The Hong Kong Monetary Authority (HKMA) released today the classified loan ratio of the banking sector at the end of the 2nd quarter. The ratio was 1.97%, broadly similar to 1.98% at the end of March. As I have actually pointed out on different events, the classified loan ratio continues to face upward pressure, primarily driven by business realty (CRE) loans. Pressures in international CRE (consisting of retail residential or commercial properties and workplaces) originating from the increase of e-commerce and remote work in current years are also apparent in Hong Kong. An increase in workplace completions has likewise caused continuing changes in the costs and leas of CRE in Hong Kong during the very first half of 2025. Moreover, the high interest rate environment over the past few years has actually worsened the debt-servicing problem of commercial residential or commercial property developers and financiers, drawing market attention and raising concerns on the ability of banks to successfully manage the appropriate risk exposures and monetary stability danger. I intend to clarify these questions here.
Standing together with enterprises
CRE rates and rents are currently under pressure from numerous factors, consisting of rate of interest and market supply and demand dynamics, which have actually caused a decrease in the value of loan security. Borrowers are not surprisingly stressed as to whether banks will require instant payment. To resolve this, the HKMA and the banking sector have consistently stressed that while the fall in regional residential or commercial property rates and leas recently have caused a down adjustment to the independent residential or commercial property appraisals, banks consider a host of factors when evaluating credit limits, consisting of the debtor's credit need, overall financial position and payment capability. Banks will not change a credit line merely due to a change in the value of the residential or commercial property collateral.
There have actually likewise been mistaken beliefs that landlords may refuse to adjust rents in response to market conditions or even leave residential or commercial properties vacant out of issue over banks requiring loan payments. However, this does not line up with banks' real practices, and is likewise not logical from a threat management angle. In truth, banks have actually earlier made it clear that they would not require instant payment solely due to a decrease in rental earnings. This practical and flexible method determination to stand together with enterprises, as well as their position and dedication to ride out hard times with the community.
If a borrower in short-term financial difficulty breaches the regards to the loan covenant, will it result in the bank demanding instant payment? The answer is not necessarily so. In practice, banks will initially work out with the debtor, for example, by adjusting the repayment plan such as the loan tenor. Banks will take suitable credit actions only as a last hope to secure the stability of their operations and the interest of depositors.
Protecting banking stability and depositor interests
The general public may thus question if banks' assistance for enterprises will come at the cost of banking stability and depositor interests. There is no requirement to worry as the HKMA has actually been closely keeping an eye on the overall healthy advancement of Hong Kong's banking sector. Our company believe that the credit danger associated with CRE loans is workable. A considerable portion of Hong Kong banks' exposures connecting to regional residential or commercial property development and investment loans are to the large gamers with reasonably great financial health. For exposures to small and medium-sized regional residential or commercial property developers and financiers, including some with weaker financials or higher gearing, banks have currently taken credit threat mitigating procedures early on, and many of these loans are secured. Besides, there is no concentration risk at private borrower level.
A recent media report highlighted the dangers related to CRE loans, with a particular concentrate on the accounting of banks' "anticipated credit losses". In truth, this is merely a calculation based on modelling for accounting functions. Loans categorized as "anticipated credit losses" do not always represent uncollectable bills, and for that reason can not be used as a basis for a thorough assessment of banks' possession quality.
Similarly, some other commentaries have actually focused exclusively on banks' classified loan ratios, which provides a somewhat limited perspective. Hong Kong has actually gone into a credit downcycle in recent years, having actually been affected by aspects like macroeconomic adjustment and rate of interest level. This has actually naturally resulted in a boost in the classified loan ratio of the banking sector. While the classified loan ratio has actually slowly returned to the long-lasting average of around 2%, from 0.89% at the end of 2021, the ratio remains far listed below the 7.43% seen in 1999 after the Asian Financial Crisis.
To acquire an extensive understanding of credit quality, one can think about the following extensively and long-used indicators:
- The first standard indication is the capital adequacy ratio: The healthy advancement of the banking sector involves developing up capital during the growth phase of the credit cycle, such that when the credit cycle changes and we see credit expenses go up and a degeneration in property quality, banks would have sufficient capital to soak up the credit expenses. Banks in Hong Kong have sufficient capital - the Total Capital Ratio for the banking sector stood at 24.2% at the end of March 2025, well above the international minimum requirement of 8%.
- The 2nd crucial indication is the provision protection ratio: When assessing non-performing loans, the essential concern is whether the relevant losses will impact a bank's core structure. The arrangement coverage ratio is utilized to gauge if the provisions for non-performing loans suffice. If a bank embraces prudent threat management and its arrangement coverage ratio remains above 100% after subtracting the value of security from the non-performing loans, it implies that the prospective losses from non-performing loans have been properly shown in the bank's provisions. For the Hong Kong banking sector, provisions suffice, with the provision protection ratio (after subtracting the value of collateral) standing at about 145% at the end of March 2025.
- The 3rd sign is undoubtedly financial strength: Despite the higher public attention on non-performing loans, one crucial requirement when examining a bank's strength is whether the bank can keep great financial strength and its profit model can be sustained after deducting credit expenses. In this regard, Hong Kong's banking system taped revenue growth in the last 3 consecutive years even after considering the expenditures for expected credit losses. The total pre-tax operating profit of retail banks increased by 8.4% year-on-year in 2024, and by 15.8% year-on-year in the very first quarter of 2025, demonstrating sound monetary strength.
These three key signs reveal that Hong Kong's banking system is well-capitalised and has adequate arrangements and good monetary strength to stand up to market volatilities. In the face of a still-challenging macroeconomic environment, the credit dangers dealt with by the banking sector have actually increased over the last few years, yet the revenue designs of banks have not been impacted. I would likewise like to take this opportunity to clarify the earlier "bad bank" rumour. The facility of a "bad bank" is a remarkable procedure which would only be considered when banks have really major balance sheet problems. This is entirely irregular with the present scenario of banks in Hong Kong, which are running in a sound way with strong monetary strength.
Hong Kong's banking sector has actually safely sailed through the 1998 Asian Financial Crisis, the 2008 Great Financial Crisis, the few years following the Covid-19 pandemic in addition to the 2023 banking turmoil in the US and Europe, demonstrating its strength and durability. Although the worldwide economic outlook goes through various uncertainties and many industries have been severely impacted, the banking sector has actually stayed sympathetic to clients in troubles and has been riding out obstacles with them, one crisis after another. This is a testimony to both the ability and dedication of the banks to weather challenging times with the neighborhood. The HKMA, together with the banking sector, will continue to do their utmost to support the advancement, upgrade and improvement of the real economy.