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 mentioned on different events, the classified loan ratio continues to face upward pressure, primarily driven by business realty (CRE) loans. Pressures in worldwide CRE (consisting of retail residential or commercial properties and workplaces) originating from the increase of e-commerce and remote work in recent years are likewise apparent in Hong Kong. An increase in workplace conclusions has actually likewise led to continuing adjustments in the prices and leas 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 problem of industrial residential or commercial property developers and financiers, drawing market attention and raising questions on the ability of banks to successfully handle the pertinent threat direct exposures and financial stability risk. I hope to clarify these inquiries here.

Standing together with enterprises

CRE prices and rents are presently under pressure from various factors, of rate of interest and market supply and demand dynamics, which have caused a decrease in the value of loan security. Borrowers are understandably fretted regarding whether banks will demand immediate payment. To resolve 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 resulted in a down modification to the independent residential or commercial property evaluations, banks think about a host of aspects when examining credit line, including the debtor's credit need, overall financial position and payment capability. Banks will not adjust a credit line merely due to a modification in the value of the residential or commercial property collateral.

There have actually also been misconceptions that property managers might refuse to change rents in action to market conditions and even leave residential or commercial properties vacant out of concern over banks demanding loan payments. However, this does not line up with banks' actual practices, and is also not sensible from a danger management angle. In truth, banks have actually earlier made it clear that they would not demand instant repayment exclusively due to a decrease in rental income. This practical and flexible technique shows banks' determination to stand together with enterprises, along with their position and commitment to ride out hard times with the neighborhood.

If a debtor in short-lived monetary problem breaches the regards to the loan covenant, will it lead to the bank demanding instant repayment? The answer is not always so. In practice, banks will initially work out with the debtor, for instance, by adjusting the repayment strategy such as the loan tenor. Banks will take appropriate credit actions just as a last resort 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 cost of banking stability and depositor interests. There is no requirement to fret as the HKMA has been carefully keeping an eye on the general healthy development of Hong Kong's banking sector. Our company believe that the credit danger connected with CRE loans is manageable. A significant portion of Hong Kong banks' direct exposures connecting to local residential or commercial property development and financial investment loans are to the big gamers with fairly great monetary health. For exposures to little and medium-sized regional residential or commercial property developers and investors, consisting of some with weaker financials or higher gearing, banks have actually currently taken credit threat mitigating measures early on, and the majority of these loans are protected. Besides, there is no concentration danger at private debtor level.

A recent media report highlighted the risks related to CRE loans, with a particular concentrate on the accounting of banks' "anticipated credit losses". In reality, this is merely a calculation based on modelling for accounting functions. Loans classified as "predicted credit losses" do not always represent uncollectable bills, and for that reason can not be used as a basis for a thorough evaluation of banks' property quality.

Similarly, some other commentaries have focused exclusively on banks' classified loan ratios, which supplies a somewhat restricted perspective. Hong Kong has actually gone into a credit downcycle in recent years, having actually been affected by elements like macroeconomic modification and interest rate level. This has actually naturally led to a boost in the classified loan ratio of the banking sector. While the classified loan ratio has actually gradually returned to the long-lasting 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 get a comprehensive understanding of credit quality, one can think about the following extensively and long-used signs:

- The very first fundamental indicator is the capital adequacy ratio: The healthy development of the banking sector includes building up capital throughout the expansion phase of the credit cycle, such that when the credit cycle adjusts and we see credit expenses increase and a wear and tear in possession quality, banks would have sufficient capital to soak up 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 international minimum requirement of 8%.

• The 2nd essential indication is the provision coverage ratio: When examining non-performing loans, the important question is whether the relevant losses will affect a bank's core foundation. The provision coverage ratio is used to determine if the provisions for non-performing loans suffice. If a bank adopts prudent danger management and its provision coverage ratio stays above 100% after deducting the value of collateral from the non-performing loans, it suggests that the prospective losses from non-performing loans have actually been effectively shown in the bank's provisions. For the Hong Kong banking sector, arrangements suffice, with the provision protection ratio (after subtracting the value of collateral) standing at about 145% at the end of March 2025.
• The third indicator is certainly monetary strength: Despite the greater public attention on non-performing loans, one crucial criterion when assessing a bank's strength is whether the bank can preserve excellent financial strength and its profit design can be sustained after deducting credit costs. In this regard, Hong Kong's banking system tape-recorded earnings development in the last 3 successive years even after taking into consideration the expenses 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.
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  These 3 essential signs reveal that Hong Kong's banking system is well-capitalised and has enough arrangements and excellent financial 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 over the last few years, yet the earnings designs of banks have not been affected. I would also like to take this opportunity to clarify the earlier "bad bank" rumour. The facility of a "bad bank" is an amazing measure which would only be considered when banks have very severe balance sheet problems. This is completely 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 safely sailed through the 1998 Asian Financial Crisis, the 2008 Great Financial Crisis, the few years following the Covid-19 pandemic along with the 2023 banking turmoil in the US and Europe, demonstrating its strength and resilience. Although the worldwide economic outlook undergoes different uncertainties and numerous industries have actually been significantly impacted, the banking sector has remained considerate to customers in difficulties and has been riding out challenges with them, one crisis after another. This is a testimony to both the ability and dedication of the banks to weather challenging 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.
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