End-Year Review and Prospects and Priorities for 2003 David Carse Deputy Chief Executive Hong Kong Monetary Authority 28 January 2003

2 Objectives of the presentation Describe the performance of the banks (mainly the retail sector) in 2002 Discuss the prospects for 2003 Outline the HKMA’s general aims and main specific priorities for 2003

3 Capital Adequacy Ratio of All Locally Incorporated Authorized Institutions Note: There is a break in series at end-December 2001 owing to a change in the reporting population. The banking sector remains well capitalized

4 Volume growth for both deposits and loans remained sluggish in 2002 Retail Banks (year-on-year % growth)

5 But previous excess deposit growth has resulted in surplus liquidity which banks have been able to invest profitably Retail Banks Excess liquidity is defined as customer deposits minus customer loans

6 In particular, the banks have invested heavily in higher- yielding debt securities Retail Banks

7 As a result, the net interest margin was slightly higher in 2002, despite some decline in the second half Retail Banks (quarterly annualised) Note: Figure for Q4/02 is provisional.

8 Asset quality has been improving Retail Banks Classified loans as % of total loans Net of specific provisions

9 But rising personal bankruptcies have had an adverse impact on the consumer portfolio Personal Bankruptcy Petitions (quarterly figures)

10 This has shown up particularly in sharply higher charge- offs on credit cards Note: There is a break in series at Q owing to an increase in the number of surveyed institutions. Figures for Q4/02 are up to Nov02 only.

11 Number of Accounts and Total Receivables of Credit Cards Growth in the number of cards and in receivables has slowed No. in million HK$ billion Note: There is a break in series at Q owing to an increase in the number of surveyed institutions. Figures for Q4/02 are up to Nov 02 only.

12 The quality of residential mortgage loans has continued to be good, helped by some restructuring Note: There is a break in series at December 2000 owing to an increase in the number of surveyed institutions.

13 This is despite the fact that the number and amount of loans in negative equity has been increasing

therefore saw a combination of positive and negative factors - reflected in mixed results for the banks Positive factors included –the accrual profits from treasury –the widening of deposit margins –fee income from wealth management –good control of expenses –the absence of corporate bad debts Negative factors included –lack of volume growth –squeeze on lending margins –credit card charge offs

15 Bankers are generally cautious about the outlook for 2003 Volume growth in lending is likely to remain sluggish It may be more difficult to grow treasury profits Continued focus on wealth management initiatives Bankruptcies are likely to remain at a high level But the hope is that credit card charge-offs will be lower than in 2002 This helps to explain why a number of banks are forecasting higher profits for 2003

16 What are the HKMA ’ s general aims for 2003? Continued close monitoring of AIs’ financial position and performance Use of stress tests to pick up early warning signals Continued enhancement of our regulatory framework –recent IMF FSAP assessment confirms that there are no major gaps –but need to keep up with changing local environment and changing international standards

17 What are the HKMA ’ s specific priorities? Focus on non-banking risks –make sure that these do not compromise the reputation and core business of the banks –implement the new securities regime on 1 April –step up monitoring of the banks’ involvement in insurance business Strengthen credit evaluation and monitoring –ensure that banks take full account of borrowers’ total indebtedness –implement CCRA and issue guidelines on sharing of positive consumer data

18 What are the HKMA ’ s specific priorities? Enhance supervision of other types of banking risk, particularly interest rate, liquidity and fx risks Proceed with the DPS to enhance financial stability –working on the draft Bill for introduction into Legco in the next few months –HKMA to administer the Scheme Anti-money laundering and terrorist financing –issue a new Supplement to our Guideline

19 What are the HKMA ’ s specific priorities? New Capital Accord –working to introduce by end 2006 –based on QIS 3, aggregate capital ratio of local banks will fall by about 1.0% under Standardised Approach (SA) –note that IRB Approach will not necessarily result in a lower capital requirement than SA –therefore smaller banks which use SA will not necessarily be worse off –but such banks should still try to enhance their risk management systems, e.g. loan classification