{"id":847,"date":"2018-02-26T07:24:49","date_gmt":"2018-02-26T07:24:49","guid":{"rendered":"https:\/\/www.antya.ca\/research\/hong-kong-monetary-authority-blindsided-by-indian-banks-in-hk-could-increase-regulatory-scrutiny\/"},"modified":"2026-02-17T06:27:33","modified_gmt":"2026-02-17T06:27:33","slug":"hong-kong-monetary-authority-blindsided-by-indian-banks-in-hk-could-increase-regulatory-scrutiny","status":"publish","type":"post","link":"https:\/\/www.antya.ca\/research\/hong-kong-monetary-authority-blindsided-by-indian-banks-in-hk-could-increase-regulatory-scrutiny\/","title":{"rendered":"Hong Kong Monetary Authority\u2013Blindsided by Indian Banks in HK \u2013 Could Increase Regulatory Scrutiny"},"content":{"rendered":"
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\nFollow Antya Investments<\/a><\/div>\n<\/p><\/div>\n<\/p><\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n
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As far as the Punjab National Bank (PNB IN) PNB is concerned, its financial statements have become unreliable now that allegations surrounding unauthenticated transactions using the SWIFT system have surfaced. Since it is PNB\u2019s position that bank was not aware of these transactions, the bank\u2019s capital adequacy ratios as disclosed in the past were incorrect simply because appropriate risk-weights on an additional $1.8B of loans were missing. Going forward, the bank could make a provision for the entire $1.8B that it claims to be missing in action, and then book any recoveries from assets that have been seized by the enforcement directorate and the income tax authorities to income, in F19 and beyond. That makes the past unreliable and the future uncertain.<\/p>\n

In PNB\u2019s future, an earnings slowdown due to dilutive financing, higher operational risk weights requiring higher capital and hence lower ROEs, and a more moderate asset growth profile are in store. Therefore, ANTYA recommends that investors find alternative investments to earn a better return.<\/p>\n<\/div><\/div>\n<\/div>\n

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Punjab National Bank (\u201cPNB\u201d) gained international notoriety earlier in February 2018, when much to the chagrin of the Government of India (\u201cGOI\u201d) which is its largest shareholder at 57%, and the Reserve Bank of India (\u201cRBI\u201d) which is its primary supervisor, PNB alleged fraud approximating $1.8B committed by a group of individuals in connivance with bank officials (we will refer to it as \u201callegations\u201d, or \u201cevent\/s\u201d since the truth will come out in due course). Apparently, the event went unnoticed for more than six years, and breached the entire operational risk infrastructure of PNB \u2013 disclosed as part of its Basel III filings \u2013 consisting of \u201cthree lines of defense\u201d viz:<\/p>\n

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  1. The first line of defense represented by various HO Divisions which are Control Units, Business Units, or Support Units<\/li>\n<\/ol>\n
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    1. The second line of defense represented by the Operational Risk Management Department; and<\/li>\n<\/ol>\n
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      1. The third line of defense represented by the Inspection & Audit Division which is [apparently] a challenge function to the first two lines of defense.<\/li>\n<\/ol>\n

        If the event had been contained domestically, it would cause us less consternation. However, the tentacles of these allegations head offshore in multiple jurisdictions. We lower our lens on Hong Kong, and one of the parties affected by these events, Allahabad Bank (ALBK IN) (\u201cbank\u201d). We would be remiss if we omitted the rather interesting fact that the Hong Kong (\u201cHK\u201d) branch is the only foreign branch of the bank, whilst it has 3245 branches in India.<\/p>\n

        In a filing with the National Stock Exchange on February 16, 2018, the bank said it had advanced $366.87 million through its overseas branch in Hong Kong. Similarly, on February 17, 2018, Uco Bank (UCO IN) in its filing said that it had \u201cextended credit of USD 411.82 million\u201d to a \u201c\u2026.few of the<\/p>\n

        Corporate Clients associated with the incident of recent fraud \u2026 in Punjab National Bank\u201d. State Bank Of India (SBIN IN) had an exposure of $212 million to the same event, although it\u2019s not clear if it was through its Hong Kong operations or elsewhere.<\/p>\n

        How will Hong Kong Monetary Authority Respond?<\/strong><\/p>\n

        Hong Kong Monetary Authority (\u201cHKMA\u201d) is the supervisor of banking in HK. It would not surprise us that after these events, HKMA is looking closely at all Indian banks operating in HK. Capital adequacy is always a key concern for any banking regulator, and given the large sums exposed to this event risk arising from India, HKMA would like to ensure that deposits are safe and that in the case of a liquidity crunch all depositor obligations can be met without disruption or panic. ANTYA also believes that as HKMA digs deeper, it will be extremely concerned by a lack of prudence, oversight, and banking etiquette exhibited by subsidiaries of authorized institutions (\u201cAI\u201d) from India doing banking in HK. In this regard, HKMA would not be alone, given recent developments in South Africa related to Bank of Baroda discussed here ( Zuma Sacked, PNB Hacked, and Bank of Baroda South Africa Axed).<\/p>\n

        Allahabad Bank \u2013 Description of its international presence<\/strong><\/p>\n

        The Bank is having one overseas branch with a dealing room in Hong Kong. The business of Hong Kong has increased from `12,519 crores [$1.9B] as on 31st Mar\u201916 to `14,130.68 crores [$2.17B] as on 31st Mar\u201917. The business of the branch increased by 12.87% on a Y-o-Y basis. The total deposit as on 31stMar\u201917 stood at `2535.54 crores [$390M], whereas advances stood at `11595.14 crores [$1.78B].<\/em><\/p>\n

        The global investment portfolio of the Bank as of 31.03.2017 stands at` 55711.96 crores [$8.57B], which includes a domestic investment of ` 55433.36 crores [$8.52B] and Overseas investment by our Hong Kong Branch to the tune of HKD 333.85 Mio [M], i.e., ` 278.60 crores [$42.7M] (converted @ 1HKD = ` 8.3450).<\/em><\/p>\n

        Source: 2017 Annual Report<\/p>\n

        The 2017 annual report of the bank runs into 314 pages, out of which two short paragraphs are devoted to the bank\u2019s overseas presence in HK. However, in ANTYA\u2019s view, there is enough in those two paragraphs to cause heartburn to HKMA in particular, and to investors in Indian banks in general. In our opinion, these disclosures reveal a complete abdication of prudent banking practices by the management team of the bank in HK.<\/p>\n

        The bank said the following for F17:<\/p>\n

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        1. Total deposits of $390M.<\/li>\n<\/ol>\n
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          1. Investments of $42.7M; and<\/li>\n<\/ol>\n
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            1. Loans outstanding of $1.78B.<\/li>\n<\/ol>\n

              On the balance sheet loans of $1.78B is backed by $42.7M in investments and $390M in deposits. To provide context to the investment number disclosed by the bank, HKMA expects an authorized institution to have a minimum capital of at least HK$300M or $38.3M. The loan to deposit ratio (\u201cLDR\u201d) in North America ranges between 60%-90%. HSBC Holdings Plc (HSBA LN) which has a significant presence in HK, reported LDR approaching 70% for 2017. That compares to 456% for Allahabad Bank in HK. So what gives?<\/p>\n

              Could it be that Allahabad Bank is undercapitalized in HK, and is offside HKMA rules?<\/strong><\/p>\n

              Rules are meant to be broken. So, goes the expression. ANTYA is not suggesting that the bank violated any laws in HK. We highlight that regulatory guidelines involve principles that need to be applied, and then there is the spirit behind the regulations which maintains the sanctity of operations. It appears Indian bankers stay onside rules but pay little heed to \u201c the spirit\u201d comprising regulations.<\/p>\n

              In ANTYA\u2019s opinion, prudence in banking calls for adherence to both.<\/p>\n

              Part 4.5 of chapter 4 of the HKMA\u2019s Guide to Authorisation for banking in HK says that \u201cIn the case of an institution incorporated outside Hong Kong, the<\/em> primary responsibility for supervising capital adequacy rests with the home supervisor. In arriving at his own assessment of the financial strength of an overseas institution, the MA will take the views of the home supervisor into account but may also wish to make his own independent assessment, taking into account for example whether the institution in question is state-owned\u201d.<\/em><\/p>\n

              \u201cThe MA will generally require an overseas bank which wishes to set up a branch or a subsidiary in Hong Kong to maintain capital levels consistent with the latest applicable capital standards issued by the Basel Committee. The MA will generally accept calculations of the capital requirements which are based on the <\/em>methodology of the home supervisor provided that this is consistent with the various national discretions allowed under the Basel Committee\u2019s capital standards. However, the MA also reserves the right to require capital requirements to be recalculated on the basis of the methodology used in Hong Kong to check that they are not over-stated\u201d.<\/em><\/p>\n

              Under these guidelines, authorized institutions in HK, that are not locally incorporated such as the bank, have significant leeway in managing their operations. It seems that Allahabad Bank in HK has escaped HKMA scrutiny because of the cover provided by its parent, which is also a state-owned institution in India.<\/p>\n

              No On-Site Supervision Either<\/strong><\/p>\n

              Beyond capital adequacy, HKMA also conducts on-site examinations of authorized institutions to assess asset quality and adequacy of internal controls. The frequency of inspection varies from institution to institution.<\/p>\n

              Para 3.28 of The Legal and Supervisory Framework of HKMA says that<\/p>\n

              \u201cNormally, the minimum frequency of on-site examinations will be once every <\/em>year for major locally incorporated institutions and once every 4 to 5 years for <\/strong><\/em>overseas incorporated institutions<\/em><\/strong>\u201d.<\/em><\/p>\n

              Once again, the bank business practices appear to have escaped scrutiny by HKMA.<\/p>\n

              Extraordinarily Large Single Credit Exposure<\/strong><\/p>\n

              Moving beyond capital adequacy and on-site supervision, we believe HKMA is bound to take strong exception to the bank\u2019s performance when it comes to adhering to guidelines related to CR-G-8, large Exposures, and Risk Concentrations. It is a comprehensive document that sets out minimum standards and requirements that authorized institutions are expected to follow.<\/p>\n

              Para 1.1.5, on the first page of the policy manual, says that \u201cFor the purpose<\/em> of this module, any exposure to a counterparty or a group of related counterparties which is greater than or equal to 10% of an AI\u2019s capital base is regarded as a large exposure.\u201d<\/em><\/p>\n

              The bank\u2019s exposure of $366.8M to a single credit was equal to 94% of its deposit base in HK, and almost 10x it\u2019s capital.<\/strong><\/p>\n

              Nevertheless, all rules have some exceptions, and in this instance, \u201cUnder<\/em> \u00a781(6) of the Banking Ordinance, the financial exposure of an AI is exempted from the application of \u00a781(1) if such exposure falls within the following categories:<\/em><\/p>\n