Hong Kong’s $32 billion pile of bad debt spurs talks to form ‘bad bank’

HONG KONG – The pile of non-performing loans at Hong Kong lenders has grown so large that some in the industry have discussed the creation of a “bad bank” to soak up the financial hub’s soured debt.

The talks between some of the city’s biggest banks, described by people familiar with the matter, have been preliminary, and lenders would face significant hurdles before putting the idea into action.

Yet the discussions underline growing concern among industry insiders over a bad loan build-up.

Soured loans increased to US$25 billion (S$32 billion) at the end of March, or 2 per cent of the total and a two-decade high, Fitch Ratings estimated, based on Hong Kong Monetary Authority (HKMA) figures.

This may climb to 2.3 per cent by year-end, the biggest jump in the Asia-Pacific region, and loan quality is likely to deteriorate further in 2026, according to the ratings company.

Hong Kong’s banks are coming under increasing pressure to offload loans backed by real estate assets after rolling them over or amending the original terms in the past to avoid write-downs.

The delay by some banks in recognising impairments has helped mask even weaker underlying asset quality.

“We should be seeing more distressed sales – it’s a little alarming that we’re not,” said Mr Jason Bedford, a former UBS Group analyst who made a name for predicting the troubles that hit Chinese regional banks in 2019.

Lenders, including Hang Seng Bank and Bank of Communications, recently engaged with advisory firms and held early-stage discussions about setting up a special vehicle to take their bad debt, people familiar with the matter said.

One of the proposed entities is modelled after China’s distressed asset managers and could allow banks to recoup at least a portion of the loans, said the people. It is unclear how much traction the proposal has received among banks and Hong Kong regulators.

Hong Kong also narrowly averted a deeper crisis in June as banks, after tense negotiations, agreed to a record US$11 billion refinancing for troubled developer New World Development.

Political and economic turmoil over the past few years has shaken the city’s real estate sector, where office vacancies are surging to a record.

“There’s too much supply of commercial real estate, particularly office space, hence we continue to see Hong Kong banks’ asset quality deterioration stemming from the sector this year,” said Fitch analyst Savio Fan.

Still, the HKMA said the banking sector’s overall asset quality “is manageable and provisions remain sufficient” even as its bad loan ratio edged up.

The total capital ratio of locally incorporated banks stood at 24.2 per cent at the end of March, while the average liquidity coverage ratio of the major banks was 182.5 per cent, far above international minimum requirements, according to the HKMA.

While Fitch predicts loan quality will continue to deteriorate, it has said the situation is manageable given that lenders have large buffers. 

Hang Seng’s credit-impaired gross loans surged to HK$19.8 billion (S$3.2 billion) at the end of 2024, up from HK$1.08 billion a year ago. Impairments at Dah Sing Banking Group, whose unit was downgraded by Moody’s Investors Service in June, more than doubled to HK$1.79 billion in 2024.

The city’s largest bank, HSBC Holdings, had US$33.2 billion of exposure to Hong Kong commercial real estate at December 2024, of which about US$4.6 billion was credit-impaired.

While the valuation of commercial real estate in Hong Kong has likely fallen more than 50 per cent in the last few years, it has not “really declined a lot” on property company and bank books since there have been few transactions, according to Mr Cusson Leung, chief investment officer at KGI Asia.

“It’s a big dilemma for both the developers and the banks,” said Mr Leung. “If a bank forces the sale of a commercial property at a 50 per cent discount, it would have implications on the valuations of other buildings and collateral and, under the current poor market sentiment towards commercial real estate, this could have undesirable consequences.”

In the first half of 2025, HK$2.9 billion, or 20 per cent, out of a total of HK$14.8 billion in transactions of mortgage sales and assets were sold at a capital loss, according to data from Colliers International.

The HKMA said it monitors that banks have “appropriate and timely loan classification and provisioning at all times” and subjects them to independent validation by external auditors.

The lenders are now at risk of taking a hit on their lending income as well, as the Hong Kong Interbank Offered Rate (Hibor), a benchmark for loan rates, has collapsed. One-month Hibor slumped to 1.1 per cent from 4.6 per cent at the end of 2024, according to Bloomberg-compiled data. Corporate lending has also been weak. 

Fitch’s Mr Fan said he “definitely sees some pressure” on net interest margins due to the drop in Hibor, but at the same time, fee income looks “quite strong” from wealth management. 

For Mr Bedford, the situation for Hong Kong lenders is different from that of the troubled regional Chinese banks, which were using special-purpose vehicles to intentionally hide bad loans.

Financial disclosures in Hong Kong have always been very “market-based”, he said. 

Ultimately, though, banks are trying to maintain the mark-to-market value of their property so they do not take huge impairment losses, he said, adding that there is a “structural incentive” not to do anything that will create an immediate change to valuations. 

“Hong Kong banks are going through a very textbook credit cycle,” said Mr Bedford. “Non-performing loans are going up, loan growth stalls, banks start to increase risk scoring standards and the economy slows.” BLOOMBERG