HSBC 2008 Annual Report Download - page 16

HSBC HOLDINGS PLC
Report of the Directors: Operating and Financial Review (continued)
Challenges and uncertainties
14
presenting challenges to HSBC which are specific
to those areas.
Europe
In the UK, the economy has entered recession and
the currency has fallen in value against the US
dollar, the yen and the euro. Changes in the
marketplace are emerging following the part-
nationalisation of some major financial institutions,
and political interaction with the regulatory
environment is becoming more frequent as the
government seeks to stimulate lending to preserve
economic activity. A period of low interest rates will
reduce deposit spreads and HSBC’s retail business
model will be more dependent on transactional fees
and lending margin. Pension funding requirements,
in particular for UK defined benefit schemes, will
place increased financing demands on corporates,
which may lead to unfunded commitments being
drawn down, adding to pressure on system liquidity.
The recent deterioration in credit quality is expected
to continue as the economy contracts, with loan
impairment charges rising as a result. Market
volatility is also expected to continue.
In France, changes in the marketplace are slowly
emerging following government measures to
stimulate lending and preserve economic activity. A
period of low interest rates will not adversely impact
spreads in the short-term but will have an adverse
effect in later years. HSBC’s retail business model is
dependent on banking fees to maintain profitability
and a recovery in financial markets is necessary in
order to enhance brokerage and management fees
and stimulate fund management activities.
Deterioration in credit quality is expected to
continue as the economy contracts, with commercial
loan impairment charges rising as a result. Personal
loan impairment charges are expected to remain at
around current levels unless there is a very deep
recession.
Conditions are likely to remain difficult in a
number of markets in which HSBC currently trades
and volatility is expected to continue.
Hong Kong and Rest of Asia-Pacific
In Asia-Pacific, a prolonged period of low interest
rates is expected which will put pressure on HSBC’s
net interest income from its strong deposit base.
With capital market and currency volatility endemic,
customers are likely to seek capital protection and
become increasingly rate and risk sensitive, seeking
out products which offer deposit insurance and
government guarantees. Regulatory reforms in the
areas of wealth management product complexity,
sales requirements and liquidity and reserve ratios
are likely, and these will lead to a higher cost of
compliance, greater standardisation and slower
product approvals. International trade is expected to
continue to contract, affecting import and export
volumes and reducing HSBC’s earnings from trade
financing. The quality of the asset book will
deteriorate if economic factors beyond HSBC’s
control do not improve, reducing customer credit
ratings and, as a consequence, increasing risk-
weighted asset allocations and capital requirements.
This could be exacerbated if capital continues to be
repatriated from emerging markets to more
developed economies to take advantage of lower
asset prices, adversely affecting emerging markets’
balance of payments and foreign exchange reserves.
However, Asia is expected to adapt quickly to secure
recovery from the global recession, led by mainland
China and India.
The fall in global demand for oil products and
related prices, and the contraction in financial
surpluses held by key oil-producing countries
following the declines in capital markets, will reduce
the ability of some countries in the Middle East to
maintain spending, borrowing and investment
domestically and internationally. This will result in
the cancellation or postponement of infrastructure
projects which, together with weakening property
prices, is expected to reduce both credit cover and
revenue streams for financial institutions. The
availability of economically priced, long-term
funding is likely to contract. Business activity and
private investment will also slow as consumer
confidence declines. These factors will combine to
place pressure on net revenues and on capital
requirements.
North America
In the US, the steep decline in the housing market,
with falling home prices and increasing foreclosures,
and rising unemployment have resulted in significant
write-downs of loans and advances and mortgage-
backed securities. The effect of these write-downs
subsequently spread to other capital market
activities, leading many financial institutions to seek
additional capital, merge with larger and stronger
institutions and, in some cases, fail. Many lenders
reduced or stopped providing funding to borrowers,
including to other financial institutions. This market
turmoil and resultant tightening of credit have led to
an increased level of delinquencies, a fall in
consumer confidence, increased market volatility
and a widespread reduction in business activity in
general. To date, various government intervention
measures designed to stabilise the markets, including