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As a small-cap finance stock with a market capitalisation of HK$32.3b, the risk and profitability of Bank of Zhengzhou Co Ltd (HKG:6196) are largely tied to the underlying economic growth of the region it operates in HK. A bank’s cash flow is directly impacted by economic growth as it is the main driver of deposit levels and demand for loans which it profits from. After the Financial Crisis in 2008, a set of reforms called Basel III was created with the purpose of strengthening regulation, risk management and supervision in the banking sector. These reforms target bank level regulation and aims to improve the banking sector’s ability to absorb shocks arising from economic stress which could expose financial institutions to vulnerabilities. Since its financial standing can unexpectedly decline in the case of an adverse macro event such as political instability, it is important to understand how prudent the bank is at managing its risk levels. Low levels of leverage coupled with sufficient liquidity may place Bank of Zhengzhou in a safe position in the face of adverse headwinds. We can measure this risk exposure by analysing three metrics for leverage and liquidity which I will take you through today.
Check out our latest analysis for Bank of Zhengzhou
Why Does 6196’s Leverage Matter?
Banks with low leverage are exposed to lower risks around their ability to repay debt. A bank’s leverage can be thought of as the amount of assets it holds compared to its own shareholders’ funds. Though banks are required to have a certain level of buffer to meet its capital requirements, Bank of Zhengzhou’s leverage level of less than the suitable maximum level of 20x, at 12.72x, is considered to be very cautious and prudent. With assets 12.72 times equity, the banks has maintained a prudent level of its own fund relative to borrowed fund which places it in a strong position to pay back its debt in times of adverse events. If the bank needs to increase its debt levels to firm up its capital cushion, there is plenty of headroom to do so without deteriorating its financial position.
What Is 6196’s Level of Liquidity?
Due to its illiquid nature, loans are an important asset class we should learn more about. Generally, they should make up less than 70% of total assets, which is consistent with Bank of Zhengzhou’s state given its much lower ratio of 33%. This means less than half of the bank’s total assets are tied up in the form of illiquid loans, leading to high liquidity, perhaps at the expense of generating interest income.