Hong Kong Banking Sector: 2008 Review and Priorities for 2009

1. Hong Kong Banking Sector:2008 End-Year Review and Prospects and Priorities for 2009 Hong Kong Monetary Authority 13 February 2009

2. Performance of the Banking Sector in 2008 (1) 20082007 0.96% (Sep 08) 0.85% 0.05% (Dec 08) 0.11% 2.72% (2008) 2.90% 10,949 (Dec 08) 1,861 13.8% (Sep 08) 13.4% 45.0% (Q4 08) 51.9% 69.4% (Dec 08) 65.1% 1.84% (2008) 1.90% 45.2% (2008) 40.5% • Overall asset quality • Classified loan ratio (retail banks) • Mortgage delinquency ratio • Credit card charge-off ratio • No. of negative equity mortgages • Average consolidated CAR • Liquidity ratio (quarterly average) • HK$ loan-to-deposit ratio • Net interest margin • Cost-to-income ratio

3. Performance of the Banking Sector in 2008 (2)

4. Performance of the Banking Sector in 2008 (3) • Profitability of the banking sector in 2008 was affected by the global financial crisis • impairment charges for loans and securities investments increased significantly • net interest margin narrowed • fees and commissions income declined • operating costs increased

5. Banking Sector Issues Arising in 2008 (1) • Global Financial Crisis (Jan – Sept 2008) • ensuring prudent valuation and adequate impairment charge • promoting sound liquidity risk management • encouraging adoption of leading disclosure practices • sharing of observations on sound risk management practices

6. Banking Sector Issues Arising in 2008 (2) • Global Financial Crisis (Sept – Dec 2008) • created easy monetary conditions • urged banks to continue their support for SMEs • introduced deposit guarantee • established contingent bank capital facility (CBCF) • reminded banks to remain prudent to address the “moral hazard” of the deposit guarantee and CBCF • adopted a flexible approach to CAR

7. Banking Supervision – Priorities for 2009 Banking Supervision – Priorities for 2009 • Key supervisory focus in light of financial crisis • Step up monitoring of AIs’ asset quality, trend of problem loans and fall in value of securities portfolio • Ensure effective capital management and planning process • Step up monitoring of AIs’ liquidity position and quality of liquid assets • Close monitoring of AIs’ internal stress test programmes

8. Banking Supervision – Implementation of LehmanReport Recommendations • Working with the SFC, make appropriate enhancements to supervisory approach for banks’ securities business • Jointly with the SFC, consult market on some of the longer-term recommendations • Monitor banks’ implementation of new regulatory requirements • Strengthen supervisory resources and step-up supervision work • Enhance monitoring of banks’ securities business

9. Other Supervisory Initiatives for 2009 • To establish a dedicated division to enhance the surveillance of financial markets and treasury activities of AIs • To continue specialisation of supervisory resources in major risk areas, amid the increasing complexity of AIs’ operations • To carry on other routine supervisory activities focusing on the emerging risks of AIs • Basel II implementation, risk-based examinations, thematic reviews (e.g., RMB, credit risk) and specialised examinations (e.g. treasury, technology and operational risks)

10. Banking Policy – Developments in 2008 Major Work in 2007 • Capital Adequacy • monitoring and assessment of Basel II implementation • refinements to supervisory review process • Liquidity Risk Management • BCBS Principles for Sound Liquidity Risk Management and Supervision • review of existing liquidity risk supervisory framework • AML/CFT • FATF Mutual Evaluation • Supervisory guidance

11. Banking Policy – Priorities for 2009 Major Work in 2007 • Capital Adequacy • Basel II framework • Liquidity Risk Management • Continued review of liquidity regime • Review of the HKMA’s Work on Banking Stability • Policy response and implementation plan • AML/CFT • FATF Mutual Evaluation follow-up

12. Banking Development – Developments in 2008 (1) Banking Development - Key achievements in 2007 (1) • Securities Enforcement – Lehman • Received 19,760 Lehman-related complaints, of which 18,274 cases have gone through preliminary assessment • Implemented an expedited process to facilitate the SFC top-down investigation, with the first batch of 24 cases referred to the SFC in mid-October • Opened investigations on 4,584 Lehman-related complaints, of which 238 cases involving 12 banks were referred to the SFC for further action • Deployed over 200 staff (existing staff and secondees from external audit firms) to handle the Lehman-related complaints

13. Banking Development – Developments in 2008 (2) Banking Development - Key achievements in 2007 (1) • Securities Enforcement – Others • Received 88 cases with potential grounds for discipline (including 45 accumulator-related cases): preliminary assessment done on 67 cases (including 35 accumulator-related cases), of which 14 cases were opened for investigation (including four accumulator-related cases) • Completed investigations into five cases: one resulted in disciplinary proceedings while the other four cases were found to be without sufficient grounds • A registered institution and two former individuals were disciplined by the SFC as a result of the HKMA’s investigations/recommendations

14. Banking Development - Key achievements in 2007 (3) Deposit Protection Assisted the Deposit Protection Board in implementing the Deposit Protection Scheme (DPS) implemented a number of mechanisms for monitoring Scheme members’ compliance with DPS rules and guidelines conducted simulation tests and a payout rehearsal to enhance the readiness of the DPS to payout maintained public awareness and enhanced understanding of the DPS developed a project plan for reviewing the coverage of the DPS and commenced conducting the review Issued guidelines to AIs to ensure proper representations are made by them in respect of the protection status of their products under the full deposit guarantee Banking Development –Developments in 2008 (3) 13

15. Banking Development – Priorities for 2009 (1) Banking Development - Priorities for 2008 • Securities Enforcement • Continue to deal with Lehman related complaints. Specifically : • co-operate closely with the SFC to ensure an effective and efficient enforcement process • continue to refer complaints to the SFC to facilitate its top-down investigations of RIs (authority to discipline RIs rests with the SFC) • continue to investigate into potential misconduct on the part of individuals with a view to administering appropriate sanctions

16. Banking Development – Priorities for 2009 (2) Banking Development - Priorities for 2008 • Deposit Protection • Continue to assist the Hong Kong Deposit Protection Board to operate the Deposit Protection Scheme (DPS) : • enhance payout readiness through simulation tests and payout rehearsals • undertake on-going publicity to maintain and enhance public awareness and understanding of the DPS • ensure compliance with DPS rules and guidelines, e.g. representation rules • Conduct consultation on enhancement of DPS : • develop proposals within Q1 • issue consultation paper in early Q2 • topics to be covered: protection limit and membership, and if possible, product coverage and payment basis

17. Concluding Remarks Major Work in 2007 • Banking system remains robust but 2009 will be very challenging • AIs should remain prudent in credit assessment, but should not cut credit indiscriminately • Further refinement to regulatory framework in light of lessons learned from the financial crisis • Continued focus on conduct of securities business • Review of Deposit Protection Scheme