The Hong Kong Monetary Authority (HKMA) published today the classified loan ratio of the banking sector at the end of the 2nd quarter. The ratio was 1.97%, broadly comparable to 1.98% at the end of March. As I have actually discussed on various celebrations, the classified loan ratio continues to face upward pressure, mainly driven by business real estate (CRE) loans. Pressures in global CRE (consisting of retail residential or commercial properties and offices) stemming from the increase of e-commerce and remote operate in current years are also apparent in Hong Kong. An increase in workplace conclusions has actually likewise led to continuing adjustments in the costs and leas of CRE in Hong Kong throughout the very first half of 2025. Moreover, the high rates of interest environment over the past couple of years has worsened the debt-servicing problem of commercial residential or commercial property developers and financiers, drawing market attention and raising questions on the capability of banks to successfully handle the relevant danger exposures and monetary stability risk. I wish to clarify these inquiries here.
Standing together with business
CRE costs and rents are presently under pressure from different elements, including interest rates and market supply and demand characteristics, which have caused a decrease in the worth of loan collateral. Borrowers are understandably fretted regarding whether banks will demand instant payment. To resolve this, the HKMA and the banking sector have repeatedly emphasised that while the fall in local residential or commercial property rates and leas over the last few years have caused a down change to the independent residential or commercial property appraisals, banks consider a host of aspects when evaluating credit limits, consisting of the borrower's credit demand, general monetary position and payment capability. Banks will not adjust a credit line merely due to a change in the worth of the residential or commercial property security.
There have actually also been mistaken beliefs that landlords might refuse to change rents in action to market conditions and even leave residential or commercial properties vacant out of concern over banks requiring loan payments. However, this does not line up with banks' real practices, and is likewise not rational from a risk management angle. In truth, banks have earlier made it clear that they would not require immediate payment entirely due to a decline in rental earnings. This pragmatic and flexible technique demonstrates banks' willingness to stand together with business, along with their position and dedication to ride out tough times with the neighborhood.
If a customer in short-lived monetary trouble breaches the terms of the loan covenant, will it cause the bank demanding immediate repayment? The response is not always so. In practice, banks will first negotiate with the debtor, for instance, by adjusting the payment strategy such as the loan tenor. Banks will take proper credit actions just as a last option to protect the strength of their operations and the interest of depositors.
Protecting banking stability and depositor interests
The public may thus question if banks' assistance for business will come at the expense of banking stability and depositor interests. There is no requirement to stress as the HKMA has actually been carefully keeping an eye on the overall healthy advancement of Hong Kong's banking sector. We think that the credit danger associated with CRE loans is workable. A substantial part of Hong Kong banks' exposures connecting to local residential or commercial property advancement and financial investment loans are to the big gamers with fairly excellent financial health. For exposures to little and medium-sized local residential or commercial property designers and financiers, consisting of some with weaker financials or higher tailoring, banks have actually currently taken credit risk reducing steps early on, and many of these loans are secured. Besides, there is no concentration risk at specific customer level.
A current media report highlighted the risks associated with CRE loans, with a particular focus on the accounting of banks' "expected credit losses". In truth, this is merely a calculation based on modelling for accounting functions. Loans categorized as "predicted credit losses" do not always represent bad debts, and therefore can not be utilized as a basis for an extensive assessment of banks' asset quality.
Similarly, some other commentaries have focused solely on banks' classified loan ratios, which offers a somewhat limited point of view. Hong Kong has gone into a credit downcycle in the last few years, having actually been affected by elements like macroeconomic modification and rates of interest level. This has actually naturally led to a boost in the classified loan ratio of the banking sector. While the classified loan ratio has actually gradually returned to the long-term average of around 2%, from 0.89% at the end of 2021, the ratio stays far below the 7.43% seen in 1999 after the Asian Financial Crisis.
To gain a comprehensive understanding of credit quality, one can consider the following extensively and long-used indications:
- The very first standard indicator is the capital adequacy ratio: The healthy development of the banking sector includes constructing up capital throughout the growth stage of the credit cycle, such that when the credit cycle adjusts and we see credit costs increase and a deterioration in asset quality, banks would have enough capital to absorb the credit costs. Banks in Hong Kong have adequate capital - the Total Capital Ratio for the banking sector stood at 24.2% at the end of March 2025, well above the worldwide minimum requirement of 8%.
- The second key sign is the provision protection ratio: When examining non-performing loans, the sixty-four-thousand-dollar question is whether the pertinent losses will impact a bank's core structure. The arrangement coverage ratio is utilized to assess if the provisions for non-performing loans are adequate. If a bank adopts sensible threat management and its arrangement protection ratio remains above 100% after subtracting the worth of security from the non-performing loans, it suggests that the possible losses from non-performing loans have been properly reflected in the bank's provisions. For the Hong Kong banking sector, provisions are enough, with the provision coverage ratio (after deducting the value of collateral) standing at about 145% at the end of March 2025.
- The third sign is clearly financial strength: Despite the higher public attention on non-performing loans, one essential criterion when evaluating a bank's soundness is whether the bank can maintain excellent monetary strength and its profit model can be sustained after deducting credit costs. In this regard, Hong Kong's banking system tape-recorded earnings development in the last 3 successive years even after taking into account the expenses for anticipated credit losses. The overall pre-tax operating earnings of retail banks increased by 8.4% year-on-year in 2024, and by 15.8% year-on-year in the first quarter of 2025, showing sound financial strength.
These 3 key indicators show that Hong Kong's banking system is well-capitalised and has sufficient provisions and great financial strength to stand up to market volatilities. In the face of a still-challenging macroeconomic environment, the credit risks dealt with by the banking sector have increased in current years, yet the earnings designs of banks have actually not been affected. I would also like to take this chance to clarify the earlier "bad bank" rumour. The facility of a "bad bank" is an extraordinary measure which would just be considered when banks have really serious balance sheet problems. This is totally irregular with the present circumstance of banks in Hong Kong, which are running in a sound manner with strong monetary strength.
Hong Kong's banking sector has securely cruised through the 1998 Asian Financial Crisis, the 2008 Great Financial Crisis, the few years following the Covid-19 pandemic along with the 2023 banking turmoil in the US and Europe, showing its strength and strength. Although the international financial outlook goes through numerous unpredictabilities and numerous markets have been badly impacted, the banking sector has actually remained supportive to clients in difficulties and has actually been riding out obstacles with them, one crisis after another. This is a testimony to both the capability and commitment of the banks to weather hard times with the community. The HKMA, together with the banking sector, will continue to do their utmost to support the development, upgrade and transformation of the real economy.
