2004 End-Year Review and Prospects and Priorities for 2005

1. 2004 End-Year Review and Prospects and Priorities for 2005 William Ryback Deputy Chief Executive Hong Kong Monetary Authority 2 February 2005

2. Performance of the banking sector in 2004 (1) • Banking system remains in sound condition • Pre-tax operating profits recorded strong growth • lower credit costs through reduction in bad debt charges and credit recoveries, strong treasury gains, increase in non-interest income • partly offset decrease in net interest income and increase in operating expenses • Customer deposits grew by 7.4% • Domestic loans increased by 7.2%

3. Performance of the banking sector in 2004 (2) 20042003 2.67% (Sep 04) 3.94% 0.38% (Dec 04) 0.86% 4.51% (Q3/04) 10.02% 25,400 (Sep 04) 67,600 15.9% (Sep 04) 15.3% 1.65% (Q1-Q3/04) 1.91% 41.6% (Q1-Q3/04) 38.6% • Overall asset quality (good and improving ) • Classified loan ratio • Mortgage delinquency ratio • Credit card charge-off ratio (annualised) • No. of negative equity mortgages • Average consolidated CAR • Net interest margin (annualised) • Cost-to-income ratio

4. Banking sector issues arising in 2004 • RMB business • Interest rate environment • Internet banking frauds • Safe deposit box (control issues / Code of Banking Practice issues) • Risks & Challenges review

5. Outlook for the banking sector in 2005 • Overall - More difficult operating environment in 2005 but banks are resilient to challenges ahead • Profitability • Narrowing interest margins • Continuous cost pressure • More volatile on wider use of fair value accounting • Asset growth - Moderate increase in loan demand • Asset quality - Steady improvement • Risks and challenges • Interest rate and market risks • Implementation of Basel II and new accounting standards • China-related issues • Technology issues • Consumer protection issues

6. HKMA priorities for 2005: banking supervision • Refine the risk-based supervisory approach along the lines of complex institutions, local institutions, Mainland related institutions and foreign institutions under the re-organised Dept. structure • Focus on non-banking risks, such as those associated with securities and insurance activities • Maintain strong emphasis on supervision of e-banking and technology risk management • Continue to monitor and counter Internet banking frauds • Focused examination of key business operations and develop best industry practices • Review CAMEL rating in support of the implementation of DPS

7. HKMA priorities for 2005: banking policy(1) Basel II – revised capital adequacy framework & incentives for improved risk management • Banking (Amendment) Bill 2005 - aim to introduce the Bill into LegCo in Q2/2005 • Development of capital and disclosure rules and related guidance in close consultation with industry • Monitoring of AIs’ implementation plans • Development of validation process • Pillar 2 - developing policy framework for supervisory review • Pillar 3 -continuing discussion on disclosure framework • Liaison with overseas supervisors • discussion of home/host issues arising from cross-border implementation of Basel II • enhance regional supervisory co-operation to facilitate implementation efforts

8. HKMA priorities for 2005: banking policy(2) • Anti money laundering & control of terrorist financing • monitor compliance with and effectiveness of new AML requirements through self-assessment and on-site examination • collaborate with relevant government departments in the drafting of an omnibus bill to put customer due diligence and record-keeping requirements into law • International and Hong Kong Accounting Standards • assessing implications of new standards on regulatory reporting and providing guidance to the industry • Review of Basel Core Principles • leading a drafting team to revise these international standards for banking supervision • Active role in regional supervisory forums (e.g. CPLG and EMEAP)

9. HKMA priorities for 2005: banking development (1) • DPS • Continue to make preparation for the launch of DPS in H2/06 if the external environment at that time permits. Major tasks include : • development of an efficient payout system; and • specification of a set of rules governing the scheme’s operation • CCRA • Monitor the operation as well as AIs’ compliance with the relevant SPM module • Explore extending the coverage to sole proprietorships and partnerships and review the adequacy of information covered in the database

10. HKMA priorities for 2005: banking development (2) • Consumer Issues and Code of Banking Practice • Complete the review of the terms and conditions for other banking services • Promote good banking practices through on-going review of the Code • Monitor AIs’ compliance with the Code • Enforcement Effort concerning AIs’ Securities Business • Ensure that investigation work is handled efficiently • Introduce necessary legislative changes (e.g. specific power to disclose disciplinary actions) and procedural arrangements to ensure a consistent enforcement approach with the SFC

11. Concluding remarks • Banking sector remains strong in terms of capital & asset quality • Risks & challenges: asset growth; increased competition / reducing margins; exploiting China opportunities; increasing interest rates • Areas to enhance: strategic direction; income generation / diversification; risk management; corporate governance / management strength • International standards: regulatory; accounting; risk management • Regional / international cooperation