Here are 2 possible risks from Hong Kong’s soaring household debt

Household debt-to-GDP ratio jumped 62% in 2012.

According to UBS, the household sector in HK has levered up on record low interest rates since 2010. After three years of robust loan growth, household credit-to-GDP ratio rose to a  record 62% in 2012, an increase of 11% of GDP from 51% in 2008. 

UBS adds, the bulk of consumer borrowing are mortgages (73% of the total), which rose to 45% of GDP from 38% in 2008. 

Here’s more:

We see two major risks associated with household debt. High debt ratio increases the risk of delinquency and default and thus the risk of a domestic banking crisis. This is an ex ante risk, with high leverage being a potential trigger of a bigger problem. The US subprime crisis was a case in point.

We don’t think there is high risk of default in HK. On the one hand, the successive moves by the HKMA to lower the loan-to-value ratio help screen out the ‘less prime’ borrowers.

On the other hand, the HKMA has also been exercising close oversight of banks’ lending standards. Bear in mind that even at the depth of the post bubble adjustment in early 2000s, the majority of HK households with mortgage rather put up with negative equity than chose bankruptcy.

The main risk for HK from household debt is an ex post one: the collateral damage and the negative spill-over on the economy if property prices adjust abruptly.

Given the low risk of delinquency or default, high or rising household debt ratio is unlikely a trigger for banking crisis and therefore asset price correction.

The trigger for correction could come in the form of an unexpected event shock, such as a financial crisis originated from elsewhere; a sharp spike in interest rates; a rapid economic deterioration and so on. Events shocks are hard to predict. 

Both the timing and the form of which are hard, if not impossible, to pinpoint; but the occurrence of an event shock, as we can tell from the immediate history, is by no means infrequent.

Over the last 15 years Hong Kong has already weathered five shocks—the Asian financial crisis (1997/98); the tech bubble (2001); SARS outbreak (2003); global financial crisis (2008/09) and European sovereign debt crisis (2010/11).

This, plus the fact that property prices have already reached extreme level, suggests that the concern on the potential negative household debt dynamics is not unwarranted. The authority has reasons to impose restraint whenever needed to mitigate the downside risks.