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 comparable to 1.98% at the end of March. As I have discussed on different celebrations, the classified loan ratio continues to face upward pressure, mostly driven by commercial property (CRE) loans. Pressures in worldwide CRE (including retail residential or commercial properties and workplaces) originating from the rise of e-commerce and remote work in current years are likewise apparent in Hong Kong. A boost in office completions has actually also led to continuing adjustments in the costs and leas of CRE in Hong Kong throughout the first half of 2025. Moreover, the high rate of interest environment over the previous couple of years has actually exacerbated the debt-servicing concern of industrial residential or commercial property designers and investors, drawing market attention and raising concerns on the capability of banks to effectively handle the relevant risk direct exposures and financial stability risk. I wish to clarify these queries here.
Standing together with enterprises
CRE costs and leas are presently under pressure from different factors, including rates of interest and market supply and need dynamics, which have resulted in a decline in the value of loan security. Borrowers are naturally fretted as to whether banks will require instant payment. To address this, the HKMA and the banking sector have actually consistently emphasised that while the fall in local residential or commercial property rates and rents in current years have caused a down change to the independent residential or commercial property valuations, banks think about a host of elements when examining credit line, consisting of the borrower's credit need, overall monetary position and payment capability. Banks will not change a credit limit simply due to a modification in the value of the residential or commercial property collateral.
There have also been mistaken beliefs that property owners might refuse to adjust leas in reaction to market conditions or even leave residential or commercial properties uninhabited out of concern over banks requiring loan payments. However, this does not line up with banks' real practices, and is likewise not sensible from a threat management angle. In fact, banks have actually earlier made it clear that they would not require immediate payment exclusively due to a decline in rental earnings. This practical and flexible technique shows banks' determination to stand together with business, along with their stance and dedication to ride out difficult times with the community.
If a borrower in momentary financial problem breaches the terms of the loan covenant, will it result in the bank demanding immediate repayment? The response is not necessarily so. In practice, banks will initially negotiate with the customer, for instance, by adjusting the payment strategy such as the loan tenor. Banks will take appropriate 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 general public may hence question if banks' assistance for business will come at the cost of banking stability and depositor interests. There is no requirement to worry as the HKMA has been carefully keeping an eye on the total healthy development of Hong Kong's banking sector. We believe that the credit risk connected with CRE loans is workable. A considerable part of Hong Kong banks' direct exposures associating with local residential or commercial property advancement and financial investment loans are to the large players with reasonably good financial health. For direct exposures to small and medium-sized local residential or commercial property developers and investors, consisting of some with weaker financials or greater tailoring, banks have actually already taken credit threat alleviating steps early on, and many of these loans are protected. Besides, there is no concentration risk at individual debtor level.
A recent media report highlighted the dangers related to CRE loans, with a specific focus on the accounting of banks' "expected credit losses". In truth, this is simply an estimation based upon modelling for accounting purposes. Loans categorized as "anticipated credit losses" do not necessarily represent bad debts, and therefore can not be used as a basis for an extensive evaluation of banks' possession quality.
Similarly, some other commentaries have focused exclusively on banks' classified loan ratios, which provides a somewhat restricted point of view. Hong Kong has actually gone into a credit downcycle in current years, having been affected by factors like macroeconomic modification and rates of interest level. This has naturally led to an increase in the classified loan ratio of the banking sector. While the classified loan ratio has slowly gone back 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 indicators:
- The first standard sign is the capital adequacy ratio: The healthy development of the banking sector involves constructing up capital throughout the growth stage of the credit cycle, such that when the credit cycle changes and we see credit expenses increase and a deterioration in asset quality, banks would have enough capital to soak up 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 crucial sign is the provision protection ratio: When examining non-performing loans, the essential concern is whether the relevant losses will impact a bank's core foundation. The arrangement protection ratio is used to determine if the arrangements for non-performing loans are enough. If a bank embraces prudent risk management and its provision coverage ratio remains above 100% after deducting the worth of collateral from the non-performing loans, it suggests that the potential losses from non-performing loans have been sufficiently shown in the bank's provisions. For the Hong Kong banking sector, provisions are enough, with the arrangement protection ratio (after deducting the worth of security) standing at about 145% at the end of March 2025.
- The 3rd indication is clearly monetary strength: Despite the higher spotlight on non-performing loans, one essential criterion when assessing a bank's stability is whether the bank can preserve excellent monetary strength and its profit design can be sustained after subtracting credit expenses. In this regard, Hong Kong's system taped earnings growth in the last three successive 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, showing sound financial strength.
These three crucial indicators show that Hong Kong's banking system is well-capitalised and has sufficient provisions and excellent monetary strength to withstand market volatilities. In the face of a still-challenging macroeconomic environment, the credit risks dealt with by the banking sector have increased recently, yet the earnings models of banks have not been affected. I would likewise like to take this opportunity to clarify the earlier "bad bank" rumour. The establishment of a "bad bank" is an amazing measure which would only be considered when banks have very major balance sheet issues. This is entirely inconsistent with the current situation of banks in Hong Kong, which are running in a sound manner with strong monetary strength.
Hong Kong's banking sector has actually securely cruised through the 1998 Asian Financial Crisis, the 2008 Great Financial Crisis, the couple of years following the Covid-19 pandemic along with the 2023 banking chaos in the US and Europe, showing its strength and strength. Although the global financial outlook undergoes numerous uncertainties and lots of industries have actually been significantly affected, the banking sector has actually stayed understanding to consumers in troubles and has been riding out difficulties with them, one crisis after another. This is a testament to both the ability and dedication of the banks to weather tough times with the neighborhood. The HKMA, together with the banking sector, will continue to do their utmost to support the development, upgrade and change of the real economy.