Why The Bank Of England Is Worried About Standard Chartered PLC And HSBC Holdings plc

Standard Chartered (LSE: STAN) and HSBC (LSE: HSBA) (NYSE: HSBC.US) both sailed through this year’s set of stress tests conducted by the Bank of England’s regulator, the Prudential Regulation Authority. 

However, while the banks passed the tests with flying colours, the Bank of England’s governor, Mark Carney, is concerned about the two groups’ exposure to emerging markets. Indeed, both HSBC and Standard bill themselves as banks with an emerging market focus, which has been a benefit in the past. 

But now regulators are becoming concerned about the effect an emerging market crisis could have on these banks and the possibility of spill-over effects. 

Financial stability risks

The BoE is worried about financial stability risks brewing overseas and it’s easy to see why. For example, the Asian banking industry is becoming increasingly difficult to understand as shadow banking takes off, and lenders use exotic methods of financing that are often difficult to understand. 

What’s more, analysts are worried about the vast volume of debt built up within China over the past few years, especially in the property sector. Much of this debt was snapped up by investors across Asia, which means that Chinese crisis could rapidly become a regional, or even global crisis if companies start to default. 

And Standard is already reeling from a rising number of defaults across Asia. Standard’s management announced that total impairment charges, or bad debts during the third quarter had jumped to $539m, more than double the figure reported for the same period a year ago. Total impairments for the year to the end of the third quarter hit $1.6bn and operating profit for the quarter fell 16% year on year. 

Annual tests

The BoE and PRA are now planning annual stress tests for the banking industry, as regulators try to determine whether or not leading banks can handle a severe financial shock.

The bank is now planning to make global risk assessment a key part of these stress tests. According to Mark Carney:

“You can expect we will look towards some of those global risks much more closely…Given the footprint of some of our largest banks in Asia and given the risk profile in Asia, quite frankly you can expect that would be a component of it.”

So, it’s unlikely that the BoE will assess or pass judgment on Standard’s and HSBC’s emerging market exposure until the results of next year’s stress tests are released. Still, the situation within emerging markets is concerning.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.