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 pointed out on different celebrations, the classified loan ratio continues to deal with upward pressure, mainly driven by business property (CRE) loans. Pressures in international CRE (consisting of retail residential or commercial properties and offices) coming from the increase of e-commerce and remote operate in recent years are likewise evident in Hong Kong. A boost in office completions has also resulted in continuing changes in the costs and rents of CRE in Hong Kong during the very first half of 2025. Moreover, the high rate of interest environment over the previous few years has actually worsened the debt-servicing problem of commercial residential or commercial property designers and investors, drawing market attention and raising concerns on the capability of banks to effectively handle the pertinent threat direct exposures and financial stability danger. I hope to clarify these inquiries here.

Standing together with enterprises

CRE prices and leas are currently under pressure from different factors, including rates of interest and market supply and need characteristics, which have resulted in a decline in the worth of loan collateral. Borrowers are not surprisingly stressed regarding whether banks will demand instant payment. To resolve this, the HKMA and the banking sector have repeatedly emphasised that while the fall in local residential or commercial property costs and rents in recent years have actually resulted in a down change to the independent residential or commercial property appraisals, banks think about a host of factors when reviewing credit limits, including the debtor's credit demand, total financial position and payment capability. Banks will not adjust a credit line merely due to a modification in the worth of the residential or commercial property collateral.

There have actually also been misunderstandings that proprietors may decline to change rents in response to market conditions or perhaps leave residential or commercial properties vacant out of concern over banks demanding loan repayments. However, this does not line up with banks' real practices, and is likewise not sensible from a danger management angle. In reality, banks have earlier made it clear that they would not require instant repayment solely due to a decrease in rental income. This pragmatic and versatile approach demonstrates banks' willingness to stand together with enterprises, along with their position and dedication to ride out hard times with the community.

If a borrower in momentary financial difficulty breaches the terms of the loan covenant, will it lead to the bank requiring instant repayment? The answer is not always so. In practice, banks will first work out with the customer, for example, by changing the payment plan such as the loan tenor. Banks will take proper credit actions only as a last option to protect the stability of their operations and the interest of depositors.

Protecting banking stability and depositor interests

The general public may hence wonder if banks' assistance for enterprises will come at the cost of banking stability and depositor interests. There is no requirement to stress as the HKMA has been carefully monitoring the general healthy advancement of Hong Kong's banking sector. Our company believe that the credit danger associated with CRE loans is manageable. A substantial part of Hong Kong banks' exposures connecting to local residential or commercial property development and investment loans are to the big players with reasonably good monetary health. For exposures to little and medium-sized regional residential or commercial property designers and investors, consisting of some with weaker financials or higher tailoring, banks have actually currently taken credit threat mitigating measures early on, and the majority of these loans are secured. Besides, there is no concentration threat at specific borrower level.

A recent media report highlighted the threats related to CRE loans, with a specific focus on the accounting of banks' "anticipated credit losses". In reality, this is simply an estimation based upon modelling for accounting purposes. Loans categorized as "predicted credit losses" do not always represent bad financial obligations, and for that reason can not be utilized as a basis for a detailed assessment of banks' asset quality.

Similarly, some other commentaries have actually focused exclusively on banks' classified loan ratios, which supplies a rather restricted point of view. Hong Kong has entered a credit downcycle in recent years, having actually been impacted by aspects like macroeconomic modification and rate of interest level. This has actually naturally caused a boost 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 listed below the 7.43% seen in 1999 after the Asian Financial Crisis.

To gain an extensive understanding of credit quality, one can consider the following commonly and long-used indicators:

- The first fundamental indicator is the capital adequacy ratio: The healthy advancement 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 costs increase and a wear and tear in possession quality, banks would have adequate 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 international minimum requirement of 8%.
- The 2nd key sign is the arrangement coverage ratio: When evaluating non-performing loans, the sixty-four-thousand-dollar question is whether the pertinent losses will affect a bank's core foundation. The arrangement coverage ratio is used to determine if the provisions for non-performing loans suffice. If a bank embraces prudent risk management and its provision coverage ratio remains above 100% after deducting the worth of security from the non-performing loans, it suggests that the possible losses from non-performing loans have actually been adequately reflected in the bank's arrangements. For the Hong Kong banking sector, provisions suffice, with the provision coverage ratio (after subtracting the value of collateral) standing at about 145% at the end of March 2025.
- The third indicator is clearly financial strength: Despite the greater public attention on non-performing loans, one essential requirement when examining a bank's soundness is whether the bank can keep good financial strength and its profit model can be sustained after subtracting credit costs. In this regard, Hong Kong's banking system taped earnings development in the last 3 successive years even after taking into consideration the costs for expected credit losses. The overall 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 very first quarter of 2025, showing sound financial strength.

These 3 key indicators reveal that Hong Kong's banking system is well-capitalised and has sufficient arrangements and good financial strength to stand up to market volatilities. In the face of a still-challenging macroeconomic environment, the credit risks dealt with by the banking sector have increased in the last few years, yet the revenue models of banks have not been impacted. I would likewise like to take this opportunity to clarify the earlier "bad bank" rumour. The establishment of a "bad bank" is a remarkable procedure which would just be considered when banks have very severe balance sheet problems. This is entirely inconsistent with the present circumstance of banks in Hong Kong, which are operating in a sound manner with strong financial 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 as well as the 2023 banking turmoil in the US and Europe, demonstrating its strength and durability. Although the global financial outlook goes through different unpredictabilities and many industries have been seriously impacted, the banking sector has actually stayed sympathetic to clients in troubles and has actually been riding out challenges with them, one crisis after another. This is a testament to both the ability 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.