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 discussed on different occasions, the classified loan ratio continues to deal with upward pressure, mostly driven by business property (CRE) loans. Pressures in global CRE (including retail residential or commercial properties and workplaces) stemming from the rise of e-commerce and remote operate in current years are likewise obvious in Hong Kong. A boost in office conclusions has also resulted in continuing changes in the rates and rents of CRE in Hong Kong during the very first half of 2025. Moreover, the high interest rate environment over the previous couple of years has actually worsened the debt-servicing concern of business residential or commercial property developers and financiers, drawing market attention and raising concerns on the ability of banks to efficiently manage the pertinent danger exposures and monetary stability threat. I intend to clarify these inquiries here.

Standing together with business

CRE rates and rents are presently under pressure from different elements, including rates of interest and market supply and need dynamics, which have actually led to a decline in the worth of loan collateral. Borrowers are understandably stressed as to whether banks will require immediate payment. To address this, the HKMA and the banking sector have actually consistently stressed that while the fall in local residential or commercial property costs and rents over the last few years have actually caused a down adjustment to the independent residential or commercial property valuations, banks think about a host of aspects when evaluating credit line, consisting of the debtor's credit demand, overall monetary position and repayment ability. Banks will not change a credit line merely due to a change in the worth of the residential or commercial property collateral.

There have actually also been misunderstandings that proprietors might decline to change leas in reaction to market conditions or even leave residential or commercial properties vacant out of concern over banks requiring loan payments. However, this does not align with banks' real practices, and is likewise not logical from a threat management angle. In fact, banks have earlier made it clear that they would not require instant repayment entirely due to a decrease in rental income. This practical and flexible method shows banks' willingness to stand together with business, in addition to their stance and commitment to ride out hard times with the community.

If a customer in short-term monetary difficulty breaches the terms of the loan covenant, will it cause the bank demanding immediate repayment? The response is not always so. In practice, banks will first negotiate with the borrower, for example, by adjusting the payment strategy such as the loan tenor. Banks will take appropriate just as a last option to protect the strength 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 expense of banking stability and depositor interests. There is no requirement to fret as the HKMA has actually been carefully monitoring the total healthy advancement of Hong Kong's banking sector. We think that the credit threat associated with CRE loans is workable. A considerable portion of Hong Kong banks' direct exposures associating with local residential or commercial property development and financial investment loans are to the large players with relatively great financial health. For direct exposures to small and medium-sized regional residential or commercial property developers and investors, including some with weaker financials or greater gearing, banks have actually already taken credit danger reducing steps early on, and the majority of these loans are secured. Besides, there is no concentration risk at private borrower level.

A recent media report highlighted the dangers related to CRE loans, with a particular focus on the accounting of banks' "anticipated credit losses". In reality, this is merely a computation based on modelling for accounting functions. Loans categorized as "expected credit losses" do not always represent bad financial obligations, and therefore can not be used as a basis for an extensive assessment of banks' property quality.

Similarly, some other commentaries have actually focused exclusively on banks' classified loan ratios, which offers a rather limited viewpoint. Hong Kong has entered a credit downcycle recently, having actually been impacted by factors like macroeconomic change and rates 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 actually gradually 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 an extensive understanding of credit quality, one can think about the following commonly and long-used indications:

- The first basic indicator is the capital adequacy ratio: The healthy advancement of the banking sector includes developing up capital during the expansion stage of the credit cycle, such that when the credit cycle changes and we see credit costs increase and a deterioration in asset quality, banks would have enough capital to soak up the credit costs. Banks in Hong Kong have adequate 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 second essential indicator is the provision protection ratio: When evaluating non-performing loans, the sixty-four-thousand-dollar question is whether the relevant losses will affect a bank's core structure. The arrangement coverage ratio is utilized to assess if the provisions for non-performing loans are enough. If a bank adopts prudent danger management and its provision protection ratio remains above 100% after deducting the value of collateral from the non-performing loans, it suggests that the possible losses from non-performing loans have actually been sufficiently shown in the bank's arrangements. For the Hong Kong banking sector, provisions are adequate, with the arrangement coverage ratio (after deducting the value of collateral) standing at about 145% at the end of March 2025.
• The 3rd indicator is undoubtedly financial strength: Despite the higher public attention on non-performing loans, one crucial criterion when assessing a bank's strength is whether the bank can keep great monetary strength and its profit design can be sustained after subtracting credit expenses. In this regard, Hong Kong's banking system tape-recorded profit growth in the last 3 successive years even after taking into account the expenditures for expected 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 three essential signs reveal that Hong Kong's banking system is well-capitalised and has adequate arrangements and great financial strength to endure market volatilities. In the face of a still-challenging macroeconomic environment, the credit threats dealt with by the banking sector have actually increased in the last few years, yet the revenue models of banks have not been affected. I would likewise like to take this chance to clarify the earlier "bad bank" rumour. The facility of a "bad bank" is an extraordinary step which would just be considered when banks have really major balance sheet problems. This is completely irregular with the present circumstance of banks in Hong Kong, which are operating in a sound way with strong monetary strength.
  
  Hong Kong's banking sector has securely cruised 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 durability. Although the global economic outlook is subject to different unpredictabilities and numerous industries have been seriously affected, the banking sector has stayed sympathetic to consumers in difficulties and has actually been riding out challenges with them, one crisis after another. This is a testimony to both the capability and commitment of the banks to weather hard times with the neighborhood. The HKMA, together with the banking sector, will continue to do their utmost to support the advancement, upgrade and change of the genuine economy.