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As a £ 142.44B market capitalisation bank, HSBC Holdings plc (LSE:HSBA) is well-positioned to benefit from the improving credit quality as a result of post-GFC recovery. Economic growth fuels demand for loans and affects a borrower’s ability to repay which directly impacts the level of risk HSBC Holdings takes on. As a consequence of the GFC, tighter regulations have led to more conservative lending practices by banks, leading to more prudent levels of risky assets on their balance sheets. Since the level of risky assets held by a bank impacts its cash flow and therefore the attractiveness of its stock as an investment, I will take you through three metrics that are insightful proxies for risk. See our latest analysis for HSBC Holdings
What Is An Appropriate Level Of Risk?
By nature, HSBC Holdings is exposed to risky assets by lending to borrowers who may not be able to repay their loans. Loans that cannot be recovered by the bank are known as bad loans and typically should make up less than 3% of its total loans. Bad debt is written off as expenses when loans are not repaid which directly impacts HSBC Holdings’s bottom line. Since bad loans only make up 1.58% of total assets for the bank, it exhibits prudent bad debt management and faces an industry-average risk of default.
Does HSBC Holdings Understand Its Own Risks?
The ability for HSBC Holdings to forecast and provision for its bad loans accurately serves as an indication for the bank’s understanding of its own level of risk. If it writes off more than 100% of the bad debt it provisioned for, then it has inadequately estimated the factors that may have added to a higher bad loan level which begs the question – does HSBC Holdings understand its own risk? With an extremely low bad loan to bad debt ratio of 48.38%, HSBC Holdings has significantly under-provisioned by -51.62% which is well below the appropriate margin of error. This may be due to a one-off bad debt occurence or a constant underestimation of the factors contributing to its bad loan levels.
How Big Is HSBC Holdings’s Safety Net?
HSBC Holdings makes money by lending out its various forms of borrowings. Deposits from customers tend to bear the lowest risk given the relatively stable amount available and interest rate. Generally, the higher level of deposits a bank retains, the less risky it is deemed to be. HSBC Holdings’s total deposit level of 61.73% of its total liabilities is within the sensible margin for for financial institutions which generally has a ratio of 50%. This indicates a prudent level of the bank’s safer form of borrowing and a prudent level of risk.