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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 similar to 1.98% at the end of March. As I have pointed out on different occasions, the classified loan ratio continues to face upward pressure, primarily driven by commercial real estate (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 evident in Hong Kong. A boost in workplace conclusions has likewise resulted in continuing modifications 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 exacerbated the debt-servicing problem of industrial residential or commercial property designers and financiers, drawing market attention and raising concerns on the ability of banks to effectively handle the pertinent threat direct exposures and monetary stability danger. I wish to clarify these questions here.
Standing together with business
CRE costs and rents are presently under pressure from different aspects, including rate of interest and market supply and demand characteristics, which have resulted in a decrease in the worth of loan collateral. Borrowers are understandably stressed as to whether banks will require immediate repayment. To resolve this, the HKMA and the banking sector have actually consistently stressed that while the fall in regional residential or commercial property rates and leas recently have led to a down modification to the independent residential or commercial property evaluations, banks consider a host of elements when reviewing credit limitations, including the debtor's credit demand, overall financial position and repayment capability. Banks will not adjust a credit line simply due to a change in the worth of the residential or commercial property security.
There have likewise been misunderstandings that property owners might decline to adjust rents in action to market conditions or perhaps leave residential or commercial properties vacant out of issue over banks requiring loan repayments. However, this does not line up with banks' real practices, and is likewise not sensible from a risk management angle. In truth, banks have actually earlier made it clear that they would not require immediate repayment entirely due to a decline in rental earnings. This practical and versatile approach demonstrates banks' willingness to stand together with enterprises, as well as their stance and dedication to ride out hard times with the community.
If a customer in short-lived financial difficulty breaches the terms of the loan covenant, will it cause the bank demanding immediate repayment? The response is not necessarily so. In practice, banks will first negotiate with the customer, for example, by adjusting the payment strategy such as the loan tenor. Banks will take proper credit actions just as a last hope to safeguard the strength of their operations and the interest of depositors.
Protecting banking stability and depositor interests
The general public might thus question if banks' support for business will come at the expense of banking stability and depositor interests. There is no need to worry as the HKMA has been closely keeping track of the total healthy development of Hong Kong's banking sector. We think that the credit danger associated with CRE loans is workable. A considerable part of Hong Kong banks' direct exposures relating to regional residential or commercial property development and investment loans are to the big gamers with fairly excellent monetary health. For direct exposures to small and medium-sized local residential or commercial property designers and investors, including some with weaker financials or greater gearing, banks have actually already taken credit threat alleviating steps early on, and most of these loans are protected. Besides, there is no concentration danger at specific customer level.
A current media report highlighted the dangers related to CRE loans, with a specific focus on the accounting of banks' "anticipated credit losses". In reality, this is merely a computation based on modelling for accounting purposes. Loans classified as "expected credit losses" do not necessarily represent bad financial obligations, and for that reason can not be utilized as a basis for an extensive evaluation of banks' possession quality.
Similarly, some other commentaries have actually focused solely on banks' classified loan ratios, which supplies a somewhat limited viewpoint. Hong Kong has gone into a credit downcycle recently, having been impacted by elements like macroeconomic change and rate of interest level. This has actually naturally led to a boost in the classified loan ratio of the banking sector. While the classified loan ratio has slowly gone back 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 gain a thorough understanding of credit quality, one can consider the following commonly and long-used indications:
- The first basic sign is the capital adequacy ratio: The healthy development of the banking sector involves constructing up capital during the expansion phase of the credit cycle, such that when the credit cycle adjusts and we see credit expenses go up and a degeneration in property quality, banks would have enough capital to absorb the credit costs. 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%.
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