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The recent announcement by the HKMA (Hong Kong Monetary Authority) regarding the Banking (Capital) (Amendment) Rules 2023 marks a significant step in aligning Hong Kong’s banking regulations with global standards set by the BCBS (Basel Committee on Banking Supervision). With the new regulations in force since 1 January 2025, this implementation has reshaped the banking landscape in Hong Kong. This article explores the key changes introduced by the amendment and their implications for the future of banking in the region.
Author: Rachel Fung, Intern
Overview of Basel III
Basel III is the third of three Basel Accords, a series of frameworks and policies devised by the BCBS that sets internationally agreed upon standards for bank capital requirements, stress tests, liquidity regulations, and leverage in order to mitigate the risk of bank runs and bank failures and to enhance the stability and resilience of the banking sector in several jurisdictions. It was developed in response to the deficiencies in financial regulation revealed by the 2007–2008 financial crisis and builds upon the standards of Basel I, introduced in 1988, and Basel II, introduced in 2004.
Basel III specifically introduces stricter capital requirements and emphasizes risk management practices to protect against financial shocks. The incorporation of Basel III into Hong Kong’s regulatory framework is vital for maintaining its status as an international financial center.
Basel III have come into effect in Hong Kong through changes to the Banking (Capital) (Amendment) Rules 2023.
Capital Requirements:
A significant increase in the Common Equity Tier 1 (CET1) capital ratios has been imposed, requiring banks to maintain a CET1 ratio (see note) of no less than 12%, a substantial rise from the former requirement of 10.5%. These higher capital buffers intend to provide greater stability within the banking sector, thereby enhancing its ability to withstand potential economic downturns. However, this increase in capital requirements could also hinder banks' capacities to extend credit, potentially impacting overall economic growth.
Note: CET1 ratio is equivalent to Common Equity Tier 1 Capital / Risk-Weighted Assets
Output Floor:
Output floors are best conceptualised as a safety net for businesses, as no matter the method through which banks internally calculate capital requirements, there is a set capital amount they must satisfy. The introduction of output floors requires institutions employing internal models to demonstrate that their capital calculations meet or exceed this established threshold. While this initiative standardizes risk assessments amongst banks, it may inadvertently compel them to adopt broader and homogenized methodologies that do not fully capture the unique risks inherent in their individual operations.
Operational Risk:
Adjustments to how operational risk is assessed will likely require banks to hold additional capital against potential operational losses. Under the new framework, banks may be mandated to implement the SMA (Standardized Measurement Approach), which could lead to an approximate 20% increase in capital reserves to adequately buffer against potential operational risks. This change responds to the increasing recognition of operational risk as a critical factor in financial stability. While enhancing preparedness against operational failures, this requirement may impose considerable financial burdens, particularly on smaller institutions that may lack the resources to comply with these elevated standards.
Sovereign Concentration Risk:
New measures will address risks associated with concentrated sovereign exposures, encouraging banks to diversify their portfolios. These measures aim to mitigate the impact of economic downturns in specific countries. For example, banks may be restricted in the amount of sovereign debt they can hold from any single country, promoting a more balanced risk profile. Yet, such restrictions may also limit banks' investment strategies, potentially curtailing their ability to invest in stable sovereign bonds that typically present lower risks.
Market Risk and CVA Risk:
One key amendment regards the calculation of market risk and credit valuation adjustment (CVA) risk, which will impact the risk-weighted assets of banks. This new framework provides a more detailed assessment of various risk factors, including interest rates, credit spreads, and equity prices. As part of this update, institutions are now also obligated to recalibrate for potential future exposure (PFE) in their models, which considers the possibility of increased exposure over the life of a transaction due to market fluctuations.
These changes aim to create a more accurate reflection of the risk associated with trading activities and counterparty exposures.
While these changes are designed to improve risk management and enhance the resilience of financial institutions, they also introduce challenges in compliance and operational execution. Banks may face increased costs and complexities as they adjust their risk models to align with the new regulatory standards, necessitating a careful balance between regulatory compliance and effective risk management.
Impact on Consumers
So how does this regulatory shift impact financial institutions in Hong Kong? In short, the full adoption of Basel III is expected to fortify the overall credibility of Hong Kong’s financial system. Stricter lending criteria may result in more stringent credit assessments, increased borrowing costs, and restricted access to credit for certain individuals and businesses.
While these measures serve to enhance the resilience of the banking sector, they may concurrently pose challenges for consumers seeking financing. However, enhanced transparency in financial product disclosures is anticipated to improve consumer comprehension and confidence in banking services.
The government's endorsement of these regulatory changes highlights its focus on maintaining a robust financial system capable of withstanding economic uncertainties. A HKMA spokesperson stated:
"The HKMA has given due consideration to the views of the banking industry in determining the local implementation timeline for the Basel III's final reform package. Its full adoption will ensure that the regulatory framework in Hong Kong remains aligned with international standards agreed by the BCBS."
Through these reforms, policymakers seek to enhance the overall soundness of the banking sector, mitigating systemic risks while ensuring that Hong Kong remains an attractive and stable international financial center. The strengthened regulatory environment is expected to bolster investor confidence and reinforce trust in the city’s banking institutions.
Sources:
Rachel Fung is an LLB finalist from the University of Kent. She completed her 2-month internship with Ravenscroft & Schmierer during the summer in 2024, followed by a 1-month internship during the winter 2024/2025 and is striving to build her professional career as a solicitor.
Rachel Fung
Intern
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