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 comparable to 1.98% at the end of March. As I have actually mentioned on different celebrations, the classified loan ratio continues to face upward pressure, primarily driven by commercial property (CRE) loans. Pressures in international CRE (including retail residential or commercial properties and workplaces) originating from the increase of e-commerce and remote operate in current years are likewise evident in Hong Kong. An increase in office completions has actually likewise caused continuing modifications in the prices and rents of CRE in Hong Kong during the very first half of 2025. Moreover, the high interest rate environment over the past couple of years has actually intensified the debt-servicing burden of business residential or commercial property designers and financiers, drawing market attention and raising concerns on the ability of banks to efficiently manage the appropriate danger exposures and financial stability threat. I want to clarify these questions here.
Standing together with business
CRE costs and rents are currently under pressure from various factors, consisting of rates of interest and market supply and need dynamics, which have caused a decline in the value of loan collateral. Borrowers are understandably stressed regarding whether banks will demand instant payment. To resolve this, the HKMA and the banking sector have actually consistently stressed that while the fall in regional residential or commercial property prices and leas recently have caused a down modification to the independent residential or commercial property evaluations, banks think about a host of aspects when evaluating credit limitations, including the borrower's credit need, total monetary position and payment capability. Banks will not change a credit limit simply due to a change in the worth of the residential or commercial property collateral.
There have likewise been misconceptions that landlords may decline to change leas in reaction to market conditions and even leave residential or commercial properties vacant out of issue over banks demanding loan payments. However, this does not line up with banks' actual practices, and is likewise not sensible from a risk management angle. In fact, banks have actually earlier made it clear that they would not require instant payment entirely due to a decrease in rental earnings. This practical and flexible technique shows banks' desire to stand together with business, along with their position and commitment to ride out hard times with the community.
If a debtor in short-term monetary trouble breaches the terms of the loan covenant, will it lead to the bank demanding instant repayment? The answer is not always so. In practice, banks will first work out with the debtor, for instance, by changing the repayment strategy such as the loan tenor. Banks will take proper credit actions only as a last hope to safeguard the stability of their operations and the interest of depositors.
Protecting banking stability and depositor interests
The public might hence wonder if banks' assistance for business will come at the expense of banking stability and depositor interests. There is no requirement to fret as the HKMA has been carefully keeping track of the overall healthy development of Hong Kong's banking sector. Our company believe that the credit threat connected with CRE loans is manageable. A substantial part of Hong Kong banks' direct exposures associating with regional residential or commercial property advancement and financial investment loans are to the big gamers with reasonably good financial health. For exposures to little and medium-sized local residential or commercial property designers and financiers, including some with weaker financials or higher gearing, banks have actually currently taken credit danger reducing steps early on, and the majority of these loans are secured. Besides, there is no concentration risk at private borrower level.
A recent media report highlighted the threats connected with CRE loans, with a specific 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 "predicted credit losses" do not always represent uncollectable bills, and therefore can not be utilized as a basis for a thorough evaluation of banks' property quality.
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Similarly, some other commentaries have actually focused exclusively 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 factors like macroeconomic adjustment and rate of interest level. This has naturally led to a boost in the classified loan ratio of the banking sector. While the classified loan ratio has gradually gone back to the long-lasting average of around 2%, from 0.89% at the end of 2021, the ratio remains far below the 7.43% seen in 1999 after the Asian Financial Crisis.
To gain a thorough understanding of credit quality, one can think about the following widely and long-used signs:
- The very first basic sign is the capital adequacy ratio: The healthy development of the involves developing up capital during the expansion stage of the credit cycle, such that when the credit cycle changes and we see credit costs increase and a deterioration in property quality, banks would have sufficient capital to absorb 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 worldwide minimum requirement of 8%.
- The second crucial indicator is the arrangement coverage ratio: When examining non-performing loans, the sixty-four-thousand-dollar question is whether the appropriate losses will affect a bank's core foundation. The arrangement coverage ratio is utilized to determine if the provisions for non-performing loans are enough. If a bank adopts sensible threat management and its provision coverage ratio remains above 100% after subtracting the worth of security from the non-performing loans, it implies that the prospective losses from non-performing loans have actually been adequately shown in the bank's provisions. For the Hong Kong banking sector, arrangements are enough, with the provision protection ratio (after subtracting the value of security) standing at about 145% at the end of March 2025.
- The 3rd sign is obviously monetary strength: Despite the greater spotlight on non-performing loans, one important criterion when examining a bank's soundness is whether the bank can keep excellent financial strength and its earnings design can be sustained after subtracting credit expenses. In this regard, Hong Kong's banking system taped profit growth in the last 3 consecutive years even after taking into consideration the expenditures for anticipated credit losses. The total 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 very first quarter of 2025, demonstrating sound financial strength.
These three essential indications reveal that Hong Kong's banking system is well-capitalised and has sufficient arrangements and great financial strength to withstand market volatilities. In the face of a still-challenging macroeconomic environment, the credit dangers dealt with by the banking sector have increased over the last few years, yet the earnings models of banks have not been impacted. I would also like to take this chance to clarify the earlier "bad bank" rumour. The establishment of a "bad bank" is an extraordinary measure which would just be thought about when banks have extremely serious balance sheet issues. This is completely inconsistent with the existing circumstance of banks in Hong Kong, which are operating in a sound way with strong financial 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 turmoil in the US and Europe, demonstrating its strength and strength. Although the worldwide economic outlook goes through different unpredictabilities and many markets have actually been severely affected, the banking sector has stayed considerate to clients in problems and has actually been riding out challenges with them, one crisis after another. This is a testimony to both the capability and dedication of the banks to weather hard times with the neighborhood. The HKMA, together with the banking sector, will continue to do their utmost to support the development, upgrade and transformation of the genuine economy.