Recently, Hong Kong's banking sector has once again been thrust into the spotlight due to reports that some institutions are discussing the establishment of a so-called "bad bank" (equivalent to China's Asset Management Companies, or AMCs) to address the growing problem of non-performing loans. Although the Hong Kong Monetary Authority (HKMA) quickly stepped in to clarify that it has no intention of setting up such a platform and emphasized that the banking system remains sound, there are signs suggesting that the rumors may not be entirely groundless.
According to estimates by Fitch Ratings based on HKMA data, as of the end of March 2025, the total amount of non-performing loans in Hong Kong's banking sector had reached USD 25 billion, accounting for 2% of total loans, the highest level in the past two decades. Fitch further predicts that this ratio may rise to 2.3% by the end of the year, and loan quality could continue to deteriorate into 2026.
In fact, under the pressure of a complex international environment and China’s economic adjustments in recent years, potential risks in Hong Kong’s banking sector have gradually surfaced. Data released by the HKMA shows that by the end of 2024, total real estate loans in Hong Kong’s banking system had reached HKD 3.4 trillion, accounting for about one-third of total lending.
However, Hong Kong's property market peaked back in 2018 and has remained sluggish ever since, impacted by the U.S.-China trade tensions, the COVID-19 pandemic, and the global interest rate hike cycle. Although the extremely loose monetary environment in 2021 briefly boosted property prices, the U.S. Federal Reserve began accelerating rate hikes in 2022. As a result, Hong Kong's benchmark interest rate rose passively, leading to a sudden tightening of financing conditions. This put significant pressure on the capital chains of property developers and strained the cash flow of small and medium-sized enterprises (SMEs), eventually spreading to the banking system and triggering a notable increase in non-performing loan ratios.
The financial reports of several major banks provide a very clear illustration of the situation. Hang Seng Bank released its interim report in late July, revealing that its net profit attributable to shareholders had plummeted by 30.46% in the first half of the year, causing its share price to fall by 6% on the same day. The key reason was the significant credit loss provisions, which reached HKD 4.861 billion, of which HKD 2.54 billion came from bad loans in Hong Kong’s commercial real estate sector. The main issue is oversupply in the office and retail property markets, which has negatively impacted rental income and asset values. This caused its non-performing loan (NPL) ratio in the Hong Kong commercial real estate segment to surge to 20%, up from 15% at the end of 2024, driving its overall NPL ratio up to 6.69%, which was a ten-year high.
In addition, Bank of China (Hong Kong), one of the city’s note-issuing banks, also posted a less-than-optimistic outlook. In the first quarter of this year, the bank’s net impairment provisions reached HKD 1.264 billion, an increase of HKD 381 million year-on-year. Its total loan exposure to non-mainland property developers stood at HKD 250.9 billion, with an NPL ratio of 1.37%, up 1.24 percentage points. The bank explained that the rise in the NPL ratio was mainly due to the downgrade of loans from a few small to mid-sized local property developers in Hong Kong. Xu Haifeng, the bank’s Deputy Chief Executive, explicitly stated that under the prolonged high-interest rate environment, many local small and mid-sized property firms are facing short-term cash flow pressures.
Taken together, these figures clearly indicate that the drag from the property market on the asset quality of Hong Kong’s banking sector should not be underestimated.
Although HKMA Chief Executive Eddie Yue has repeatedly emphasized that Hong Kong’s banking system remains sound, even citing indicators such as the capital adequacy ratio, provision coverage ratio, and overall financial strength, an analysis that includes other relevant indicators reveals another aspect of reality, suggesting that potential risks in the banking sector warrant closer attention.
First, the proportion of Hong Kong's "classified loans", namely Substandard, Doubtful, and Loss categories, has risen to 1.96%. This is not only significantly higher than the 20-year average of 0.93%, but also exceeds the 1.38% recorded during the global financial crisis. This indicates that the level of bad debt in Hong Kong has been accumulating to a relatively high level. Combined with Fitch's forecast that the non-performing loan ratio will rise to 2.3% by year-end, the trend of risk accumulation is becoming increasingly evident.
Secondly, weakening profitability further highlights the pressure facing the banking sector. Historical data show that net interest margin (NIM) and asset quality are the two key variables that determine bank profitability. When asset quality improves and NIM expands, profits can grow rapidly; conversely, when asset quality deteriorates and NIM narrows, profits can experience a sharp decline. For example, in 2024, the ratio of classified loans rose from 1.57% to 1.96%, while NIM narrowed from 1.67% to 1.52%, causing the overall pre-tax operating profit growth of banks to plunge from 62% in 2023 to just 8%. Given that a significant portion of Hong Kong banks’ lending is directed toward the property sector, their asset quality is naturally closely tied to the real estate market. However, even after Hong Kong began cutting its benchmark interest rate in line with the U.S. in 2024 and introduced a series of measures to stimulate the property market, real estate prices have continued to decline. On the other hand, NIM is linked to benchmark interest rates. Since Hong Kong’s monetary policy is pegged to the U.S., and the U.S. is about to enter a rate-cutting cycle, Hong Kong will inevitably follow suit. This means banks’ traditional profit model is being squeezed from both sides: falling interest rates are compressing net interest margins, while a sluggish property market is increasing credit risk.
If Hong Kong’s property market fails to show signs of recovery after interest rate cuts, the challenges facing the city's banking sector will become even more severe. Based on current indications, this possibility is not low. Major developers like New World Development and Emperor International have already reported substantial losses and debt defaults, and more small- and medium-sized developers may follow suit. If a wave of defaults occurs, the banking system’s liquidity and credit resources will come under even greater strain.
Even more concerning is that, according to data from the HKMA, risk indicators for non-financial companies listed in Hong Kong have been deteriorating steadily since 2017 and have now surpassed levels seen during the global financial crisis. At the same time, the leverage ratio of local non-financial firms has continued to rise. This suggests that businesses will become increasingly reliant on financial resources to maintain operations. In other words, risks in the real estate and banking sectors could reinforce each other and eventually spill over into the real economy, potentially evolving into systemic risk.
Overall, while Hong Kong’s banking sector still appears stable on the surface, internal risks are steadily accumulating. The ratio of classified loans has already surpassed levels seen during the global financial crisis, and some major banks face significant exposure to commercial real estate risks. At the same time, profit growth in the sector has slowed considerably. Looking ahead, as the market enters a rate-cutting cycle, banks’ net interest margins are expected to shrink sharply. If the property market continues to decline, the challenges facing the banking sector will become even more severe. Meanwhile, these related risks may spread to the real economy, which means that the regulators and the broader market should pay close attention to this.
Final analysis conclusion:
HKMA Chief Executive Eddie Yue has denied rumors about the establishment of a “bad bank” and maintains that the city's banking system remains sound. However, a review of multiple indicators suggests that potential risks are already beginning to surface. If the economy enters a rate-cutting cycle while the property market continues to decline, Hong Kong’s banking sector could face a dual blow: deteriorating asset quality and shrinking net interest margins. This would significantly compound existing challenges, and the associated risks could spill over into the real economy, potentially leading to systemic risk.
