of growth. Credit has been a nagging concern for policy makers and regulators, but executives at big banks continue to reassure shareholders that the environment is benign and that their own lending books are relatively blemish-free.

Meanwhile, the HK dollar is at a three-decade low and Armageddon is approaching. Hong Kong’s foreign exchange market, usually the least interesting financial market in the world, has been making headlines recently.

BIS says Hong Kong's "credit gap" surged to record highs last year and is in a league of its own, even by the frothy standards of China and East Asia.

Australian Banks

Risks are building in Australia's credit markets, BIS said and is raising warning signs about the potential for stress in the banking system.

Researchers at the Bank for International Settlements, which is owned by 60 central banks, looked at four measures that are designed to raise early alarms before financial vulnerabilities may emerge.

Three of those measures –Australia's debt-service ratio, household debt service ratio and cross-border claims –are coded amber, meaning they exceed a threshold that points to a high risk of a banking crisis in the coming years.

Australia flashed amber in three of the four areas, while Canada flashed red in two and amber in the other two. China and Russia flashed red in two areas.

Hyun Song Shin, the BIS' head of research, cautioned however that tougher bank capital rules introduced since the crisis should be taken into account, and that amber or red warnings were only a starting point for a closer look at vulnerabilities.

Asia's Big Developers at Shock

Asia's big developers are "more vulnerable" to shocks after their profitability waned from the boom years at the start of the decade, the BIS warned. The "sector's deteriorating fundamentals give reason for concern," it said.

Many firms' returns on assets are below their costs of debt, the BIS said, citing a study of developers in China, Hong Kong, Indonesia, Malaysia, Singapore and Thailand.

Higher interest rates, sinking property prices or falling currencies are shocks that could worsen developers' financial health, with the potential for significant economic repercussions. Even without external jolts, falling returns on assets and declining interest coverage ratios "could pose problems" for the firms, it said.

While easy money drove property booms worldwide after the global financial crisis, the BIS argues a tightening in the years ahead could force developers to sell off inventory—driving down prices—and lay off workers.

Thailand's developers were the exception to the theme of sinking profitability. Much of the data only ran through the end of 2016.