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Credit Risk Management Of Commercial Real Estate Exposures

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 various occasions, the classified loan ratio continues to face upward pressure, primarily driven by commercial realty (CRE) loans. Pressures in global CRE (including retail residential or commercial properties and offices) originating from the increase of e-commerce and remote work in current years are likewise evident in Hong Kong. An increase in workplace conclusions has also resulted in continuing modifications in the rates and leas of CRE in Hong Kong during the first half of 2025. Moreover, the high interest rate environment over the past few years has actually exacerbated the debt-servicing burden of commercial residential or commercial property designers and investors, drawing market attention and raising concerns on the ability of banks to effectively manage the appropriate danger exposures and financial stability risk. I want to clarify these inquiries here.

Standing together with enterprises

CRE prices and leas are presently under from numerous elements, consisting of rates of interest and market supply and demand dynamics, which have led to a decrease in the value of loan collateral. Borrowers are understandably worried as to whether banks will demand instant 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 actually led to a down change to the independent residential or commercial property valuations, banks consider a host of elements when reviewing credit line, consisting of the borrower’s credit need, general financial position and repayment ability. Banks will not change a credit limitation simply due to a modification in the worth of the residential or commercial property collateral.

There have actually also been misunderstandings that property owners might refuse to change rents in response to market conditions or perhaps leave residential or commercial properties vacant out of concern over banks requiring loan repayments. However, this does not align with banks’ actual practices, and is likewise not sensible from a danger management angle. In fact, banks have actually previously made it clear that they would not require immediate repayment solely due to a decrease in rental earnings. This practical and versatile method demonstrates banks’ determination to stand together with business, as well as their stance and commitment to ride out challenging times with the community.

If a borrower in short-lived financial problem breaches the regards to the loan covenant, will it result in the bank demanding instant repayment? The answer is not necessarily so. In practice, banks will initially work out with the debtor, for example, by adjusting the payment strategy such as the loan tenor. Banks will take proper credit actions only as a last option to safeguard the soundness of their operations and the interest of depositors.

Protecting banking stability and depositor interests

The general public might hence wonder if banks’ support for enterprises will come at the cost of banking stability and depositor interests. There is no requirement to stress as the HKMA has actually been closely monitoring the total healthy development of Hong Kong’s banking sector. Our company believe that the credit risk connected with CRE loans is manageable. A considerable portion of Hong Kong banks’ exposures relating to local residential or commercial property development and financial investment loans are to the large players with relatively excellent financial health. For exposures to small and medium-sized regional residential or commercial property designers and financiers, consisting of some with weaker financials or greater gearing, banks have actually currently taken credit risk reducing steps early on, and the majority of these loans are protected. Besides, there is no concentration threat at private debtor level.

A recent media report highlighted the risks connected with CRE loans, with a particular focus on the accounting of banks’ “anticipated credit losses”. In fact, this is simply an estimation based on modelling for accounting functions. Loans classified as “expected credit losses” do not always represent uncollectable bills, and therefore can not be used as a basis for an extensive evaluation of banks’ property quality.

Similarly, some other commentaries have focused exclusively on banks’ classified loan ratios, which offers a rather restricted viewpoint. Hong Kong has actually gone into a credit downcycle recently, having actually been affected by aspects 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 slowly gone back to the long-lasting average of around 2%, from 0.89% at the end of 2021, the ratio remains far listed 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 commonly and long-used indicators:

– The very first fundamental indication is the capital adequacy ratio: The healthy advancement of the banking sector includes developing capital throughout the growth stage of the credit cycle, such that when the credit cycle adjusts and we see credit expenses increase and a degeneration 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 worldwide minimum requirement of 8%.
– The second key sign is the arrangement coverage ratio: When assessing non-performing loans, the important question is whether the relevant losses will affect a bank’s core foundation. The arrangement protection ratio is used to assess if the provisions for non-performing loans suffice. If a bank embraces sensible threat management and its arrangement protection ratio remains above 100% after deducting the value of security from the non-performing loans, it suggests that the potential losses from non-performing loans have actually been effectively shown in the bank’s arrangements. For the Hong Kong banking sector, provisions suffice, with the provision coverage ratio (after deducting the value of security) standing at about 145% at the end of March 2025.
– The third indication is certainly monetary strength: Despite the greater public attention on non-performing loans, one essential requirement when examining a bank’s stability is whether the bank can maintain great financial strength and its profit design can be sustained after subtracting credit expenses. In this regard, Hong Kong’s banking system recorded revenue growth in the last three successive years even after considering the expenditures for expected credit losses. The total pre-tax operating earnings 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, demonstrating sound monetary strength.

These three essential indications reveal that Hong Kong’s banking system is well-capitalised and has adequate provisions and excellent 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 increased recently, yet the revenue models of banks have actually 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 thought about when banks have extremely severe balance sheet problems. This is completely inconsistent with the present situation of banks in Hong Kong, which are operating in a sound manner with strong financial strength.

Hong Kong’s banking sector has securely 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 chaos in the US and Europe, showing its strength and strength. Although the international financial outlook undergoes numerous unpredictabilities and many markets have been badly affected, the banking sector has actually 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 difficult times with the neighborhood. The HKMA, together with the banking sector, will continue to do their utmost to support the development, upgrade and change of the real economy.