The Hong Kong Monetary Authority (HKMA) published today the classified loan ratio of the banking sector at the end of the second quarter. The ratio was 1.97%, broadly similar to 1.98% at the end of March. As I have actually discussed on various celebrations, the classified loan ratio continues to deal with upward pressure, mainly driven by business property (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 recent years are also apparent in Hong Kong. An increase in workplace completions has actually also resulted in continuing changes in the prices and leas of CRE in Hong Kong during the very first half of 2025. Moreover, the high rates of interest environment over the past couple of years has exacerbated the debt-servicing problem of business residential or commercial property designers and investors, drawing market attention and raising concerns on the capability of banks to efficiently manage the appropriate risk exposures and financial stability risk. I want to clarify these inquiries here.
Standing together with enterprises
CRE rates and rents are currently under pressure from various elements, consisting of interest rates and market supply and demand characteristics, which have led to a decrease in the worth of loan security. Borrowers are not surprisingly fretted regarding whether banks will demand immediate repayment. To address this, the HKMA and the banking sector have actually repeatedly emphasised that while the fall in local residential or commercial property rates and leas in current years have actually led to a downward modification to the independent residential or commercial property evaluations, banks think about a host of aspects when examining credit line, consisting of the borrower's credit demand, overall financial position and payment capability. Banks will not adjust a credit line simply due to a change in the value of the residential or commercial property security.
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There have actually also been mistaken beliefs that property managers might decline to change leas in response to market conditions or even leave residential or commercial properties vacant out of concern over banks requiring loan repayments. However, this does not line up with banks' actual practices, and is likewise not logical from a risk management angle. In reality, banks have actually earlier made it clear that they would not demand immediate repayment solely due to a decline in rental income. This practical and flexible technique demonstrates banks' desire to stand together with enterprises, as well as their stance and commitment to ride out hard times with the community.
If a debtor in momentary monetary difficulty breaches the terms of the loan covenant, will it cause the bank demanding instant repayment? The response is not necessarily so. In practice, banks will first negotiate with the borrower, for instance, by adjusting the repayment strategy such as the loan tenor. Banks will take appropriate credit actions just as a last option to secure the stability of their operations and the interest of depositors.
Protecting banking stability and depositor interests
The general public might therefore question if banks' support for business will come at the expense of banking stability and depositor interests. There is no need to worry as the HKMA has actually been closely keeping track of the general healthy development of Hong Kong's banking sector. Our company believe that the credit risk related to CRE loans is manageable. A significant part of Hong Kong banks' direct exposures relating to regional residential or commercial property development and investment loans are to the big gamers with relatively great financial health. For exposures to small and medium-sized regional residential or commercial property developers and financiers, consisting of some with weaker financials or greater tailoring, banks have actually already taken credit danger alleviating steps early on, and the majority of these loans are secured. Besides, there is no concentration risk at individual borrower level.
A current media report highlighted the dangers associated with CRE loans, with a particular concentrate on the accounting of banks' "expected credit losses". In reality, this is simply an estimation based on modelling for accounting functions. Loans classified as "anticipated credit losses" do not always represent bad financial obligations, and for that reason can not be used as a basis for a thorough assessment of banks' possession quality.
Similarly, some other commentaries have focused solely on banks' classified loan ratios, which offers a somewhat minimal perspective. Hong Kong has actually gotten in a credit downcycle recently, having been affected by elements like macroeconomic change and rates of interest level. This has naturally caused an increase 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 stays far below the 7.43% seen in 1999 after the Asian Financial Crisis.
To gain an extensive understanding of credit quality, one can think about the following widely and long-used indicators:
- The very first fundamental indication is the capital adequacy ratio: The healthy development of the banking sector includes developing up capital during the growth phase of the credit cycle, such that when the credit cycle changes and we see credit expenses increase and a deterioration in property quality, banks would have enough capital to take in the credit costs. 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 worldwide minimum requirement of 8%.
- The 2nd key indicator is the provision coverage ratio: When assessing non-performing loans, the essential question is whether the appropriate losses will affect a bank's core structure. The provision coverage ratio is utilized to gauge if the arrangements for non-performing loans are adequate. If a bank embraces prudent threat management and its arrangement protection ratio remains above 100% after deducting the value of collateral from the non-performing loans, it indicates that the possible losses from non-performing loans have been adequately shown in the bank's provisions. For the Hong Kong banking sector, arrangements are enough, with the provision coverage ratio (after deducting the worth of security) standing at about 145% at the end of March 2025.
- The third sign is clearly monetary strength: Despite the higher spotlight on non-performing loans, one important criterion when assessing a bank's soundness is whether the bank can maintain excellent monetary strength and its earnings design can be sustained after deducting credit expenses. In this regard, Hong Kong's banking system recorded revenue growth in the last three successive years even after considering the expenditures for anticipated credit losses. The total pre-tax operating revenue 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, demonstrating sound financial strength.
These three essential indications reveal that Hong Kong's banking system is well-capitalised and has adequate arrangements and great financial strength to endure 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 profit designs of banks have actually not been affected. I would also like to take this chance to clarify the earlier "bad bank" rumour. The establishment of a "bad bank" is an extraordinary step which would only be thought about when banks have very major balance sheet problems. This is entirely irregular with the present situation of banks in Hong Kong, which are operating in a sound manner with strong monetary strength.
Hong Kong's banking sector has actually safely cruised through the 1998 Asian Financial Crisis, the 2008 Great Financial Crisis, the couple of years following the Covid-19 pandemic in addition to the 2023 banking chaos in the US and Europe, showing its strength and durability. Although the global economic outlook is subject to different unpredictabilities and numerous industries have actually been significantly impacted, the banking sector has remained considerate to customers in problems and has actually been riding out difficulties with them, one crisis after another. This is a testimony to both the ability and dedication of the banks to weather difficult times with the community. The HKMA, together with the banking sector, will continue to do their utmost to support the advancement, upgrade and change of the real economy.
