2001 End-Year Review and Prospects and Priorities for 2002

1. 2001 End-Year Reviewand Prospects and Priorities for 2002 David Carse Deputy Chief Executive Hong Kong Monetary Authority 31 January 2002

2. Performance of the banking sector in 2001 • The banking sector remains strong and resilient • But the operating environment in 2001 was challenging: • the weak state of the economy (exacerbated by 9/11) • continued weak loan demand • continued squeezing of margins, particularly on mortgage loans • faster growth in expenses than in income • rise in personal sector bankruptcies • Reflecting this, a number of banks will record lower profits than in 2000

3. Chart 1Post-tax operating profit

4. Chart 2Net interest margin (annualized)

5. Chart 3Growth of customer deposits(year-on-year)

6. Chart 4Growth of loans for use in Hong Kong (year-on-year)

7. Chart 5Cost-income ratio

8. Chart 6Bad debt charge as % of average total assets

9. Chart 7Gross classified loans as % of total loans

10. Chart 8Asset quality of credit cards and mortgage loans (Survey Figures)

11. Chart 9Consolidated capital adequacy ratio of locally incorporated authorized institutions (AIs)

12. Outlook for the banking sector in 2002 • In the absence of major shocks, the forecasts of the banks are generally suggesting: • some growth in lending (albeit modest) • no major pick-up in non-performing commercial loans (although there are concerns about growing consumer loan defaults) • provisions may rise, but upsurge not expected • generally, some profit growth • However, the outlook is very difficult to predict and the scope for variation is more on the downside • The operating environment is unlikely to show much improvement until later in the year

13. Outlook for the banking sector in 2002 (2) • Banks’ strategies are likely to include focusing on: • diversifying income by source and by type • enhancement of asset/liability management • cost-cutting (including relocation of back offices and outsourcing) • developing business in Mainland China • Consolidation will remain an issue for the local banks and is likely to continue

14. HKMA achievements in 2001 (1) • Interest rate deregulation - completed on schedule • Deposit insurance - framework for funding and premium developed • Three building condition -removed • Code of Banking Practice - revised version published • Consumer protection - comparative study of arrangements in HK, UK and Australia published • Banking Amendment Ordinance 2001 - new framework for managers put in place (including new guideline) • New Capital Accord - impact study on HK conducted

15. HKMA achievements in 2001 (2) • Securities and Futures Bill - framework for regulation of “registered institutions” finalised • Financial disclosure - new guidelines published • Money laundering - guidance issued on controls against money laundering and terrorist financing • Supervisory policy manual (SPM) - 30 modules (about half of the total) completed • Negative equity - guideline on LTV ratio issued and statistics collected • Risk based supervision - rolled out to foreign banks

16. HKMA priorities for 2002 • Banking supervision • the conduct of day-to-day supervision through tools such as on-site examinations and off-site reviews • Banking policy • the formulation of supervisory policies (e.g. on capital adequacy) designed to promote the safety and soundness of banks • Banking development • the formulation of policies designed to promote the development of the banking industry (plus specialised supervision of securities business, money laundering and e-banking)

17. Banking supervision: priorities • On-site examination program - focus on asset quality • Risk-based supervision - further develop through the introduction of greater automation and standardisation of work processes and through quality assurance • Securities business, money laundering and e-banking - provide support to the specialised teams • Consolidation process - assist, promote and monitor • Managers - apply the new regime under the Banking Ordinance • Licensing - process possible requests to upgrade from RLB to licensed bank under new market entry regime

18. Banking policy: priorities • New Capital Accord - participate in the next consultation and further develop plans for implementation in HK • Loan classification system - review in the light of the New Accord • Other supervisory policies (e.g. interest rate risk) - prepare new or revised guidelines for inclusion in SPM • Basel Core Principles - complete second review of Hong Kong’s compliance • Property market - monitor developments, including trends in negative equity • Review of statistical returns - aim to reduce reporting burden

19. Banking development: priorities • DIS - final consultation paper in Q1 and draft Bill in Q4 • Market entry criteria - implement proposals taking account of response to consultation • Sharing of personal credit data - work with the banks, Privacy Commissioner and Consumer Council to develop an acceptable framework • CCRA - aim to implement a voluntary scheme • Consumer protection - monitor compliance with the revised Code of Banking Practice and participate in the new COBP Committee

20. Specialised supervision: priorities • Securities business - begin to implement the new regime under the Securities and Futures Bill • Money laundering - conduct in-depth examinations, participate in fight against terrorist financing and revise guideline • E-banking - conduct in-depth examinations and prepare guidelines on e-banking issues and on business continuity planning (including lessons learned from 9/11)

21. Closing remarks • All the market reform measures embarked upon in 1999 have been addressed one way or another - as a result, the banking industry is now more free and competitive than before • But, as indicated earlier, we still have a lot to keep us occupied and we have to be alert to new challenges that may arise • Apart from the specific priorities mentioned, an underlying objective will be to try to improve our own processes so as to provide top quality supervision in as cost-effective a manner as possible