HSBC Holdings Regulatory News (HSBA)

Contents

We recognise that the primary role of risk management is to protect our customers, business, colleagues, shareholders and the communities that we serve, while ensuring we are able to support our strategy and provide sustainable growth.

All our people are responsible for the management of risk, with the ultimate accountability residing with the Board. Our Group Risk and Compliance function, led by the Group Chief Risk and Compliance Officer, plays an important role in reinforcing our culture and values. We are focused on creating an environment that encourages our people to speak up and do the right thing.

Group Risk and Compliance is independent from the global businesses, including our sales and trading functions, to provide challenge, oversight and appropriate balance in risk/reward decisions.

We aim to use a comprehensive risk management approach across the organisation and across all risk types, underpinned by our culture and values. This is outlined in our risk management framework, including the key principles and practices that we employ in managing material risks, both financial and non-financial. The framework fosters continuous monitoring, promotes risk awareness, and encourages sound operational and strategic decision making. It also supports a consistent approach to identifying, assessing, managing and reporting the risks we accept and incur in our activities. We continue to actively review and develop our risk management framework and enhance our approach to managing risk through our activities with regard to: people and capabilities; governance; reporting and management information; credit risk management models; and data.

A summary of our current policies and practices regarding the management of risk is set out in the 'Risk management' section on pages 132 to 135 of the Annual Report and Accounts 2022.

Key developments in the first half of 2023

We continued to actively manage the risks related to macroeconomic and geopolitical uncertainties, as well as other key risks described in this section. In addition, we sought to enhance our risk management in the following areas:

- We enhanced our management of concentration risk at country and single customer group levels by implementing new frameworks to strengthen our control of risk tolerance and appetite.

- We have continued to strengthen our third-party risk policy and enhanced the way third-party risk is overseen and managed across all non-financial risks. Our processes, framework and reporting capabilities have been enhanced to improve the control and oversight of our material third parties, to help maintain our operational resilience and meet new and evolving regulatory requirements.

- We continued to make progress with our comprehensive regulatory reporting programme to strengthen our global processes, improve consistency and enhance controls.

- We continued our programme to enhance our framework for managing risks associated with machine learning and artificial intelligence ('AI').

- Through our climate risk programme, we continued to embed climate considerations throughout the organisation, including enhancing our approach to assessing the impact of climate on capital, and continued the development of risk metrics to manage our exposure to climate risk.

- We deployed industry-leading technology and advanced analytics capabilities into new markets to improve our ability to identify suspicious activities and prevent financial crime. We continue to monitor regulatory changes.

- We continued to develop and enhance our electronic communication policies and standards, to help ensure escalations and follow-up actions can better focus on substantive issues.

Areas of special interest

During the first half of 2023, a number of areas were considered as part of our top and emerging risks because of the effect they have on the Group. In this section we have focused on risks related to geopolitical and macroeconomic risk and the interbank offered rate ('Ibor') transition.

Geopolitical and macroeconomic risk

The Russia-Ukraine war has had far-reaching geopolitical and economic implications. HSBC is monitoring the impacts of the war, and continues to respond to the significant sanctions and trade restrictions imposed against Russia by the UK, the US and the EU, as well as other countries. In response to such sanctions and trade restrictions, as well as to asset flight, Russia has implemented certain countermeasures. The global economy has largely adapted to the imposition of significant sanctions and trade restrictions, with European countries diversifying their energy sources to reduce their dependence on Russian energy supplies.

Further sanctions-related matters, including sanctions evasion by parties in third countries and Russian countermeasures may adversely impact the Group, its customers and the markets in which it operates. Our business in Russia, which principally serves multinational corporate clients headquartered in other countries, is not accepting new business or customers and is consequently on a declining trend. Following a strategic review in 2022, HSBC Europe BV (a wholly-owned subsidiary of HSBC Bank plc) entered into an agreement to sell its wholly-owned subsidiary HSBC Bank Russia (RR) (Limited Liability Company), subject to regulatory and governmental approvals.

Global supply chain disruptions caused by the war in Ukraine have eased, although inflation is likely to remain high in several regions as the demand for services remains relatively strong. This has prompted central banks to continue tightening monetary policies. Since the beginning of 2023, the US Federal Reserve Board ('FRB') has delivered a cumulative 75 basis point ('bps') increase in the Federal Funds rate. The European Central Bank and the Bank of England have each tightened their policy rates by 150 bps over the same period. All three central banks and their counterparts in other developed markets are expected to increase rates further in the near term. While the peak in rates may be getting closer, as of early-July 2023, interest-rate futures did not suggest that central banks in developed markets (with the possible exception of the FRB) will begin to ease monetary policy until well into 2024. This may change if inflation moderates more significantly than expected, or if recession concerns increase. Some central banks in emerging markets have already begun to ease on monetary policy.

Fiscal policies are likely to remain relatively generous in coming years as demand increases for public spending on items including social welfare, defence and decarbonisation initiatives. This may increasingly happen against a backdrop of slower growth, volatile energy prices and high interest rates. Financial markets are showing a degree of forbearance, with long-term yields relatively contained. However, this may be tested by the acceleration in the coming months of central bank sales of government securities accumulated over several years of quantitative easing. Sovereigns with high public debt burdens could come under renewed focus as investors question the sustainability of that debt. We continue to monitor our risk profile closely in the context of uncertainty over global macroeconomic policies.

Higher inflation and interest rate expectations around the world - and the resulting economic uncertainty - have had an impact on expected credit losses and other credit impairment charges ('ECL') during the first half of 2023. In certain markets, the combined pressure of higher inflation and interest rates may impact the ability of our customers to repay their debt. Our Central scenario, which has the highest probability weighting in our IFRS 9 'Financial Instruments' calculations of ECL, assumes low growth and a higher inflation environment across many of our key markets.

The Central scenario has been assigned our standard weighting across all of our major markets, reflecting narrowing forecast dispersion, reduced uncertainty, and a view that forecasts now sufficiently capture the weak growth outlook. Our approach to macroeconomic scenarios remained unchanged in 2Q23, but the shift in UK interest rate expectations in June resulted in updates to key scenario variables. There remains continued uncertainty with respect to the relationship between the economic drivers and the historical loss experience, which has required adjustments to modelled ECL in cases where we determined that our models were unable to capture the material underlying risks. For retail portfolios where models do not sufficiently capture the interest rate and inflation risks, there has been a globally consistent approach developed that is utilised for assessing the affordability pressure on potentially affected customers and the consequential impact this would have on ECL. This is incorporated into ECL via management judgemental adjustments.

For further details of our Central and other scenarios, see 'Measurement uncertainty and sensitivity analysis of ECL estimates' on page 69.

Given that key sectors of the global economy such as trade and manufacturing are underperforming, and the risk of recessions remains, the demand for Chinese exports may also diminish. While the mainland China commercial real estate market showed signs of recovery and stabilisation in early 2023, recent market data remains mixed, suggesting both an uncertain and protracted recovery. China's government policy measures relating to the mainland China commercial real estate market introduced in late 2022 have resulted in improved financial support for onshore borrowers, although offshore financial market conditions remain challenging in light of a continued shortage of liquidity. Corporates operating in this sector are therefore facing continued challenges and are becoming increasingly divided, with state-owned enterprises and certain privately-owned enterprises likely to see some improvements in their performances and allocations of investments and liquidity, while other entities may still remain subject to performance uncertainty and material market pressure. We will continue to monitor the sector closely, notably the risk of further credit migration and idiosyncratic defaults.

Global tensions over trade, technology and ideology are manifesting themselves in divergent regulatory standards and compliance regimes, presenting long-term strategic challenges for multinational businesses.

The US-China relationship remains complex. In addition to the US, the UK, the EU and other countries have also imposed certain sanctions and trade restrictions on Chinese persons and companies. There is a continued risk of additional sanctions and trade restrictions being imposed by the US and other governments in relation to human rights, advanced technology, and other issues with China, and this could create a more complex operating environment for the Group and its customers.

China has in turn announced a number of its own sanctions and trade restrictions that target, or provide authority to target, foreign individuals and companies, and materials for technology production.

These and any future measures and countermeasures that may be taken by the US, China and other countries may affect the Group, its customers and the markets in which the Group operates.

The conclusion of the Windsor Framework between the UK and the EU introduced a new system of checks on goods moving from the UK to Northern Ireland, and removed a major area of friction. On 27 June 2023, the UK and the EU also signed a memorandum of understanding on regulatory cooperation in financial services, potentially paving the way for closer coordination of policymaking for the sector.

Over the medium to long term, the UK's withdrawal from the EU may impact markets and increase economic risk, particularly in the UK, which could adversely impact our profitability and prospects for growth in this market. We are monitoring the situation closely, including the potential impacts on our customers. 

As the geopolitical landscape evolves, compliance by multinational corporations with their legal or regulatory obligations in one jurisdiction may be seen as supporting the law or policy objectives of that jurisdiction over another, creating additional compliance, reputational and political risks for the Group. We maintain dialogue with our regulators in various jurisdictions on the impact of legal and regulatory obligations on our business and customers.

It remains the Group's policy to comply with all applicable laws and regulations of all jurisdictions in which it operates, although geopolitical risks and tensions, and potential ambiguities in the Group's compliance obligations will continue to present challenges and risks for the Group. These could have a material adverse impact on the Group's business, financial condition, results of operations, prospects and strategy, as well as on the Group's customers.

Expanding data privacy, national security and cybersecurity laws in a number of markets could pose potential challenges to intra-Group data sharing. These developments may affect our ability to manage financial crime risks across markets due to limitations on cross-border transfers of personal information.

Ibor transition

Interbank offered rates ('Ibors') were previously used extensively to set interest rates on different types of financial transactions and for valuation purposes, risk measurement and performance benchmarking.

Following the UK's Financial Conduct Authority ('FCA') announcement in July 2017 that it would no longer continue to persuade or require panel banks to submit rates for the London interbank offered rate ('Libor') after 2021, we have been actively working to transition legacy contracts from Ibors to products linked to near risk-free replacement rates ('RFRs') or alternative reference rates.

The publication of sterling, Swiss franc, euro and Japanese yen Libor interest rate benchmarks, as well as Euro Overnight Index Average ('Eonia'), and two US dollar Libor settings ceased from the end of 2021. Following this, the publication of all remaining settings of US dollar Libor ceased from 30 June 2023. To support any remaining contracts referencing these benchmarks, the FCA has compelled the ICE Benchmark Administration Limited to publish the three-month sterling Libor setting using an alternative 'synthetic' methodology until 31 March 2024, and one-month, three-month and six-month US dollar Libor settings until 30 September 2024. We continue to support our customers in the transition of the limited number of outstanding contracts relying on 'synthetic' Libor benchmarks in line with these dates.

Our Ibor transition programme - which is tasked with the development of RFR products and the transition of legacy Ibor products - has implemented the required processes, technology and RFR product capabilities in support of the benchmark cessation events. As a result, the transition of the majority of legacy contracts was undertaken successfully throughout 1H23 with the remaining contracts expected to largely complete in 3Q23. Specifically, our derivatives portfolio was largely transitioned through clearing house conversion mechanisms, and the use of industry legal fall-back provisions at cessation, leaving a limited number of trades that continue to be discussed with customers. Our wholesale and private bank lending portfolios for both uncommitted and committed facilities have been repapered with client consent, albeit a small number of wholesale contracts will continue repapering activities until their first interest rate fixing date after cessation. Where applicable, our structured notes and certain MREL instruments of the Group are being transitioned in line with jurisdictional legislative solutions and through client and investor notification. In respect of HSBC's regulatory capital and other MREL instruments that include references to legacy Ibors (including indirect references) in their terms, HSBC expects to be able to remediate or mitigate these risks by the relevant calculation dates, which may occur post-cessation of the relevant Ibor. HSBC remains committed to seeking to remediate or mitigate relevant risks relating to Ibor-demise, as appropriate.

While the majority of our legacy contracts referencing demised Ibors have been transitioned, as a result of other demising benchmarks or remaining contracts, we continue to be exposed to, and actively monitor, risks including:

- regulatory compliance and conduct risks, as the use of 'synthetic' Libor rates, transition of legacy contracts to RFRs or alternative rates, or sales of products referencing RFRs, may not deliver fair client outcomes; and

- legal risk, as issues arising from the use of legislative solutions and from legacy contracts that the Group is unable to transition may result in unintended or unfavourable outcomes for clients and market participants, which could potentially increase the risk of disputes.

While the level of risk has diminished in line with our process implementation and continued transition of contracts, we will monitor these risks through the remainder of the transition of legacy contracts. Throughout 2023, we plan to continue to engage with our clients and investors to complete an orderly transition of contracts

that reference the remaining demising Ibors. Additionally, plans and policies are in place to help us to react to any future regulatory notification of the intention to demise an interest rate benchmark.

Financial instruments impacted by Ibor reform

Interest Rate Benchmark Reform Phase 2, the amendments to IFRSs issued in August 2020, represents the second phase of the IASB's project on the effects of interest rate benchmark reform. The amendments address issues affecting financial statements when changes are made to contractual cash flows and hedging relationships.

Under these amendments, changes made to a financial instrument measured at other than fair value through profit or loss that are economically equivalent and required by interest rate benchmark reform, do not result in the derecognition or a change in the carrying amount of the financial instrument. Instead they require the effective interest rate to be updated to reflect the change in the interest rate benchmark. In addition, hedge accounting will not be discontinued solely because of the replacement of the interest rate benchmark if the hedge meets other hedge accounting criteria.

1 Comprises financial instruments referencing other significant benchmark rates yet to transition to alternative benchmarks (euro Libor, SOR, THBFIX, MIFOR, Sibor, CDOR and TIIE). An announcement was made by the South African regulator during the first half of 2023 on the cessation of the Johannesburg interbank average rate ('JIBAR'). Therefore, JIBAR is also included in 'Others' during the current period.

2 Gross carrying amount excluding allowances for expected credit losses.

The amounts in the above table relate to HSBC's main operating entities where HSBC has material exposures impacted by Ibor reform, including in the UK, Hong Kong, France, the US, Mexico, Canada, Singapore, the UAE, Bermuda, Australia, Qatar, Germany, Thailand, India and Japan. The amounts provide an indication of the extent of the Group's exposure to the Ibor benchmarks that are due to be replaced. Amounts are in respect of financial instruments that:

- contractually reference an interest rate benchmark that is planned to transition to an alternative benchmark;

- have a contractual maturity date beyond the date by which the reference interest rate benchmark is expected to cease; and

- are recognised on HSBC's consolidated balance sheet.

-

Credit risk

Overview

Credit risk is the risk of financial loss if a customer or counterparty fails to meet an obligation under a contract. Credit risk arises principally from direct lending, trade finance and leasing business, but also from certain other products, such as guarantees and derivatives.

Credit risk in the first half of 2023

There were no material changes to credit risk policy in the first half of 2023.

A summary of our current policies and practices for the management of credit risk is set out in 'Credit risk management' on page 145 of the Annual Report and Accounts 2022.

At 30 June 2023, gross loans and advances to customers and banks of $1,072bn increased by $32.7bn, compared with 31 December 2022. This included favourable foreign exchange movements of $12.3bn.

Excluding foreign exchange movements, growth was driven by a $29.3bn increase in personal loans and advances to customers. This was partly offset by a $6.4bn decrease in wholesale loans and advances to customers and a $2.6bn decrease in loans and advances to banks.

The underlying increase in personal loans and advances to customers was driven mainly by an increase in France (up $22.3bn) due to our retail banking operations in France no longer being classified as assets held for sale. It also comprised increases in Hong Kong (up $4.4bn), in the UK (up $1.8bn), in Mexico (up $1.2bn) and in Australia (up $1.0bn) driven mainly by mortgage growth. These were partly offset by a decrease in Oman (down $1.2bn) from the reclassification of our business in the country into 'assets held for sale'.

The underlying decrease in wholesale loans and advances to customers was driven mainly by lower commercial real estate exposures in Hong Kong (down $8.3bn) and mainland China (down $1.5bn). It also comprised a decrease in Oman (down $2.1bn) from the reclassification of our business in the country into 'assets held for sale'. These were partly offset by increases in France (up $2.1bn) and in the UK (up $2.1bn). The increase in the UK included loans and advances to customers of $7.1bn from HSBC Innovation Bank Limited (formerly SVB UK).

At 30 June 2023, the allowance for ECL of $12.8bn increased by $0.2bn compared with 31 December 2022, including adverse foreign exchange movements of $0.1bn. The $12.8bn allowance comprised $12.3bn in respect of assets held at amortised cost, $0.4bn in respect of loan commitments and financial guarantees, and $0.1bn in respect of debt instruments measured at fair value through other comprehensive income ('FVOCI').

Excluding foreign exchange movements, the allowance for ECL in relation to loans and advances to customers increased by $0.1bn from 31 December 2022. This was attributable to:

- a $0.1bn increase in wholesale loans and advances to customers, which included a $0.4bn increase driven by stage 3, offset by a $0.3bn decrease driven by stages 1 and 2; and

- broadly unchanged allowances for ECL in personal loans and advances to customers across all stages.

In wholesale lending, mainland China's commercial real estate sector continued to deteriorate in 2023, resulting in new and additional stage 3 charges.

In personal lending, stable allowances reflected customer resilience during the period, despite significant inflationary pressures.

The Group ECL charge for the first six months of 2023 was $1.3bn, inclusive of recoveries. This was driven by higher stage 3 charges, notably in the Hong Kong commercial real estate sector, as well as continued economic uncertainty and inflationary pressures.

The ECL charge comprised: $0.5bn in respect of personal lending, of which the stage 3 charge was $0.3bn; and $0.8bn in respect of wholesale lending, of which the stage 3 and POCI charge was $0.7bn.

Summary of credit risk

The following disclosure presents the gross carrying/nominal amount of financial instruments to which the impairment requirements in IFRS 9 are applied and the associated allowance for ECL.

The following tables analyse loans by industry sector and represent the concentration of exposures on which credit risk is managed. The allowance for ECL increased from $12.6bn at 31 December 2022 to $12.8bn at 30 June 2023.

1 Total ECL is recognised in the loss allowance for the financial asset unless total ECL exceeds the gross carrying amount of the financial asset, in which case the ECL is recognised as a provision.

2 For further details on gross carrying amounts and allowances for ECL related to assets held for sale, see 'Assets held for sale' on page 68.

3 Includes only those financial instruments that are subject to the impairment requirements of IFRS 9. 'Prepayments, accrued income and other assets', as presented within the consolidated balance sheet on page 110, includes both financial and non-financial assets.

4 Represents the maximum amount at risk should the contracts be fully drawn upon and clients default.

5 Debt instruments measured at FVOCI continue to be measured at fair value with the allowance for ECL as a memorandum item. Change in ECL is recognised in 'Change for expected credit losses and other credit impairment charges' in the income statement.

The following table provides an overview of the Group's credit risk by stage and industry, and the associated ECL coverage. The financial assets recorded in each stage have the following characteristics:

- Stage 1: These financial assets are unimpaired and without a significant increase in credit risk for which a 12-month allowance for ECL is recognised.

- Stage 2: A significant increase in credit risk has been experienced on these financial assets since initial recognition for which a lifetime ECL is recognised.

- Stage 3: There is objective evidence of impairment and the financial assets are therefore considered to be in default or otherwise credit impaired for which a lifetime ECL is recognised.

- POCI: Financial assets that are purchased or originated at a deep discount are seen to reflect the incurred credit losses on which a lifetime ECL is recognised.

1 Represents the maximum amount at risk should the contracts be fully drawn upon and clients default.

2 Purchased or originated credit-impaired ('POCI').

Unless identified at an earlier stage, all financial assets are deemed to have suffered a significant increase in credit risk when they are 30 days past due ('DPD') and are transferred from stage 1 to stage 2.

The following disclosure presents the ageing of stage 2 financial assets by those less than 30 and greater than 30 DPD and therefore presents those financial assets classified as stage 2 due to ageing (30 DPD) and those identified at an earlier stage (less than 30 DPD).

1 Days past due ('DPD').

2 The days past due amounts presented above are on a contractual basis and include the benefit of any customer relief payment holidays granted.

1 Represents the maximum amount at risk should the contracts be fully drawn upon and clients default.

2 Purchased or originated credit impaired ('POCI').

1 Days past due ('DPD').

2 The days past due amounts presented above are on a contractual basis and include the benefit of any customer relief payment holidays granted.

Stage 2 decomposition

The following table presents the stage 2 decomposition of gross carrying amount and allowances for ECL for loans and advances to customers. It also sets out the reasons why an exposure is classified as stage 2 and therefore presented as a significant increase in credit risk at 30 June 2023.

The quantitative classification shows gross carrying values and allowances for ECL for which the applicable reporting date probability of default ('PD') measure exceeds defined quantitative thresholds for retail and wholesale exposures, as set out in Note 1.2 'Summary of significant accounting policies', on page 342 of the Annual Report and Accounts 2022.

The qualitative classification primarily accounts for customer risk rating ('CRR') deterioration, watch-and-worry and retail management judgemental adjustments.

A summary of our current policies and practices for the significant increase in credit risk is set out in 'Summary of significant accounting policies' on page 342 of the Annual Report and Accounts 2022.

1 Where balances satisfy more than one of the above three criteria for determining a significant increase in credit risk, the corresponding gross exposure and ECL have been assigned in order of categories presented.

2 Days past due ('DPD').

Assets held for sale

At 30 June 2023, the most material balances held for sale came from our banking business in Canada. During the first half of 2023 the planned sale of our retail banking operations in France became less certain and no longer met the definition of held for sale.

'Loans and other credit-related commitments' and 'financial guarantees', as reported in credit disclosures, also include exposures and allowances relating to financial assets classified as 'assets held for sale'.

At 30 June 2023, gross loans and advances of our banking business in Canada were $56.3bn, and the related allowances for ECL were $0.2bn.

Lending balances held for sale continue to be measured at amortised cost less allowances for impairment and, therefore, such carrying amounts may differ from fair value.

These lending balances are part of associated disposal groups that are measured in their entirety at the lower of carrying amount and fair

value less costs to sell. Any difference between the carrying amount of these assets and their sales price is part of the overall gain or loss on the associated disposal group as a whole.

For further details of the carrying amount and the fair value at 30 June 2023 of loans and advances to banks and customers classified as held for sale, see Note 15 on the interim condensed financial statements.

1 Comprising assets held for sale relating to the planned merger of our business in Oman, and the planned sales of our branch operations in Greece and our business in Russia.

Measurement uncertainty and sensitivity analysis of ECL estimates

The recognition and measurement of ECL involves the use of significant judgement and estimation. We form multiple economic scenarios based on economic forecasts, apply these assumptions to credit risk models to estimate future credit losses, and probability-weight the results to determine an unbiased ECL estimate. Management judgemental adjustments are used to address late-breaking events, data and model limitations, model deficiencies and expert credit judgements.

At 30 June 2023, management recognised a reduction in uncertainty in most markets. It was management's view that the Central scenario sufficiently reflected the muted global economic environment and that the probability weightings assigned to this scenario for each of our major markets should increase and revert to the standard weight of 75%.

Methodology

At 30 June 2023, four economic scenarios were used to capture the current economic environment and to articulate management's view of the range of potential outcomes. Each scenario is updated with new forecasts and estimates each quarter.

The Upside, Central and Downside scenarios are drawn from external consensus forecasts, market data and distributional estimates of the entire range of economic outcomes.

The fourth scenario, the Downside 2, represents management's view of severe downside risks.

Economic scenarios produced to calculate ECL are aligned to HSBC's top and emerging risks.

In June 2023, following a significant shift in UK policy interest rate expectations, the Central scenario for the UK was updated and key economic and financial variables were updated. Outer scenario economic variables for the UK were changed in parallel with these Central scenario adjustments. 

Description of economic scenarios

In the Central scenario, global economic forecasts have improved since 1Q23. In western Europe and North America, GDP and employment have proved resilient to higher inflation and interest rates, as well as the failure of several US banks. In Hong Kong and mainland China, the post-pandemic reopening has led to a faster than expected improvement in growth and expectations, which has now been reflected in forecasts.

Stronger than expected growth means that inflation has declined at a slower pace than projected. For many markets, inflation forecasts have been raised. Further monetary tightening is also expected although interest rates are, in most markets, thought to be at, or close to, their peak. The UK and China are key exceptions.

In the UK, interest rates are expected to rise over the remainder of 2023. There remains uncertainty around the speed and extent of the increases, which may impose additional downside risks. In China, policy interest rates have been cut. 

The Upside and Downside scenarios are designed to encompass the potential crystallisation of a number of key macro-financial risks. Higher inflation, tighter monetary policy and financial conditions, and an escalation of geopolitical risks pose key downside risks to the outlook. To the upside, a swifter decline in inflation, a cut to interest rates and greater cooperation between the US and China on trade and investment are assumed to drive faster economic growth.

The scenarios used to calculate ECL are described below.

The consensus Central scenario

HSBC's Central scenario features a slowdown in GDP growth and a rise in unemployment across our major markets in 2023, relative to 2022, with the exception of Hong Kong and mainland China.

Global GDP forecasts have been raised in recent quarters due to stronger-than-expected growth in 1Q23, underpinned by resilience in household consumption. Nevertheless, the outlook for the remainder of 2023 and the beginning of 2024 remains subdued as high inflation continues to erode disposable income and curtail investment. In Hong Kong and mainland China, higher growth expectations reflect the removal of pandemic-related restrictions.

The Central scenario assumes that inflation gradually declines through 2023 and only reverts to central bank target ranges in 2025.

Global GDP is expected to grow by 2.0% in 2023 in the Central scenario. The average rate of global GDP growth is expected to be 2.6% over the forecast period, slightly below the 2.8% average five-year growth rate expectation prior to the onset of the pandemic.

Across the key markets, the Central scenario assumes the following:

- GDP growth in mainland China is expected to continue at a rate above the official target of 5% in 2023, with policy stimulus offsetting headwinds from a weak property sector and lower external demand. In Hong Kong, the resumption of international travel and tourism, and the recovery in mainland China are expected to sustain the rapid rebound in GDP, led by the services sector and high employment.

- In the UK, persistently high inflation and wage growth have caused a significant reappraisal of interest rate expectations. A substantially higher terminal rate for interest rates implies a bigger impact on confidence, discretionary income and investment. We have sought to reflect this in an updated Central scenario, which incorporates a recession for the UK that begins in the second half of 2023 and persists into 2024.

- In the remainder of western Europe and North America, economic growth is expected to slow in the second half of 2023, as tighter monetary policy and elevated inflation squeeze corporate margins and households' real disposable income. Tighter financial conditions are expected to weigh on credit growth.

- Unemployment is expected to rise gradually in most of our key markets from 2022 levels as economic growth slows. It is forecast to fall in mainland China and Hong Kong as the economic recovery continues.

- Inflation is expected to remain above central bank targets in our key markets in 2023 as core inflation and food prices remain high. Inflation is subsequently expected to converge back to central bank targets over the next two years of the forecast. Mainland China is expected to be an exception as inflation remains low throughout the forecast horizon.

- Policy interest rates in key markets are expected to peak later this year following rapid tightening cycles over the past 18 months to bring inflation rates back towards their targets. Thereafter, they are expected to fall slowly and remain at higher levels than they were pre-pandemic. In the UK, policy interest rates are forecast to rise until the end of the year and remain high for an extended period of time.

- The Brent crude oil price is expected to average $77 per barrel in 2023, before dropping back as demand weakens. Over the entire projection the oil price is expected to average $69 per barrel.

The Central scenario was created from consensus forecasts available in May, and market-based projections updated in June. For the UK, significant UK variables, including GDP, unemployment and policy rates were updated in late June.

The following table describes key macroeconomic variables in the consensus Central scenario.

1 The five-year average is calculated over a projected period of 20 quarters from 3Q23 to 2Q28.

The graphs compare the respective Central scenario with current economic expectations beginning in the second quarter of 2023.

GDP growth: Comparison of Central scenarios

Note: Real GDP shown as year-on-year percentage change.

Note: Real GDP shown as year-on-year percentage change.

Note: Real GDP shown as year-on-year percentage change.

Note: Real GDP shown as year-on-year percentage change.

The consensus Upside scenario

The consensus Upside scenario features stronger growth, lower unemployment and a faster fall in inflation compared with the Central

scenario. Asset prices, including housing, also rise more quickly in this scenario. Other upside risk themes include a de-escalation of geographical tensions and looser financial conditions.

The following table describes key macroeconomic variables in the consensus Upside scenario.

1 Cumulative change to the highest level of the series during the 20-quarter projection.

2 Lowest projected unemployment rate in the scenario.

3 Lowest projected year-on-year percentage change in inflation in the scenario.

Downside scenarios

Downside scenarios explore the intensification and crystallisation of a number of key economic and financial risks. High inflation and the monetary policy response to it remain key concerns for global growth. While supply chain disruptions caused by the Covid-19 pandemic and the Russia-Ukraine war are easing, helping to reduce headline price inflation across many markets, core inflation remains high. This reflects tight labour markets, which is putting upward pressure on wages, and resilience in demand. In turn, it raises the risk of a more forceful policy response from central banks, encompassing a steeper trajectory for interest rates, a higher terminal rate and ultimately, economic recession.

The rapid increase in interest rates has already led to a repricing of asset valuations, as corporate and household borrowers face steep increases in debt service costs. Policymakers have also raised

concerns that, following the collapse of several US regional banks, financial conditions could tighten further, acting as another constraint on activity. Insolvencies and default rates could rise sharply as businesses find it difficult to refinance, and cash buffers diminish amid weaker demand.

In addition, mainland China's recovery from the pandemic may be weaker than expected, with negative implications for global growth and Hong Kong in particular. 

In the consensus Downside scenario, economic activity is considerably weaker compared with the Central scenario, driven by an intensification of geopolitical risks that aggravate supply chain disruptions and cause global energy and other commodity prices to rise. In this scenario, the economies of our key markets experience moderate recession, unemployment rates increase, and asset prices fall.

The following table describes key macroeconomic variables in the consensus Downside scenario.

1 Cumulative change to the lowest level of the series during the 20-quarter projection.

2 The highest projected unemployment rate in the scenario.

3 The highest projected year-on-year percentage change in inflation in the scenario.

Downside 2 scenario

The Downside 2 scenario features a deep global recession and reflects management's view of the tail of the economic risk distribution. It incorporates the simultaneous crystallisation of a number of risks. The narrative features an escalation in geopolitical

tensions, which leads to further disruptions to supply chains. This creates additional upward pressure on inflation, prompting central banks to keep interest rates higher than in the Central scenario. However, demand subsequently falls sharply and unemployment rises before inflation pressures begin to subside.

The following table describes key macroeconomic variables in the Downside 2 scenario.