The Implications From The Financial Crisis

Published Date: 02 Nov 2017

ABSTRACT

This report is prepared for HSBC Holdings plc to demonstrate the implications from the financial crisis and analyze the emerging risks from the uncertainty of Euro-zone. In addition, the report will analyze the performance of subsidiaries in Hong Kong because of its strategic significance in the company’s long-term development.

INTRODUCTION

HSBC Holdings plc (HSBC) is a multinational banking and financial services organization, ranking second in the world biggest public companies in 2011(Forbes magazine,20111) .

While most financial institutions took a hard hit during the financial tsunami (2007-2010), HSBC’s loss was comparatively smaller, for it has weathered the subprime storm better than other global banks, which makes HSBC to be "one of the world’s strongest banks by some measures"(Jon M,20092).

Last year however, HSBC saw severe threats from Euro-zone crisis. Though its exposure to the troubled Euro-zone countries was relatively small, HSBC still experienced a loss mainly from its investment banks in Europe.

The aim of this report is to illustrate the overall impact from the financial crisis on HSBC with specific emphasis on the Hong Kong market. The following issues have been addressed to meet the respective objects: firstly, the instructive experience from the crisis and the company’s survival strategy; secondly, the impact of Euro-zone crisis on the operations and financing of HSBC; and finally, to explore the importance of the Hong Kong-market to HSBC.

1. IMPLICATION FROM THE FINIANCIL CRISIS

1.1 Financial crisis of 2007-2010

The Global Financial Crisis (GFC), which resulted from the failure of both credit rating agencies and investors, while the governments did not adopt effective measures to regulate the rapid expansion in 21st-century financial markets, exerts detrimental impact on various numerous financial institutions and stock markets throughout the world.

Many British banks became the victims of this global regression, "Cumulative losses and asset writedowns since the bursting of the financial crisis amounted to £125.4bn in January 2011, of which nearly £44bn was concentrated in Q4 2008 .....Together, Royal Bank of Scotland (30.6% of total losses), HSBC (27.8%), Barclays (21.5%) and HBOS (14.2%) accounted for nearly 95% of reported losses and asset write-downs"(Laurent Nahmias, 20113). Though the UK government immediately implement massive solutions, the overall loss of the UK banking system was tremendous.

1.2 The performance of HSBC during the crisis

According to the BBC news in 20084,HSBC lost $17.2bn (£8.7bn) after the decline in the housing market in the United States (US), for the defaults on mortgages and credit card payments significantly devaluated the company's loans. Because HSBC had comparatively large operations in the US, the bank’s write-down was larger than other UK banks (RBS, Barclay, HBOS, Lloyds, see chart1).

Data source: Company annual reports

However, HSBC soon closed approximately 400 branches and cut down the amount of credit payments so that the further write-downs were largely mitigated. In addition, the increasing profits from the branches in Asia, Mid-east and Latin America were higher than the expectation, which enabled the bank to enjoy a 10% rise in its annual profit (BBC news, 20084).

Additionally, in order to reinforce the capital base in the UK, HSBC accessed the capital by issuing extra rights from the existing shareholders rather than seeking financial help from the government (Kay Mitchell, 20085). Meanwhile, unlike many of its competitors, HSBC was able to lend money to other financial institutions and businesses. It was an effective way to increase its market share when other banks did not have sufficient fund to lend (Business Easy, 20086)

Implications of the crisis

In general, the performance of HSBC during the GFC can be regarded as a success, and there are several factors conductive to its survival over this specific period.

First of all, compared to other banks, HSBC managed its business operations with a conventional strategy aiming at mitigating risks. HSBC has avoided purchasing cheap but potentially distressed banks. Specifically, "the bank has a loan-to-deposit ratio of 90%, lending 90 cents for every dollar of deposits it receives. That compares with 129% for Royal Bank of Scotland Group Plc, the UK's second-largest bank, and 124% for Barclays Plc. HSBC's Tier 1 capital ratio, a measure of financial strength, is 8.8%, compared with 8.6% at RBS and 7.9% at Barclays" (Business day, 20087).Therefore, having the highest capital ratio in Europe, which means customer deposit overweight loans, the company is less risky--one of the essential fact that attributes to the company’s success during that period.

Secondly, HSBC foresaw the potential benefits form the emerging markets, such as Asia and Latin America. In the first half of the year 2008, HSBC gained more than three-quarter of its profits from these faster-growth markets. As a result, the company was able to balance out the losses from the US market, and became one of the first banks to provide loans to other business (Business day, 20087).

2. THE IMPACT OF EURO-ZONE CRISIS

2.1 European sovereign-debt crisis (ESDC)

The Euro-zone crisis, also known as European sovereign-debt crisis (ESDC), is an ongoing crisis since late 2009. This crisis is a combination of several complex factors, including rising government debt levels, trade imbalances, monetary policy inflexibility and loss of confidence (Wikipedia, 20128).

Though the sovereign debt has increased substantially in only a few Euro-zone countries, it has exerted a perceived influence on the area as a whole.

UK is very much at risk from a domino-fall of defaults, according to Mervyn King9, the governor Bank of England. It is because the UK has the highest gross foreign debt of any European country (€7.3 trillion; €117,580 per person) which is largely due to the large exposure to the highly leveraged financial industry closely connected with both the United States and the Euro-zone. Therefore, banks should strengthen their capital bases if the financial conditions are allowed.

The impact of ESDC on business performance (2010-2011)

In order to cope with the fiscal pressure from the Euro-zone crisis, HSBC has started a strategic global reorganization, aiming at improve the operating efficiency. The process of the restructuring can be divided into three parts: cutting back operations in some parts of the world, reducing the number of the staff and investing in the fast-growing emerging market.

Retreat from the troubled market

Stuart Gulliver, chief executive of HSBC, claimed that the continuing uncertainty of the macroeconomic, regulatory and political in Europe adversely affected bank industry's performance in the previous year. However, he also pointed out that the Group’s exposure to the euro-area was small in terms of the contribution from these troubled area to the balance sheet (Jill T, 201110).

In fact, in the first quarter of 2012, HSBC saw a 24% decline (US$7.05bn) of its pre-tax profit on an annual basis, which was largely due to a US$2.1bn loss in revenues attributed to the fallout of the Euro-zone crisis on rates and credit trading in the UK and France. Moreover, "……the performance in credit was even worse – down 82% to US$300m. The other declining area was balance sheet management, the business’s biggest earner, which saw a 17% drop in revenue to US$3.5bn" (Jill T, 201110).

Therefore, to reduce the loss caused by the crisis, HSBC, the biggest supplier of credit to other banks, has reduces its market share in distressed Euro-zone countries including Greece, Ireland, Italy, Portugal and Spain by $2.7bn (£1.68bn) in the previous year (2011) (Jill T, 201110).Particularly, the Group cut its exposures to this region by reducing 40% of inter-bank loans, ending its lending to Greek banks, and lowering the lending by approximately two-thirds in Spain and Irish(Business day,201111).

2.2.2 Eliminating redundant workforce

The financial crisis not only exerts the negative impact on the Euro-zone countries, but also influences the overall performance of HSBC, though only a relatively small portion of the Group’s profits comes from this area.

As a part of its aggressive cost-cutting plan, the bank, which has already cut 5,000 jobs this year, announces that another 25,000 job losses will be involved by 2013, accounting for nearly 10% of the Group’s current workforce (USA TODAY, 201112; euronews, 201113).

At first glance, it seems contradictory that while Hong Kong is one of the largest regional profit contribution in 2011 (Annual Result 201114), the number of its laid-off workers is above average. It is mainly because of the increasing salary which leads to a notably higher staff cost. Peter Wong, the bank's Asia-Pacific chief executive, points out that Hong Kong's cost-efficiency ratio is below the Group average, which indicates the possibility of improving the efficiency and eliminating bureaucracy. The implementation of the restructuring plan which primarily reduces the management layers will lower the future cost base of the operation, enhance organisational effectiveness, and make Hong Kong an even stronger part of the Group (Jamie D, 201115).

2.2.3 Focusing on high-growth markets

In 2011, HSBC saw increased revenues in faster growing regions, such as Asia, Latin America (Latam), Middle East and North Africa (MEANA) by 10%, which accounted for 49% from of the company’s annual, profits (Annual Result 201116).

Data source: HSBC Annual Results 2011

While many western banks reported weak performances last year, because of the marked recessions in the euro zone economy, HSBC achieved a 15% rise of pre-tax profits-$21.9 billion, beating all its rivals (Steve S, 201217).

It is expected that the international trade and capital flows between the emerging areas around the world will grow continuously, and very likely to increase tenfold in the next forty years (Staff reporter, 2012118). Therefore, by taking advantages of the strong performance in these dynamic markets, HSBC has a very positive outlook for 2012, despite of the uncertainties of the macroeconomics.

2.3 The impact of ESDC financial performance (2010-2011)

With the contagion of stress in the peripheral Euro-zone sovereign and financial sectors, the market dislocation and tightening liquidity have adversely affected the Group’s ability to borrow from other financial institutions and to engage in funding transactions (Annual Report and Accounts, 201119).

Moreover, the spread of the Euro-zone crisis has also increased the government intervention and control over financial institutions. These regulatory changes, which increase the requirements of capital and liquidity, undoubtedly have a material effect on the banks’ activities.

Generally, in terms of the company’s financial performance, the Euro-zone impact on HSBC is reflected in four aspects: revenue, operating expenses, credit quality and capital adequacy. Thus, in line with the Group’s operating strategy, it will emphasize on developing capital more efficiently and improving cost efficiency.

2.3.1 Headwinds for revenues

The ongoing ESDC has created a negative headwind for the Group’s performance, especially in the Global Banking and Market sector (GB&M), which provides tailored financial solutions to major government, corporate and clients worldwide(Annual Report and Accounts, 201120).

The negative impact of the Euro-zone crisis markedly reduces the revenues of Credit and Rates, and revenues in Balance Sheet and from the Group’s legacy credit portfolio within GB&M. According to the Groups annual report of 2011, the Euro-zone sovereign debt market revealed a series of problems, particularly in the second half of 2011 which led to the increasing risk aversion and limited client activities. Ultimately, the revenue fell by 10%, mainly because of the trading losses notably in Europe. The profit before tax (US$7.0bn) decreased by 24% from 2010, and is estimated to decline by 23% on an underlying basis, for the concerns of the Euro-zone debt is continuously dominating European market sentiment and adversely affects the Credit and Rates revenues within GB&M. (Annual Report and Accounts, 201121).

2.3.2 Increasing operating expenses

In 2011, the operating expenses rose by 9 %, driven by higher regulatory and compliance costs, along with the strengthening of the Swiss Franc which increases the expenses in GBP (Annual Report and Accounts, 201122).

Meanwhile, in GB&M, expenses were also increased, due to the rising amortisation charges for the performance shares in 2010 and the higher expense recognition of current-year deferred bonus awards, and the investment in strategic initiatives (Brian R, 201223).

However, the decrease in the revenues reflects the weak performance of GB&M during the crisis, which substantially reduces the performance-related awards and offsets the rise of the operating expenses to some extent (Annual Report and Accounts, 201121).

2.3.3 Improved credit quality

The year of 2011 is a hard hit for the banks with direct exposure to the Euro-zone markets, for their costs and access to funding deteriorate sharply. However, HSBC still achieved a substantial improvement of the credit quality –a significantly 15% decrease in loan impairment charges and other credit risk provisions (Annual Report and Accounts, 201124),

Although the Group’s exposure to the peripheral Euro-zone market is comparatively limited, and is largely to the strong countries, by regularly updating the assessment of higher risk countries and adjusting risk appetite and exposures to reflect these updates, HSBC improved the overall credit quality, and reduced loan impairment charges. According to the Group’s annual report, the loan impairment and other credit provisions in 2011 were US$12.1bn, 15%lower than those in 2010(Annual Report and Accounts, 201124).

2.3.4 Developing capital adequacy

Priory to ESDC, HSBC has already proved its robust financing strategy. In 2009, Standard & Poor’s announced HSBC ranked first in the world with the highest the risk-adjusted capital adequacy (RAC) ratio (Press release,200925), which indicates the Group’s strong ability to mange expected losses within the its tolerance.

For HSBC, the key priority has long been, and will remain to be reserving the strong capital position (Annual Report and Accounts, 201126).In December 2010, the Group’s core tier 1 ratio was 10.5%, and later reached to a peak of 10.8% in June 2011, exceeding the post-stress minimum core tier 1 capital requirement of 5%, which leaves HSBC as one of the best capitalized lenders in the world (Annual Result 201127).

Apart from the strategic disposals in troubled markets and closures of some GM&B positions which are parts of the Group’s mitigating action, HSBC complied with the capital adequacy requirements of the Financial Services Authority (FSA) throughout 2011 and 2010. "Internal capital generation contributed US$8.7bn to core tier 1 capital, being profits attributable to shareholders of the parent company after regulatory adjustment for own credit spread, and net dividends. Foreign currency translation differences decreased core tier 1 capital by US$2.7bn due to the strengthening of the US dollar" (Annual Report and Accounts, 201128).

In addition, the sustainable cost savings from the increasing cost efficiency are intended to facilitate self-funded growth in key markets and investment in new products, processes and technology, and provide a buffer against regulatory and inflationary headwinds (Annual Report and Accounts, 201129).

3. HONG KONG-A STRATEGIC PRIORITY

3.1 Economic background

Hong Kong is one of the most open economies in the world and its economic fortune by nature heavily depends on the world at large. However, the economic openness also makes it vulnerable to the risks from economic downturns and financial crises. Last year, Hong Kong’s real GDP growth was 5 %, slowed by supply chain disruptions due to the earthquake in Japan and slowing demand due to tightening policy from mainland China (Hao L, 201130). Meanwhile, unemployment rates in Hong Kong fell from 3.9% at the end of 2010 to 3.2% by the end of 2011 and inter-bank interest rates stayed low during 2011, rising slightly to 0.325% by 31 December (Annual Report and Accounts, 201131).

In general, Hong Kong’s economic outlook is positive, and has also proved its unshakable position in the Group’s successful performance by making a large contribution to the overall profits.

Data source: HSBC Annual Results 2011-Presentation to Investors and Analysts, p19 , 2012

3.2 Growing prominence

3.2.1 Dominant market position in Asia

While European banks are under a great pressure because of the Euro-zone crisis and new bank regulations, Asian banks are becoming increasingly conductive to the overall trade finance.

Hong Kong, ranked the first out of 41 countries in the Asia–Pacific region (Index of economic freedom, 201232), has demonstrated its increasing significance in the Group’s operations in this region.

Last year, HSBC reported pre-tax profits of US$5.8bn from operations in Hong Kong, an increase of 2%, compared with US$5.6bn in 2010 (Annual Report and Accounts, 201131).

HONG KONGS’S PROFITS CONTRIBUTION TO THE GROUP

Units: USD bn

2010

2011

Hong Kong

5.6 (29.63%)

5.8 (32.77%)

Asia-Pacific

(Hong Kong inclusively)

11.5 (60.85%)

13.2 (74.58%)

Other regions

7.4 (39.15%)

4.5 (25.42%)

Total

18.9 (100%)

17.7(100%)

Data source: HSBC Annual Results 2011-Presentation to Investors and Analysts, p 19, 2012

According to the chart, Hong Kong accounted for approximately half of the Group’s profits generated in Asia, and nearly 30% of the overall annual profits in consecutive two years. There are primarily two factors which are conductive to the rising revenues – increasing customer lending, and the growing demand for wealth management products.

3.2.2 Close connection with mainland China

Over the years, mainland China has attracted the attention from the foreign investment with its large potential market and rapidly increasing demand. Hong Kong, which is located to the south of mainland China and enjoys special political treatments, has exceptional advantages of expanding its branch network in mainland China.

In recent years, Hong Kong’ economic interactions with China have become more intense and sophisticated, chiefly through strengthened financial linkages, and financial markets that are extremely well capitalized (Index of economic freedom, 201232).

Last year, HSBC’ operations in Hong Kong reported pre-tax profits of US$5.8bn, and the Commercial Banking (CMB) sector contributed nearly 30% of the overall revenue. It is mainly because the company continued to capture cross-border opportunities, particularly with mainland China, which accounted for more than half of the new-to-bank CMB customers (Annual Report and Accounts, 201131).

3.3 Emerging challenges

3.3.1 Maintain competitive salary

It is reported in the Telegraph that Hong Kong has seen a 25% base pay increase while that in London was 12%. On average, the base salary for investment banking and fund management staff was HK$890,000 (about £74,000) (Justin H, 201133).

As a result, in 2011, the Group’s operating expenses in Hong Kong rose by 7% (Annual Report and Accounts, 201134), mainly because of the higher staff costs. Besides, the expansion to the Asian market, which leads to a rise in staff numbers to support the increased business activity, also lifts up the expense.

Additionally, Ms. Connie Leung, Hong Kong Business Leader for Mercer’s Information Products Solutions, once said rising inflation would increase the staff’s salary expectation. Thus, in order to retain the best talent to drive the business, maintaining a competitive level of compensation would be a key challenge for the employers, despite the potential of uncertain economic conditions (Mercer, 201135). Meanwhile, the Group should also continue the process of leaning the management structure, cutting down the bureaucracy size and giving the staff more responsibility.

3.3.2 Changing regulations and policies

The regulatory efficiency and the openness to the global economy of Hong Kong have been promoting entrepreneurial dynamism. However, changes in the laws and regulations, both within and outside Hong Kong may also adversely affect the company’s operations.

Last year, for example, Hong Kong introduced the new minimum wage, which increased the possibility of higher inflation, for the business incurs the rising operation cost (Tony C, 201136). Moreover, a tightening of policy to counter inflation in mainland China slowed the demand, and eased the economic growth of HSBC’ s business in Hong Kong (Annual Report and Accounts, 201131).These economic uncertainties come along with the newly implemented regulations and require HSBC to have a close watch of the changes in the market.

CONCLUSION

HSBC has outperformed its peers since 2007, especially in the Euro-zone crisis. Internally, the Group improves its business efficiency by leaning operating structures and by pursuing the robust financing policy; externally, the Group has retreated from distressed market and reinforced the position in favourable market.

Because HSBC has effectively avoided the risks and has conducted expansion in most promising markets, it has significantly maximized its profits in a difficult operating time. Nevertheless, the financial environment remains uncertain. For HSBC, as well as other financial institutions and businesses, the opportunities and the challenges still exist.

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