Basel III implementation

Our Ref: B1/15C, B9/25C B9/75C, B9/228C 18 October 2024 The Chief Executive All Authorized Institutions Dear Sir/Madam, Basel III implementation As you are aware, the revised capital standards under the Basel III final reform package will soon come into effect when the Banking (Capital) (Amendment) Rules 2023 (“BCAR”) commence operation as scheduled on 1 January 2025. In this connection, we consider it appropriate to incorporate, with immediate effect, certain adjustments to the way locally incorporated authorized institutions (“AIs”) calculate their regulatory capital requirement in relation to two important credit portfolios, viz., small and medium-sized enterprise (“SME”) exposures and residential mortgage lending, having regard to the latest design of the revised capital standards. SME exposures We understand and acknowledge that some AIs, in furtherance to the 9 measures to support SMEs announced by the HKMA on 28 March 20241 , may wish to start: (a) allocating the new risk weight of 85% under the revised standardized approach for credit risk capital calculation, as provided in the BCAR, to exposures to small businesses that are not regulatory retail exposures and are currently risk-weighted at 100% under the existing Banking (Capital) Rules (“BCR”); and

1 https://www.hkma.gov.hk/eng/news-and-media/press-releases/2024/03/20240328-7/

2 (b) subject to the state of readiness of the AIs concerned, adopting the new definition of “small business” set out in the BCAR for the purposes of (i) complying with section 64 of the existing BCR for allocating the risk weight of 75% to exposures to small businesses that are regulatory retail exposures; and (ii) allocating the new risk weight of 85% to exposures to small businesses that are not regulatory retail exposures. We also understand that some AIs which have been approved for using the IRB approach may also wish to start adopting the treatment(s) mentioned in (a) and, if applicable, (b) above in the calculation of (i) capital floor applicable to them; and (ii) capital charge for their SME exposures which have been exempted from using the IRB approach. In the light of (a) the relatively brief period of time before the BCAR come into operation; and (b) the bona fide reasons and the rationale for the approach being adopted by AIs, if an AI chooses to adopt the approach outlined above, the HKMA will take an accommodative stance and will not prioritise any supervisory reviews or measures in relation to the relevant risk weighting. Together with the reduction of the jurisdictional Countercyclical Capital Buffer (CCyB) announced by the Monetary Authority today2 , the HKMA expects AIs to make use of the additional leeway to further facilitate the financing needs of local SMEs. For banking return reporting, the relevant SME exposures to which the above approach is applied should be reported in item 20g of Part IIIb of the Return of Capital Adequacy Ratio (MA(BS)3) separately from other exposures that are also reported in item 20g. For AIs that are active in SME banking business, the HKMA will continue its engagement with individual institutions and their senior management to better understand their business strategies in relation to SME lending. The HKMA will collect information and key metrics relating to SME financing, such as AIs’ projections of credit facilities offered to SMEs and the size of their dedicated funds for supporting SMEs’ development, upgrade and transformation. The HKMA will also, through its supervisory engagements including prudential meetings with bank management and meetings with boards of directors, regularly review the progress made by individual institutions in implementing various SME support

2 https://www.hkma.gov.hk/media/eng/doc/key-information/guidelines-and-circular/2024/20241018e1.pdf

3 measures under the overarching principle of prudent risk management. Residential mortgage loans We would also like to inform you that in the light of a more comprehensive and risk-sensitive overall output floor coming into effect as part of the Basel III final reform package, the HKMA considers it now appropriate to remove the current risk-weight floor for calculating the capital requirement of relevant residential mortgage loans under the IRB approach. Relevant residential mortgage loans refer to those secured on Hong Kong properties falling within the IRB subclasses of “residential mortgages to individuals” and “residential mortgages to property￾holding shell companies” under section 142 of the BCR. We intend to notify AIs using the IRB approach of the above arrangement. Please direct to the following email account: credit_risk_SA@hkma.gov.hk any questions you may have or any clarifications you may require on the above. Yours faithfully,