2006 End-Year Review and Prospects and Priorities for 2007 Hong Kong Monetary Authority 31 January 2007

1 Performance of the banking sector in 2006 (1) Banking system remains sound and profitable Strong deposit growth (16%) outstripped steady loan growth (4%) With liquidity so plentiful, competition has been intense, particularly in the mortgage market Rising costs remain an issue, but new provisions remain low and net interest margins have recovered somewhat Consequently, pre-tax operating profits recorded good growth

2 Performance of the banking sector in 2006 (2) Overall asset quality (good ) –Classified loan ratio –Mortgage delinquency ratio –Credit card charge-off ratio (year-to-date annualised) –No. of negative equity mortgages Average consolidated CAR Net interest margin (annualised) Cost-to-income ratio *Preliminary figures % (Sep 06) 1.37% 0.20% (Dec 06) 0.19% 3.02% (Q3/06) 2.81% 8,800 (Sep 06) 11, % (Sep 06) 14.8% 1.80%* 1.68% 42.7%*41.9%

3 Banking sector issues arising in 2006 –Interest rate environment –High level of liquidity and intensifying price competition –2 major projects enhanced the safety and soundness of the banking system: –Basel II Capital & Disclosure Rules passed –Deposit Protection Scheme successfully introduced Growing wealth management and investment advisory activities Possible outbreak of influenza pandemic Internet disruption caused by Taiwan earthquake

4 Outlook for the banking sector in 2007 Challenges remain due to keen competition and uncertain interest rate environment Risks and challenges –Interest rate and market risks –Implementation of Basel II –AML/CFT Opportunities –Expansion of RMB business –Mainland subsidiarisation –Growth of Hong Kong as an IFC –Wealth management business

5 HKMA priorities for 2007 (1) Basel II initiatives –Capital & Disclosure Rules – working on supplementary guidance –Parallel reporting – indicates implementation proceeding smoothly (effect on CAR: -1%) –IRB validation – half dozen AIs working towards IRB adoption over next few years –Operational risk – formation of a specialist team –Basel II related systems – conduct of technology reviews Lending businesses –Monitor any observable relaxation in AIs’ underwriting criteria due to competitive pressure

6 HKMA priorities for 2007 (2) AML/CFT –Industry Working Group –FATF Mutual Evaluation of Hong Kong - November –Continue on-site examinations and off-site surveillance Mainland related business –Expanded scope of RMB business –Ensure the subsidiarisation and business expansion plan of AIs are implemented properly Enhancing financial sector / regional surveillance Review of Code of Banking Practice

7 HKMA priorities for 2007 (3) Assist the Deposit Protection Board to operate the DPS –Monitor compliance of Scheme members with DPS rules and guidelines –Continuously refine the payout system and procedures –Manage the DPS Fund –Undertake promotional activities to enhance public awareness and understanding of the DPS Licensing –Overseas interests to enter the Hong Kong banking market remain high –Continue to streamline procedures so as to maintain an efficient licensing service without sacrificing prudential standards

8 HKMA priorities for 2007 (4) Securities enforcement concerning AIs –Devote more dedicated resources to securities enforcement matters and related complaints –Implement streamlined disciplinary procedures to enhance efficiency –Continue cooperation with SFC to ensure consistency in enforcement approach

9 Concluding remarks Banking system remains sound but challenges remain due to keen competition and uncertain interest rate environment Risks and challenges: interest rate/market risks; Basel II implementation; exploiting China opportunities; AML/CFT DPS was launched successfully, continued effort is required to enhance its operation and reinforce public confidence in it

2006 End-Year Review and Prospects and Priorities for 2007 Hong Kong Monetary Authority 31 January 2007