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 mentioned on various events, the classified loan ratio continues to face upward pressure, mostly driven by industrial genuine estate (CRE) loans. Pressures in global CRE (consisting of retail residential or commercial properties and offices) originating from the rise of e-commerce and remote work in current years are likewise evident in Hong Kong. An increase in office conclusions has also caused continuing modifications in the prices and rents of CRE in Hong Kong during the first half of 2025. Moreover, the high rates of interest environment over the previous few years has actually intensified the debt-servicing concern of commercial residential or commercial property designers and investors, drawing market attention and raising questions on the ability of banks to efficiently manage the appropriate threat exposures and monetary stability danger. I hope to clarify these questions here.
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Standing together with business
CRE costs and rents are currently under pressure from various factors, including rate of interest and market supply and need dynamics, which have caused a decrease in the worth of loan collateral. Borrowers are naturally stressed regarding whether banks will demand instant repayment. To resolve this, the HKMA and the banking sector have actually consistently stressed that while the fall in local residential or commercial property costs and leas over the last few years have resulted in a down change to the independent residential or commercial property appraisals, banks think about a host of elements when evaluating credit limits, consisting of the debtor's credit need, general financial position and payment ability. Banks will not change a credit limitation simply due to a modification in the value of the residential or commercial property collateral.
There have likewise been misunderstandings that landlords may decline to change rents in response to market conditions or perhaps leave residential or commercial properties vacant out of issue over banks demanding loan payments. However, this does not line up with banks' real practices, and is also not sensible from a risk management angle. In truth, banks have actually previously made it clear that they would not require immediate payment solely due to a decrease in rental earnings. This pragmatic and versatile method shows banks' desire to stand together with business, along with their position and dedication to ride out challenging times with the neighborhood.
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If a customer in temporary monetary difficulty breaches the terms of the loan covenant, will it result in the bank demanding instant payment? The response is not necessarily so. In practice, banks will first work out with the borrower, for example, by adjusting the payment strategy such as the loan tenor. Banks will take appropriate credit actions just as a last hope to protect the stability 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 cost of banking stability and depositor interests. There is no requirement to worry as the HKMA has been closely keeping track of the total healthy advancement of Hong Kong's banking sector. We think that the credit danger associated with CRE loans is manageable. A significant part of Hong Kong banks' direct exposures connecting to regional residential or commercial property development and financial investment loans are to the large gamers with reasonably great monetary health. For exposures to small and medium-sized local residential or commercial property designers and financiers, including some with weaker financials or greater tailoring, banks have currently taken credit risk mitigating measures early on, and most of these loans are secured. Besides, there is no concentration danger at individual borrower level.
A recent media report highlighted the risks associated with CRE loans, with a specific concentrate on the of banks' "anticipated credit losses". In truth, this is merely an estimation based upon modelling for accounting purposes. Loans categorized as "predicted credit losses" do not necessarily represent bad debts, and therefore can not be used as a basis for a comprehensive assessment of banks' property quality.
Similarly, some other commentaries have focused solely on banks' classified loan ratios, which provides a rather minimal perspective. Hong Kong has actually entered a credit downcycle in current years, having been affected by elements like macroeconomic adjustment and interest rate level. This has naturally led to 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 listed below the 7.43% seen in 1999 after the Asian Financial Crisis.
To get a thorough understanding of credit quality, one can consider the following commonly and long-used indicators:
- The first standard sign is the capital adequacy ratio: The healthy advancement of the banking sector involves developing capital throughout the expansion phase of the credit cycle, such that when the credit cycle adjusts and we see credit costs go up and a degeneration 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 2nd key indicator is the provision protection ratio: When evaluating non-performing loans, the sixty-four-thousand-dollar question is whether the pertinent losses will impact a bank's core structure. The provision protection ratio is used to determine if the arrangements for non-performing loans suffice. If a bank embraces sensible threat management and its arrangement protection ratio remains above 100% after deducting the worth of collateral from the non-performing loans, it implies that the possible losses from non-performing loans have been effectively shown in the bank's arrangements. For the Hong Kong banking sector, arrangements suffice, with the provision coverage ratio (after deducting the worth of security) standing at about 145% at the end of March 2025.
- The 3rd sign is clearly monetary strength: Despite the greater spotlight on non-performing loans, one important criterion when assessing a bank's stability is whether the bank can keep great monetary strength and its revenue design can be sustained after deducting credit costs. In this regard, Hong Kong's banking system taped profit development in the last 3 successive years even after taking into account the expenses for anticipated credit losses. The general 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 first quarter of 2025, showing sound financial strength.
These 3 essential signs reveal that Hong Kong's banking system is well-capitalised and has adequate arrangements and good 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 increased over the last few years, yet the earnings models of banks have actually not been impacted. I would likewise like to take this chance to clarify the earlier "bad bank" rumour. The facility of a "bad bank" is an amazing step which would just be considered when banks have really serious balance sheet problems. This is totally irregular with the present scenario of banks in Hong Kong, which are operating in a sound way with strong financial strength.
Hong Kong's banking sector has actually securely sailed 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, demonstrating its strength and resilience. Although the global economic outlook undergoes numerous uncertainties and many markets have actually been significantly impacted, the banking sector has actually stayed supportive to consumers in difficulties and has been riding out difficulties with them, one crisis after another. This is a testament to both the capability and dedication of the banks to weather difficult times with the neighborhood. The HKMA, together with the banking sector, will continue to do their utmost to support the development, upgrade and improvement of the real economy.