Hong Kong's bank worsening asset quality not yet affecting financial stability but a sign of deeper economic woes

After several years of recession, geopolitical tensions, a downturn in the residential property market, and a transformation of Hong Kong’s economic model, banks are now facing the fastest worsening in asset quality in the last decade. The worries over commercial real estate and the missed repayment of some developers have further worsened sentiment about Hong Kong banks. In this note, we aim to decode the sources and magnitude of the worsening asset quality and draw implications for the Hong Kong economy and financial stability.Highest asset quality pressure over the last decadeDespite the seemingly good growth figures, the overall non-performing loan (NPL) ratio (including gross special mention and classified loans) reached 4.1% in June 2025, higher than 3.9% during the Global Financial Crisis (GFC) in 2007-09 and 2.7% when mainland China last faced the overcapacity problem in 2015-17.No longer a mainland China storyIt is important to note that Hong Kong banks’ asset quality problem is no longer a mainland China story. Between 2015 and 2021, the trends of gross classified loan ratio were similar for mainland China and total lending, standing at 0.89% in end-2021. However, the property crisis in mainland China has lifted the ratio to as high as 2.8% in September 2024 before falling to 2.2% in June 2025. In contrast, total gross classified loan ratio has been increasing gradually to around 2% for the same period. It shows that the present asset quality pressure is a consequence of local factors.Mixed performance in housing marketForming 36% of total loans, Hong Kong’s housing market has so far stabilized in rents but not in housing prices, leading to more negative equity cases at 10% of outstanding residential mortgages in Q2 2025. The mortgage delinquency ratio rose slightly to 0.13% by June 2025, which remains very low though comparable to the level reached during the 2008 global financial crisis (GFC). This low level may be related to the healthier structure of mortgages with longer maturities and lower leverage. Home sales have also picked up after the removal of stamp duties.However, there can be a few challenges. Regarding housing demand, rental yields stabilize at around 3.5%, roughly equal to mortgage rates, which can keep would-be buyers on the sidelines. The talent-scheme inflows have helped stabilize population growth, but the main increase comes from mobile residents. Supply is another headwind as the stock of private units available for sale remains high, doubling the average in 2015-19. Developers may prioritize cashflows and accept lower prices, which could pressure collateral values. If the Hong Kong government decides to increase the number of units massively in the Northern Metropolis, it can also bring a supply shock.Commercial real estate poses the biggest riskCommercial properties accounting for 8% of total loans, can bring more challenges. Hybrid work arrangements, hot desking, and weaker job growth have reduced demand. New completions have lifted vacancy, adding pressure on rents and prices. Retail also faces headwinds, but it is buffered by the more limited supply, more flexible arrangements on rent by landlords and the demand floor from basic goods.Labor market pressure is affecting individualsFor personal loans, which account for at least 11% of total loans, individual bankruptcy petitions and credit card delinquency ratios have moved towards pre-COVID-era levels. The labor market remains soft, despite a seemingly decent GDP growth number, indicating a jobless recovery. Beyond a higher unemployment rate, available jobs were only about 94% of the 2019 level in Q2 2025, with weaker wage growth than its historical average. The good news is Hong Kong households have one of the highest net-worth-to-liabilities ratios globally, indicating a strong capacity to meet debt obligations. However, the uneven wealth and growth distribution means that lower-income and highly leveraged borrowers may still face higher credit risks.More zombie firms show corporate divergenceHong Kong banks have exposure to 16% of total loans in non-property corporates, and the pressure is also mounting. Focusing on Hong Kong-listed firms with assets exceeding $500 million, the post-pandemic recovery in repayment ability (measured by EBITDA-to-interest expense) has diverged from the global average since 2022 driven by the underperformance of real estate developers. The zombie ratio (EBITDA-to-interest expense < 1) has also climbed to well above pre-COVID levels across both property and non-property sectors, highlighting a widening dispersion in corporate health among Hong Kong firms.Economic pressure can affect banks, but not financial stabilityHong Kong's banking sector is navigating tougher asset-quality conditions amid structural macro and geopolitical headwinds during the economic transition. Commercial real estate remains the primary risk, though direct exposures appear manageable. At the same time, pressure is mounting in residential mortgages, consumer credit, and non-property corporate loans, reflecting a disconnect between headline GDP growth and on-the-ground business conditions. In this context, asset-quality stress may be the tip of the iceberg for deeper economic weaknesses, with the possibility of a cyclical uptick in non-performing loans. Even so, Hong Kong's well-capitalized banks have the capacity to absorb the shock, meaning the current development is far from affecting financial stability. Write-offs may dent profitability, but accelerated restructuring should help mitigate the pressure.