Regulatory & Supervisory Framework

Supervisory Objective

The Banking Ordinance provides the legal framework for banking supervision in Hong Kong. Section 7(1) of the Ordinance provides that the principal function of the Monetary Authority (MA) is to "promote the general stability and effective working of the banking system".

Compliance with International Regulatory Standards

The HKMA seeks to establish a regulatory framework in line with international standards, in particular those issued by the Basel Committee on Banking Supervision and the Financial Stability Board. The objective is to maintain a prudential supervisory system which underpins the general stability and effective working of the banking system, while at the same time providing sufficient flexibility for authorized institutions to take commercial decisions.

Regulatory Requirements

Authorized institutions have to comply with the provisions of the Banking Ordinance which, among other things, require them to:

Maintain adequate capital and liquidity;
Submit periodic returns to the HKMA;
Adhere to limitations on exposures to any single counterparty (or group of linked counterparties) or to directors and employees; and
Seek approval for the appointment of directors and chief executives, and for controllers.

Overseas banks which operate in branch form are not required to hold capital in Hong Kong and are thus not subject to capital ratio requirements or to capital-based limits on large exposures.

Supervisory Approach

The HKMA follows international practices as recommended by international standard-setting bodies, such as the Basel Committee on Banking Supervision, to supervise authorized institutions.

The HKMA adopts a risk-based supervisory approach based on a policy of "continuous supervision", through on-site examinations, off-site reviews, prudential meetings, co-operation with external auditors and sharing information with other supervisors, with the aim of detecting any problems at an early stage.

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On-site Examinations

The HKMA periodically conducts on-site examinations of individual institutions. The coverage of an examination ranges from an investigation of specific areas to a comprehensive review of an institution's operations. The HKMA also selects authorized institutions for thematic examinations to benchmark their risk management practices on important business lines and major risk areas. On-site examinations provide a valuable opportunity to assess at first hand how an institution is managed and controlled.
Off-site Reviews

As on-site examinations are periodic in nature, in order to achieve "continuous supervision", the HKMA also conducts on-going off-site analyses of the financial condition of individual institutions and assessments of the quality of their management, including the policies and systems in managing risks. The scope of off-site reviews ranges from regular analyses of statistical returns, covering various aspects of the operations of authorized institutions, to an extensive annual review of the performance and financial position of individual institutions.
Prudential Meetings

Annual off-site reviews are usually followed by a prudential meeting with the senior management of the authorized institution to discuss prudential issues identified. Frequent contacts are also made with individual institutions at various levels of management as specific issues arise.
Co-operation with External Auditors

Co-operation with both internal and external auditors of authorized institutions is another important aspect of the supervisory process. Annual tripartite meetings are held with institutions and their external auditors, normally upon the completion of annual audits. Matters discussed typically include the annual audit, adequacy of provisions, and compliance with prudential standards and the Banking Ordinance.
Sharing of Information with Other Supervisors

The HKMA maintains close liaison with other local and overseas supervisors to exchange views on matters relating to the relevant authorized institutions.

Supervisory Framework

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“CAMEL” Rating System

The HKMA adopts the "CAMEL" rating system to assess the financial condition and overall soundness of banks in Hong Kong. “CAMEL” is an internationally recognised framework for assessing the Capital adequacy, Asset quality, Management, Earnings and Liquidity of banks. It can help identify banks whose weaknesses in financial condition, compliance with laws and regulations, risk management systems and overall operating soundness require special supervisory attention.

Asset Quality

The HKMA adopts a loan classification system and requires authorized institutions to report their asset quality every quarter according to a standardised framework. This allows the HKMA to better understand and monitor the asset quality of individual institutions and the banking industry as a whole.

Loan Classification System

Loan Category	Status
Pass	Loans for which borrowers are current in meeting commitments and for which the full repayment of interest and principal is not in doubt
Special Mention	Loans with which borrowers are experiencing difficulties and which may threaten the authorized institution's position
Substandard	Loans in which borrowers are displaying a definable weakness that is likely to jeopardise repayment
Doubtful	Loans for which collection in full is improbable and the authorized institution expects to sustain a loss of principal and/or interest, taking into account the net realisable value of collateral
Loss	Loans that are considered uncollectable after all collection options (such as the realisation of collateral or the institution of legal proceedings) have been exhausted

Loans that are classified as substandard, doubtful or loss are collectively known as “classified assets”. Banks are required to report to the HKMA regularly on provisions set aside for each category of classified assets and for different sectors in Hong Kong.

Statistics on asset quality

Capital Adequacy

Capital is vital to the operations of banks. Adequate capital helps enhance bank's financial strengths and provides additional buffers to ensure sufficient funds to handle daily operations in the event of an emergency. The higher the capital adequacy ratio of a bank, the higher its resilience.

The capital adequacy framework for banking supervision in Hong Kong closely follows the international standards published by the Basel Committee on Banking Supervision.

Applicable to all locally incorporated authorized institutions, the current framework consists of:

Prescribed Minimum Capital Adequacy Ratios

Common Equity Tier 1 capital ratio
Tier 1 capital ratio
Total capital ratio

Capital Buffers

Capital conservation buffer
Countercyclical capital buffer
Higher loss absorbency buffer (applicable to systemically important authorized institutions)

Supervisory Review Process

Setting and review of individual institution's minimum capital adequacy ratio requirements

Disclosure Standards

Disclosure related to institution's profit and loss and its financial resources (covering both capital resources and liquidity resources)

The current framework makes available a number of approaches for authorized institutions of different levels of sophistication to calculate their capital requirements. According to the Banking (Capital) Rules the use of some of the approaches requires the prior approval of the MA based on certain specified criteria. Authorized institutions are required to report their capital adequacy ratios every quarter.

Quarterly Bulletin / Half-Yearly Monetary & Financial Stability Report

Statistic on Capital Adequacy Ratio

Liquidity

For banks, liquidity is as important as blood circulation in the human body. Once liquidity dries up, banks may face the risk of bankruptcy. Therefore, banks must maintain sufficient liquidity to handle daily operational activities such as cash withdrawal from depositors, interbank clearing, repayment of debts, etc.

The liquidity framework for banking supervision in Hong Kong reflects the international standards published by the Basel Committee on Banking Supervision as part of its “Basel III” framework.

Liquidity Standards

Category 1 Institutions	Category 2 Institutions	Category 2A Institutions
Designated by the MA, mainly those institutions which are internationally active, or sizeable and sophisticated, and more significant in the context of the local banking sector Required to maintain a Liquidity Coverage Ratio (LCR) and a Net Stable Funding Ratio (NSFR) in line with the Basel III standard	Those institutions which do not fall under Category 1 Required to maintain a local Liquidity Maintenance Ratio (LMR)	A group of Category 2 institutions designated by the MA based on business size and liquidity risk of the institutions Required to maintain a local Liquidity Maintenance Ratio (LMR) and a local Core Funding Ratio (CFR)

Authorized institutions are required to have in place effective systems and controls for liquidity risk management under normal and stressed situations. The HKMA monitors the levels and trends of authorized institutions' liquidity positions and ability to withstand stress liquidity scenarios through reviewing the returns and management reports submitted by them.

Quarterly Bulletin / Half-Yearly Monetary & Financial Stability Report

Statistics on LCR

Statistics on LMR

Exposure Limits
The current provisions on exposure limits in Hong Kong are set out primarily in The Banking (Exposure Limits) Rules (Cap. 155S), which contain limits on equity exposure, single counterparty exposure (or group of linked counterparties exposure), connected party exposure and interest in land, etc.

The Rules are supplemented by The Banking (Exposure limits) Code and the following Supervisory Policy Manual (SPM) modules:
The Banking (Exposure Limits) Rules (Cap. 155S) came into effect on 1 July 2019. The Rules aim to implement the “Supervisory framework for measuring and controlling large exposures” issued by the Basel Committee on Banking Supervision locally, with a grace period of six months for compliance and also replace other exposure limits formerly set out in the Banking Ordinance to keep pace with market developments and contemporary risk management techniques. Under the Rules, there is a grace period of six months for compliance with the single counterparty (or group of linked counterparties) and connected party exposures limits.
Derivatives and Risk Management
The HKMA takes a proactive approach in the supervision of authorized institutions' derivatives activities, focusing on three areas:
- Controls - to ensure that authorized institutions have adequate internal control systems to manage the risks of derivatives activities;
- Capital - to ensure that authorized institutions have adequate capital to support possible losses in their derivatives business; and
- Capability - to ensure that there is adequate expertise within the HKMA to develop risk management policies and to supervise authorized institutions' derivatives activities.
In line with the international commitment to strengthening surveillance and risk mitigation in respect of derivatives transactions, authorized institutions and approved money brokers (where applicable) are required to report information in respect of specified types of over-the-counter (OTC) derivatives transactions to a trade repository (Hong Kong Trade Repository) operated by the HKMA and to clear specified types of OTC transactions through designated central counterparties.

Starting from March 2017, authorized institutions are also required to exchange two-way margin (i.e. both collect and post margin) for derivatives transactions not cleared through a central counterparty and to adopt specified risk mitigation standards such as swift and robust trade confirmation and dispute resolution procedures.

The broad regulatory framework for the regulation of the OTC derivatives market in Hong Kong is set out in the Securities and Futures Ordinance (“SFO”) with details set out in rules (i.e. subsidiary legislation). Key information on the regulatory requirements, including the primary legislation, subsidiary legislation covering reporting, clearing & record-keeping obligations, frequently asked questions, guidelines and manuals, public consultations and consultation conclusions etc., can be accessed via the following links to the SFC and HKMA webpages:
Regulatory Disclosure Standards

The HKMA aims to ensure that the standards for regulatory disclosure in Hong Kong remain in line with those of other leading financial centres. The Banking (Disclosure) Rules take into account the latest disclosure standards released by the Basel Committee on Banking Supervision, which prescribe quarterly, semi-annual, and annual disclosure of specified items in the form of standard templates and tables, in order to promote user-relevance and the consistency and comparability of regulatory disclosure among banks and across jurisdictions.
Collection of Financial Information

The Monetary Authority's powers to collect prudential data from authorized institutions on a routine or ad hoc basis are provided by Section 63 of the Banking Ordinance. The same section of the Ordinance also empowers the Monetary Authority to require any holding company or subsidiary or sister company of an authorized institution to submit such information as may be required for the exercise of the Monetary Authority’s functions under the Ordinance.

Submission of returns is normally made each month or quarter.