On 21 Jul 2025, the HKMA published Chapter IV of Supplementary Guidance clarifying the IRB approach under the Revised Credit Risk Framework. The proposals establish strict requirements for IRB adoption, including a 3-year rating system track record, prohibitions on phased rollouts, and 10% exemption limits for exposures. They mandate MA consent for switching approaches, define default criteria, require climate risk integration in ratings, and enforce 4-quarter parallel calculations prior to IRB implementation. Stress testing for mild recession scenarios must be conducted annually to validate capital adequacy.
This article was generated using SAMS, an AI technology by Timothy Loh LLP.
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Introduction
On 21 Jul 2025, the Hong Kong Monetary Authority (HKMA) published Chapter IV of Supplementary Guidance on the Revised Credit Risk Framework, providing detailed clarifications on the Internal Ratings-Based (IRB) approach for authorized institutions (AIs). The guidance addresses application, adoption, classification, calculation methodologies, default definitions, rating systems, and stress-testing requirements under the revised framework.
Application and Adoption Requirements
On 21 Jul 2025, the proposals establish that AIs seeking approval to use the IRB approach for specific exposure classes must submit a comprehensive implementation plan detailing the IRB adoption class(es), chosen calculation approach (foundation or advanced), and commencement date. A phased rollout within an IRB adoption class is generally prohibited; it may only be permitted under exceptional circumstances with strong justifications, such as supervisory constraints or impractical local legal restrictions. Switching from the IRB approach to the Standardized Treatment Approach (STC) requires prior MA consent and must not be motivated by regulatory capital arbitrage. Exemptions for subsets of exposures or business units are permitted only if the aggregate risk-weighted amount does not exceed 10% of the institution's total credit risk risk-weighted amount, and exemption is not driven by capital arbitrage.
Classification and Exposure Treatment
On 21 Jul 2025, the proposals clarify that financial figures for exposure classification must be derived from audited financial statements where feasible, with alternative reliable data permitted only when audited reports are unavailable. AIs may use thresholds up to $500 million for small-and-medium sized corporates and $10 million for small business retail exposures, but must adopt the $5 billion threshold for large corporates. Specialized lending must be classified into specific IRB subclasses regardless of the calculation approach used. Retail exposures require facility-level application of the $1 million threshold for revolving exposures, and loans managed individually must be classified as corporate exposures.
IRB Calculation Approaches and Switching
On 21 Jul 2025, the proposals confirm that AIs using the foundation IRB approach are not required to migrate to the advanced approach, but must select an approach commensurate with their risk management sophistication. Switching from advanced to foundation IRB approach requires MA consent and is permitted only in exceptional circumstances (e.g., business downsizing or loss of rating system reliability). The supervisory slotting criteria approach is ineligible for specialized lending if the AI can estimate credit risk components. Equity exposures previously approved for IRB must use STC from 1 January 2025.
Default Definitions and Rating Systems
On 21 Jul 2025, the proposals define 'prescribed default criteria' under §149(1), requiring AIs to treat obligors as defaulted if unlikely to pay in full or past due over 90 days. Materiality thresholds for default determination must be prudent, consistent, and aligned with parent bank standards. Rating systems must use multiple dimensions where required (e.g., obligor and facility grades for advanced IRB), avoid 'cherry-picking' across systems, and incorporate climate-related financial risks in rating assignments. AIs must maintain a 3-year credible track record of rating system use (IRB use test) prior to IRB adoption, with refinements not resetting the test period unless substantially altering the system.
Stress Testing and Parallel Calculations
On 21 Jul 2025, the proposals mandate annual stress tests assessing mild recession scenarios (e.g., 2+ consecutive quarters of negative GDP growth in Hong Kong 2001-2003 or global crises), with results informing capital adequacy. AIs must conduct parallel calculations for 4 consecutive calendar quarters (1 year) before adopting the IRB approach, or 2 quarters in exceptional cases. For switching from foundation to advanced IRB, parallel calculations must cover both approaches. Stress test results must trigger remedial actions if capital shortfalls are identified.
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