Date: July 2020
Wolters Kluwer FRR and the Hong Kong Institute of Bankers organized a webinar to discuss the impact of the twin threats of the Covid-19 pandemic and the Sino-US trade tensions on regional economies.
To shelter the economy from the impact of these systemic factors, a myriad of measures were taken to ease the flow of dollars. However, there are growing concerns that monetary policy might soon reach its limits, and further easing may exacerbate risks. Besides, a decline of credit quality across customer segments poses additional challenges.
As a result, banks are facing significant challenges in capital and risk management, across credit risk, capital risk, market risk, and liquidity risk, under the unexpected stressed market conditions.
Here are five key observations from the webinar:
- US dollar (USD) is no longer the overwhelming favorite
The USD is unlikely to plunge or depreciate sharply, but it will be very difficult for the currency to revert to its value as seen earlier in March. The surge was caused by a huge wave of safe haven demand, the result of the US Federal Reserves’ efforts to calm the markets. These included lowering the interest rate, relaunching the quantitative easing program, and buying treasuries. Moving forward, without these interventions, the USD is not expected to climb back to its previous high.
- Chinese economy is currently under downward pressure
In Asia, regional trade data remains grim, with a sluggish and subdued demand in retail and recreation. As a result, China, a key exporter is under pressure, causing a subdued economic recovery.
At the same time, the Chinese government’s economic response to the Covid-19 pandemic – at 5% of its GDP – is much smaller compared to other developed economies, and a pale shadow of the fiscal stimulus it launched 10 years ago. The smaller stimulus will result in a gradual, moderate recovery, rather than a V-shaped recovery.
- The HK dollar (HKD) will continue to be pegged to the USD, despite the Sino-US trade tensions.
The confrontation between China and the US is intensifying and is expected to impact financial markets, and the macro economy. There is concern on whether Hong Kong will unpeg from the USD and repeg to the Renminbi (RMB).
The HKMA has a much larger reserve, at twice the monetary base, to support the USD peg. In contrast, the RMB relatively smaller in terms of liquidity in Hong Kong.
While the HKD could be pegged to RMB in the future, at the moment, it is simply not good timing to do so.
- A pandemic was a known unknown risk.
The risk framework goes beyond purely financial risks, and covers pandemics and infectious diseases. In past studies, a pandemic was seen to be “somewhat likely”, and to have “moderate impact”. However, the impact of COVID-19 has played out very differently in reality.
Pandemics have a strong correlation to aspects of credit risk, market risk, and liquidity risk. One example is that there is currently serious pressure on interest rates and liquidity, both on a small and on a larger scale, resulting in market destabilization.
- Stress testing is fundamental to financial risk management
Stress Testing is equally important for regulatory compliance as well as for business risk management. Some key areas to consider include:
- Are there additional methodologies and technologies you need?
- How do you build your simulations and shortlist your risk factors to build scenarios?
- How do you draw inferences from your simulations and scenario analyses?
A broader stress test would be more realistic than stress testing only specific areas. For example, a liquidity stress test would be more comprehensive and convincing if it were connected to the whole balance sheet and other elements of credit risk.
This commentary was based off a recent webinar panel – Dive deeper into HKMA data granularity requirements. Watch it here now to learn more.