The Hong Kong Monetary Authority (HKMA) published 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 pointed out on various events, the classified loan ratio continues to face upward pressure, primarily driven by commercial genuine estate (CRE) loans. Pressures in international CRE (including retail residential or commercial properties and offices) originating from the increase of e-commerce and remote work in recent years are also evident in Hong Kong. A boost in workplace completions has actually also resulted in continuing adjustments in the costs and leas of CRE in Hong Kong throughout the very first half of 2025. Moreover, the high interest rate environment over the past few years has actually worsened the debt-servicing burden of business residential or commercial property designers and investors, drawing market attention and raising concerns on the ability of banks to successfully handle the pertinent danger exposures and financial stability threat. I wish to clarify these questions here.

Standing together with enterprises

CRE prices and leas are presently under pressure from various factors, consisting of interest rates and market supply and need dynamics, which have actually caused a decrease in the worth of loan security. Borrowers are understandably fretted regarding whether banks will require instant payment. To resolve this, the HKMA and the banking sector have repeatedly emphasised that while the fall in local residential or commercial property rates and leas over the last few years have actually resulted in a downward adjustment to the independent residential or commercial property assessments, banks think about a host of factors when reviewing credit line, consisting of the customer's credit demand, general monetary position and payment ability. Banks will not adjust a credit limitation merely due to a change in the worth of the residential or commercial property collateral.

There have also been misconceptions that property owners may refuse to change rents in response to market conditions or perhaps leave residential or commercial properties uninhabited out of concern over banks requiring loan repayments. However, this does not align with banks' real practices, and is likewise not rational from a danger management angle. In reality, banks have actually earlier made it clear that they would not require immediate payment entirely due to a decrease in rental income. This practical and flexible approach demonstrates banks' willingness to stand together with business, along with their position and dedication to ride out difficult times with the neighborhood.

If a customer in temporary financial trouble breaches the terms of the loan covenant, will it cause the bank requiring instant payment? The response is not necessarily so. In practice, banks will first negotiate with the customer, for instance, by changing the payment plan such as the loan tenor. Banks will take proper credit actions only as a last option to safeguard the stability of their operations and the interest of depositors.

Protecting banking stability and depositor interests

The general public may therefore wonder if banks' support for business will come at the expense of banking stability and depositor interests. There is no requirement to fret as the HKMA has been closely keeping an eye on the general healthy development of Hong Kong's banking sector. We believe that the credit danger associated with CRE loans is manageable. A significant portion of Hong Kong banks' direct exposures associating with local residential or commercial property advancement and investment loans are to the big gamers with reasonably good financial health. For exposures to little and medium-sized local residential or commercial property developers and financiers, including some with weaker financials or higher tailoring, banks have currently taken credit danger mitigating measures early on, and the majority of these loans are protected. Besides, there is no concentration threat at specific borrower level.

A current media report highlighted the risks connected with CRE loans, with a specific focus on the accounting of banks' "expected credit losses". In truth, this is simply a computation based upon modelling for accounting purposes. Loans categorized as "anticipated credit losses" do not always represent bad debts, and therefore can not be utilized as a basis for a detailed assessment of banks' asset quality.

Similarly, some other commentaries have focused solely on banks' classified loan ratios, which supplies a rather limited perspective. Hong Kong has actually gotten in a credit downcycle in the last few years, having actually been impacted by aspects like macroeconomic adjustment and interest rate level. This has actually naturally caused a boost in the classified loan ratio of the banking sector. While the classified loan ratio has gradually returned 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 acquire a comprehensive understanding of credit quality, one can think about the following widely and long-used signs:

- The first fundamental indication is the capital adequacy ratio: The healthy development of the banking sector includes developing capital during the growth stage of the credit cycle, such that when the credit cycle changes and we see credit costs go up and a wear and tear in asset quality, banks would have sufficient capital to take in the credit expenses. Banks in Hong Kong have ample capital - the Total Capital Ratio for the banking sector stood at 24.2% at the end of March 2025, well above the global minimum requirement of 8%.
- The second essential sign is the arrangement protection ratio: When assessing non-performing loans, the sixty-four-thousand-dollar question is whether the pertinent losses will affect a bank's core structure. The provision protection ratio is utilized to gauge if the arrangements for non-performing loans suffice. If a bank adopts prudent threat management and its provision coverage ratio stays above 100% after deducting the value of security from the non-performing loans, it implies that the prospective losses from non-performing loans have been effectively shown in the bank's arrangements. For the Hong Kong banking sector, provisions are adequate, with the provision protection ratio (after deducting the worth of collateral) standing at about 145% at the end of March 2025.
- The 3rd sign is certainly monetary strength: Despite the greater spotlight on non-performing loans, one crucial requirement when examining a bank's soundness is whether the bank can keep great monetary strength and its profit 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 costs 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, demonstrating sound financial strength.

These 3 crucial indications reveal that Hong Kong's banking system is well-capitalised and has sufficient arrangements and good monetary strength to hold up against market volatilities. In the face of a still-challenging macroeconomic environment, the credit risks dealt with by the banking sector have actually increased over the last few years, yet the revenue 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 a remarkable procedure which would just be thought about when banks have really serious balance sheet issues. This is entirely inconsistent with the present situation of banks in Hong Kong, which are operating in a sound way with strong monetary 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 along with the 2023 banking chaos in the US and Europe, demonstrating its strength and resilience. Although the worldwide financial outlook undergoes various uncertainties and many markets have actually been significantly impacted, the banking sector has stayed supportive to clients in difficulties and has actually been riding out obstacles with them, one crisis after another. This is a testimony to both the ability and commitment of the banks to weather tough times with the community. The HKMA, together with the banking sector, will continue to do their utmost to support the development, upgrade and change of the real economy.