1 Hong Kong Banking Sector: End-Year Review Hong Kong Monetary Authority 21 January 2000

2 Main tasks in 1999 Preparations for Y2K Monitoring of asset quality –two rounds of examination of local banks –refinement of guidelines for loan classification and provisioning Involvement in corporate workouts –helping to revise the Hong Kong Approach –arbitration in some problem cases –monitoring of progress on GDE and other Mainland-related cases

3 Main tasks in 1999 (2) Development of our Policy Response to the Banking Sector Consultancy Study Enactment of the 1999 Banking Amendment Ordinance

4 Balance sheet developments Banks have plentiful liquidity due to –continuing growth in deposits (+8.2% yoy to Nov 99) –continued decline in domestic loans (-8.7% yoy to Nov 99) Part of the excess liquidity has gone into increased holdings of HK$ debt securities and foreign currency assets As the economic recovery gathers pace, domestic lending should also revive –the increase in Nov 99 is the first sign of this

5 Margins The excess liquidity is putting downward pressure on lending margins, particularly on residential mortgages But it also has a beneficial impact on funding costs –spreads between BLR and short-term rates are back above pre-crisis levels (currently 468 bp for the one- month deposit rate) However, in setting the lending margins on long-term loans, banks need to beware of the risk that funding costs may rise

6 Asset quality The available statistics and feedback from the banks suggest that NPLs are near their peak There are signs of improvement in particular sectors like credit cards and taxi loans The GDE settlement should improve sentiment in relation to Mainland credits Further bad debt provisions will arise from the downgrading of existing NPLs But the banks generally expect the bad debt charge to be significantly lower in 2000

7 Profitability of local banks It is difficult to generalize about the outturn for 1999 because of wide variations in the performance of individual banks In aggregate, pre-provision operating profits are expected to have improved in 1999 due to –growth in average interest-bearing assets –maintenance of the net interest margin (reflecting lower funding costs) –reduction in operating expenses

8 Profitability of local banks (2) There has also been some moderation in the growth of the aggregate bad debt charge compared with 1998 But some banks have continued to see sharp increases in provisions in 1999 Looking ahead to 2000, the banks are generally expecting recovery in profits This is largely driven by the expected reduction in the bad debt charge in 2000

9 Work priorities in 2000 Implement recommendations of the Consultancy Study –study on deposit protection in H1 –study on credit register in H1 –review in H1 whether safe to proceed with first stage of interest rate deregulation on 1 July –review three-tier structure in H2

10 Study on deposit protection The first stage of the study will consist of a report by external consultants The aim is to try to appoint the consultants and for them to start work before the end of March 2000 We hope that the work of the consultants can be completed by end-June We would then study their conclusions and, subject to Exco’s approval, publish a set of proposals for wider consultation by end-Sept

11 The objectives of the consultancy study on deposit protection To make recommendations on the most appropriate features of a deposit insurance scheme for HK if such a scheme were to be introduced (which has not been decided) To identify and evaluate viable alternative means of deposit protection (such as enhancing the existing priority claims scheme in the Companies Ordinance)

12 The objectives of the consultancy study on deposit protection (2) To consider the relative costs and benefits of –deposit insurance –alternative means of deposit protection –maintenance of the status quo (ie no change) To produce a set of recommendations on which of the possible options (including no change) would best meet the needs of the HK banking system and its depositors To outline the action steps needed to implement any recommendations for change

13 Work priorities in 2000 (2) Finalize guideline on corporate governance Implement risk-based supervisory approach (including review of supervisory policies) Develop policy on, and enhance supervision of, e-banking –try to recruit IT specialists to form an examination team –reconvene the HKMA’s Study Group on Electronic Banking –issue further guidelines on e-banking issues

14 Work priorities in 2000 (3) Finalize arrangements for supervision of exempt dealers –HKMA will remain the front-line regulator for exempt dealers and will devote more resources to the supervision of these (three teams of examiners) –exempt AIs will be subject to broadly the same regulatory standards as licensed intermediaries –some of these will be applied through the new Securities and Futures Bill and some through the Banking Ordinance (amended as necessary) –a revised MoU will be signed with the SFC

15 Other issues for 2000 Monitor progress on consolidation Continue to monitor banks’ asset quality Supervision of banks’ MPF business Review policies on money laundering and conduct selective on-site examinations Review and update Code of Banking Practice Continue to enhance financial disclosure by banks Participate in the development of the new Basel Capital Accord