Credit risk health check

Historically, Hong Kong is an open market-driven economy and with the Hong Kong dollar pegged to the US dollar this has made the city susceptible to global economic uncertainty. Hong Kong’s increasingly deep connections to the Chinese Mainland in more recent times have made the city more sensitive to the onshore environment. Elevated interest rates and lower trade volumes, alongside falling property and equity values and lower consumer demand in the Mainland have impacted credit profiles.  

In this environment, it is critical that banks have an effective credit deterioration indicator (CDI) process. Banks normally approach CDI through escalations by relationship managers and portfolio reviews. This relies on relationship managers to understand the process, show diligence and accept responsibility in execution. Portfolio reviews depend on the availability and useability of data, but also on the quality of data analysis, which should be proactive and risk-sensitive.

In addition to traditional credit analysis, banks should also be using financial, transactional and behavioural analytics to identify fraudulent misrepresentation of financial accounts and frauds in underlying transactions. Banks should take swift action in response to any warning signs originating from these areas, and risks should be triangulated, measured and aggregated against agreed reporting criteria.

Banks in Hong Kong are also making the final preparations for the implementation of Basel III, which will become effective on 1 January 2025.

A key requirement of Basel III will change the way banks calculate their capital ratio, which may mean higher capital requirements. Banks will need to ensure that their data, systems and reporting infrastructure can support the necessary risk measurements. In practice, this means strengthening processes. For example, banks should carry out additional inquiries if there is any uncertainty about a new customer’s identity documents.

The HKMA issued a survey in April to check banks’ readiness for Basel III, from three perspectives:

1. System readiness - are all systems ready for implementation
2. Operational readiness - have policies and procedures been updated
3. Quality assurance - internal or external auditors need to check the quality

Basel III has been in the pipeline for several years so there has been plenty of time to get ready. In terms of system and operational readiness, most banks in Hong Kong are well prepared. However, some banks are less well prepared for the quality assurance element.

With the deadline for implementation rapidly approaching, these banks should act quickly to decide whether the quality assurance assessment will be done internally or externally, and the process -- including engaging third parties if required -- should be launched without delay.