1. Briefing to the Legislative Council Panel on Financial Affairs 4 February 2002 HONG KONG MONETARY AUTHORITY

2. DISCUSSION TOPICS Currency Banking Financial Infrastructure Exchange Fund 2

3. CURRENCY STABILITY - FACTS 1999 2000 1998 2001 HK - US interest rate differential (1 month) (RHS) Exchange rate (LHS) 3

4. Yen weakness and implications for regional currencies and RMB exchange rate Debt crisis in Argentina Hong Kong markets used as proxy hedge against Asian risks Public finances in Hong Kong Support for, and confidence, in the Link CURRENCY STABILITY - RISKS 4

5. 12-month Hong Kong dollar forward points 1997 1998 1999 2000 2001 CURRENCY - MARKET EXPECTATIONS 5

6. 12-month Hong Kong dollar forward points Sino-US tensions / yen Argentina / rumours about the Link Argentina / yen 6

7. CURRENCY - RISKS OF YEN WEAKNESS 80 85 90 95 100 105 110 115 120 125 130 135 SepOctNovDecJan 1 Sep 2001=100 80 85 90 95 100 105 110 115 120 125 130 135 Thai baht Philippine peso Indonesian rupiah Korean won Japanese yen 2001 7

8. CURRENCY - MARKET EXPECTATIONS ON RMB -500 0 500 1000 1500 2000 2500 3000 JanFebMarAprMayJunJulAugSepOctNovDecJan pips -500 0 500 1000 1500 2000 2500 3000 pips RMB 12-month forward HK dollar 12-month forward 2001 8

9. CURRENCY - RISKS OF ARGENTINEAN DEBT CRISIS JanFeb MarAprMayJunJulAugSepOctNovDecJan pips 12-month Argentinean peso forward (LHS) 12-month HK dollar forward (RHS) 2001 pips 0 10000 25000 20000 15000 0 5000 -500 500 9

10. BANKING SECTOR PERFORMANCE Capital adequacy ratio 1 :18.30% (Sep 01) 18.00% (Jun 01) Liquidity ratio 2 :51.38% (Sep 01) 52.47% (Jun 01) Net interest margin 2 :2.12% (Q3 annualised) 2.17% (Q2 annualised) Classified loans 2 :6.44% (Sep 01) 6.81% (Jun 01) Mortgage delinquency ratio 3 :1.22% (Dec 01) 1.28% (Sep 01) Credit card - charge-off ratio 3 :5.97% (Oct/Nov annualised) 4.75% (Q3 annualised) Growth of total HK dollar deposits 4 :0.10% (Q4) 0.30% (Q3) Growth of total domestic lending 4 :-1.30% (Q4) -1.70% (Q3) 1Locally-incorporated AIs 2Locally-incorporated banks 3Surveyed AIs (29 for RMLs, 23 for credit cards) 4All AIs 10

11. BANKING - EFFICIENCY AND COMPETITION Commercial Credit Reference Agency Positive consumer credit data Review of market entry criteria Banking consumer protection 11

12. BANKING - SAFETY AND SOUNDNESS Deposit Insurance Scheme Bank consolidation New Capital Accord Mortgage loans in negative equity 12

13. FINANCIAL INFRASTRUCTURE Objective: reinforce Hong Kong’s role as an International Financial Centre Our competitive advantage: a financial infrastructure in which financial intermediation and other financial transactions can be conducted safely and efficiently Domestic financial activities International financial activities Mainland / Hong Kong financial activities 13

14. FINANCIAL INFRASTRUCTURE FOR DOMESTIC FINANCIAL ACTIVITIES Debt market development – expansion of market size and promotion of retail investor base Retail payment systems – self regulatory approach; preparation of industry codes of practices; monitoring e-money development Integration of payment, clearing and settlement systems for money, debt securities, equities and their derivatives to enhance liquidity and promote real time DvP 14

15. FINANCIAL INFRASTRUCTURE FOR INTERNATIONAL FINANCIAL ACTIVITIES Promotion of US dollar RTGS in the region Proposal to develop a RTGS system for euro and yen International linkages of payment systems Promotion of international linkages of debt clearing systems 15

16. FINANCIAL INFRASTRUCTURE FOR INTERNATIONAL FINANCIAL ACTIVITIES Rising turnover Hong Kong and regional membership First ever PvP transaction was done in Hong Kong on 25 September 2000 between HK dollar and US dollar 0 1,000 2,000 3,000 4,000 5,000 6,000 Aug- 00 Sep- 00 Oct- 00 Nov- 00 Dec- 00 Jan- 01 Feb- 01 Mar- 01 Apr- 01 May- 01 Jun- 01 Jul- 01 Aug- 01 Sep- 01 Oct- 01 Nov- 01 Dec- 01 0 500 1,000 1,500 2,000 2,500 3,000 3,500 in US $ Mn Value No. of transactions Month US$ RTGS  Over US$5 bn daily Of which PvP (US$ / HK$)  Over US$2 bn daily US dollar RTGS turnover (daily average) 16

17. FINANCIAL INFRASTRUCTURE FOR MAINLAND / HONG KONG FINANCIAL ACTIVITIES Warrants special attention because of exchange controls and non-convertible currency in the Mainland, and rapid liberalisation Objective 1: greater use of Hong Kong for the Mainland’s international financial activities Objective 2: address asymmetric mobility of capital by developing appropriate channels to facilitate cross-border flow of funds 17

18. MAINLAND / HONG KONG FINANCIAL ACTIVITIES – INITIATIVES Location of international treasury operation of Mainland banks in Hong Kong Joint cheque clearing between Guangdong and Hong Kong Linkages in debt clearing systems Linkages in payment systems 18

19. EXCHANGE FUND PERFORMANCE 200120001999 (HK$ billion) Gain / (Loss) on HK equities*(27.1) (7.3)96.5 Gain / (Loss) on other equities*(3.2) 0.5 3.8 Exchange gain / (loss)(13.1) (11.2)(9.9) Total return from bonds, etc 50.4 63.1 13.4 Investment income7.0 45.1 103.8 * including dividends 19

20. EXCHANGE FUND INVESTMENT BENCHMARK Bonds80% Equities20% (Hong Kong : 5%) Currencies80% US dollar bloc 15% European bloc 5% Yen 20

21. EXCHANGE FUND PERFORMANCE AGAINST BENCHMARK * Preliminary, unaudited figures for 2001 21

22. INVESTMENT PERFORMANCE OF EXCHANGE FUND AND COMPARABLE BALANCED FUNDS Balanced Funds with 20% - 30% Equity Component Source: Watson Wyatt and Standard & Poor’s 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% -6% -8%  10.8% 4.8%   0.7%  Exchange Fund Return 19992000 2001 22

23. EXCHANGE FUND HISTORICAL RETURN # Hong Kong CPI-A at end-November 2001 23

24. EXCHANGE FUND ABRIDGED BALANCE SHEET (HK$ billion ) 2001 2000 Change ASSETS Deposits98.673.125.5 Debt securities733.3729.83.5 Hong Kong equities85.9152.9(67.0) Other equities35.340.6(5.3) Other assets27.527.00.5 Total assets980.61,023.4(42.8) LIABILITIES AND ACCUMULATED SURPLUS Certificates of Indebtedness107.599.28.3 Coins in circulation5.75.9(0.2) Balance of banking system0.70.7 - Exchange Fund Bills and Notes118.2109.38.9 Placements by other HKSAR government funds380.6417.2(36.6) Other liabilities65.284.0(18.8) Total liabilities677.9716.3(38.4) Accumulated surplus302.7307.1(4.4) Total liabilities and accumulated surplus980.61,023.4(42.8) 24

25. EXCHANGE FUND CHANGE IN ACCUMULATED SURPLUS I 2001 I2000 (HK$ billion) Full year Q1 Q2 Q3 Q4 Full year Investment income/(loss)7.0 (14.6) (2.0) 10.4 13.2 45.1 Other income0.2 0.1 0.0 0.1 0.0 0.2 Interest and expenses(9.9) (2.8) (2.8) (2.3)(2.0)(11.0) Net investment income/(loss)(2.7) (17.3) (4.8) 8.211.2 34.3 Treasury’s share(1.7)6.1 1.0* (4.0)*(4.8)*(18.1) Increase/(Decrease) in EF accumulated surplus (4.4)(11.2) (3.8) 4.2 6.4 16.2 *Treasury’s share in the first three quarters of financial year 2001-02 : HK$7.8 billion. 25

26. (HK$ billion) Investment in August 1998118.1 Income from Disposal and Dividends (end-Dec 2001)139.9 Size of remaining portfolio (end-Dec 2001)85.9 Disposal36.9 Long Term Investment*49.0 *Including Hong Kong equities transferred from the Land Fund in 1998 (valued at HK$9 billion in 1998). EXCHANGE FUND HONG KONG EQUITY PORTFOLIO 26

27. Briefing to the Legislative Council Panel on Financial Affairs 4 February 2002 HONG KONG MONETARY AUTHORITY 27