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China's President Xi Jinping ahead of his bilateral meeting with U.S. President Donald Trump during the G20 leaders summit in Osaka, Japan. REUTERS

KUALA LUMPUR: Banks in Asia's trade-dependent developed markets will face the most pressure on their credit profiles in the event of a sharp slowdown in the Chinese economy, Fitch Ratings said.

Fitch, in its latest report released today, said banks in these markets were among those with the strongest underwriting standards and risk controls in the region. However, the downturn in economic conditions would test asset quality and add to their existing profitability challenges.

Fitch’s' hypothetical scenario models the economic impact of a sharp Chinese economic slowdown sparked by the US imposing additional tariffs of 25 per cent on around US$300 billion of Chinese imports.

The tariff impact is sharply amplified by a separate investment shock involving a substantial retrenchment in investment activity against the backdrop of corporates' need to ease balance-sheet pressure and preserve liquidity amid weaker demand.

The firm said Chinese economic growth would trough at 3.4 per cent in 2020, compared with a base case of 5.9 per cent, before recovering to 4.2 per cent in 2021.

“A severe slowdown in China would affect Asia-Pacific banks through three main channels - direct losses on mainland exposure, broader stress from a weaker regional economic environment, and market risks from a negative shift in global investor sentiment.”

Outside of mainland China, Hong Kong banks have the most direct exposure to a Chinese slowdown, with claims on the mainland accounting for 30 per cent of Hong Kong's system assets at end-2018.

Fitch cut its assessment of the operating environment for Hong Kong's banks to 'a'/stable from 'a+'/negative in 2018 due to the growing links between the territory and mainland China.

Singaporean banks also have significant direct exposure.

Hong Kong and Singapore - along with South Korea and Taiwan - will also be hit the hardest through macroeconomic knock-on effects, given their close trade links with mainland China.

“A severe China slowdown could also undermine housing market sentiment and exacerbate home price corrections in markets where affordability is most stretched, most notably Hong Kong and Australia,” it added.

Fitch said the region's emerging markets would generally be most exposed to a shift in investor sentiment away from risky assets and markets.

“Most Asian economies have low external financing requirements relative to their international reserves, giving them a buffer against market pressures, but Sri Lanka is a clear exception, while Indonesia also has some vulnerability on this metric.”

Banks in Sri Lanka and Indonesia, it added, also had a significant proportion of outstanding loans denominated in foreign currency, which could expose them to asset quality risks from currency weakness.

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