1. HONG KONG MONETARY AUTHORITY Briefing to the Legislative Council Panel on Financial Affairs 6 February 2006

2. 2 DISCUSSION TOPICS Updates on –Currency Stability –Banking –Financial Infrastructure –Hong Kong as an International Financial Centre –Exchange Fund

3. 3 CURRENCY STABILITY (I)

4. 4 MOVEMENTS IN THE AGGREGATE BALANCE CURRENCY STABILITY (I)

5. 5 HONG KONG DOLLAR AND US DOLLAR INTEREST RATES CURRENCY STABILITY (I)

6. 6 CURRENCY - MARKET EXPECTATIONS 12-month Hong Kong dollar forward points CURRENCY STABILITY (I)

7. 7 MONETARY CONDITIONS Currency Board arrangements working effectively to normalise monetary conditions, particularly after the introduction of the three refinements. Federal funds target rate on an increasing trend; market expects peak in the first half of this year. CURRENCY STABILITY (I)

8. 8 External factors Oil prices Inflation Interest rates External imbalances Renminbi Protectionism Influenza pandemic CURRENCY STABILITY (II)

9. 9 NOMINAL AND REAL OIL PRICES * Simple average of WTI, Dubai and Brent crude oil prices.

10. 10 CURRENCY STABILITY (II)

11. 11 CURRENCY STABILITY (II) US CURRENT ACCOUNT BALANCE, INTEREST RATE SPREADS AND USD EXCHANGE RATES Note: A decrease in exchange rate indices represents depreciation of US dollar and vice versa.

12. 12 CURRENCY STABILITY (II) RENMINBI – MARKET EXPECTATIONS

13. 13 CURRENCY STABILITY (II) RMB exchange rate indices (21 Jul 05 = 100; increase = appreciation)

14. 14 CURRENCY STABILITY (III) Domestic factors Growth and inflation External position Property prices Public finance

15. 15 CURRENCY STABILITY (III) ECONOMIC GROWTH (Seasonally adjusted quarter-on-quarter change)

16. 16 CONSUMER PRICE MOVEMENTS CURRENCY STABILITY (III)

17. 17 CCPI RENTAL COMPONENT CURRENCY STABILITY (III)

18. 18 BALANCE OF PAYMENTS ACCOUNT Current account surplus CURRENCY STABILITY (III)

19. 19 PROPERTY MARKET CURRENCY STABILITY (III)

20. 20 GRAPHICAL ANALYSIS CURRENCY STABILITY (III) * Mortgage payments are based on the latest mortgage interest rates. - - - - For the high-end of the market (2005 Aug-Nov)

21. 21 Net quarterly changes in fiscal placement with the Exchange Fund FISCAL DRAWDOWNS 20002002 2001200320042005 CURRENCY STABILITY (III)

22. 22 BANKING SECTOR PERFORMANCE LOCAL AIs REMAIN WELL CAPITALISED Period-end figures.

23. 23 PROFIT GROWTH (RETAIL BANKS) 2005 2004 Growth in pre-tax operating profit+8.0% +20.9% Bad debt charge as % of -0.01% -0.02% average total assets Cost-to-income ratio 42.0% 41.4% Net interest margin 1.68% 1.66% BANKING SECTOR PERFORMANCE

24. 24 BANKING SECTOR PERFORMANCE NET INTEREST MARGIN (RETAIL BANKS)

25. 25 DIVERSIFICATION OF INCOME SOURCE (RETAIL BANKS) BANKING SECTOR PERFORMANCE

26. 26 DOMESTIC LENDING PICKED UP (RETAIL BANKS) BANKING SECTOR PERFORMANCE Total Domestic lending: +3.9% Trade financing: -2.9% Manufacturing: +0.3% Wholesale/retail: +3.2% Property lending: +2.3%

27. 27 BANKING SECTOR PERFORMANCE CONSUMER BANKING: ASSET QUALITY REMAINS GOOD BUT THERE IS SIGN OF DETERIORATION Credit card delinquency ratio (Sep 05): 0.39% Credit card charge-off ratio (Sep 05): 2.95% Mortgage delinquency ratio (Dec 05): 0.19% Rescheduled mortgage loan ratio (Dec 05): 0.35%

28. 28 BANKING SECTOR PERFORMANCE THE NUMBER OF RESIDENTIAL MORTGAGES IN NEGATIVE EQUITY INCREASED SLIGHTLY Period-end outstanding figures

29. 29 BANKING SECTOR PERFORMANCE * Latest available position: Dec 2005 for RML delinquency ratio & negative equity RMLs; Sep 2005 for other asset quality indicators. RML refers to residential mortgage loan OVERVIEW OF ASSET QUALITY

30. 30 BANKING SECTOR PERFORMANCE LOAN-TO-DEPOSIT RATIO WAS STABLE (RETAIL BANKS)

31. 31 More competitive and challenging environment, particularly for smaller banks Higher interest rates may adversely affect domestic loan demand and asset quality Provisions will rise if asset quality deteriorates Good management of interest rate and market risks is crucial Continuous pressure on profitability Banks’ balance sheets & capital level remain strong BANKING SECTOR - 2006 OUTLOOK

32. 32 Implementation of Basel II in HK: Development of implementation proposals largely complete Continue to work closely with AIs to help prepare them for compliance in 2007 Provisions relating to statutory consultation on draft Capital and Disclosure Rules and establishment of Capital Adequacy Review Tribunal under Banking (Amendment) Ordinance 2005 to take effect later this year BANKING SECTOR - WORK PROGRESS

33. 33 BANKING SECTOR - WORK PROGRESS Capital and Disclosure Rules are being drafted based on earlier implementation proposals Certain parts of the draft Rules have already been released for first-round consultation Second-round consultation will be conducted before the Rules are finalised and submitted to LegCo for negative vetting by end-June 2006

34. 34 Prevention of money laundering AIs’ self-assessment reports – initial review shows that compliance with anti-money laundering (AML) and counter-terrorist financing (CFT) requirements generally satisfactory On-site AML/CFT examination programme – enhancement underway through recruitment of AML consultant and deployment of specialised teams Industry user groups – proposal to form these groups for AIs to share AML/CFT experiences/ techniques, identify implementation issues and devise industry best practices BANKING SECTOR - WORK PROGRESS

35. 35 Continue to assist the Hong Kong Deposit Protection Board in preparing for the launch of the Deposit Protection Scheme (DPS) Progress on key preparatory tasks –Substantially completed drafting the rules governing the operation of the DPS –Testing the payout system for assessing and paying compensation to depositors –Formulated a publicity strategy for launch of the DPS Expect to start collecting contributions and providing deposit protection in the second half of 2006 Plan to brief the Panel in March BANKING SECTOR - DEPOSIT PROTECTION SCHEME

36. 36 BANKING SECTOR - POSITIVE DATA SHARING Two-year moratorium on access for review purposes ended in June 2005 Conducted the first review of the benefits of positive data sharing based on a set of indicators agreed with the Consumer Council Benefits of positive data sharing have emerged clearly –decline in the average amount of bankruptcy indebtedness –shift of credit card rollover balances to cheaper non-card credits

37. 37 20.00 25.00 30.00 35.00 40.00 45.00 Q2/03Q3/03Q4/04Q1/04Q2/04Q3/04Q4/04Q1/05Q2/05 Q3/05 35.92 40.92 25.30 Times of monthly income BANKING SECTOR - POSITIVE DATA SHARING AVERAGE INDEBTEDNESS OF BANKRUPTS IN TERMS OF MONTHLY INCOME Source: Official Receiver’s Office

38. 38 BANKING SECTOR - POSITIVE DATA SHARING Source: Hong Kong Monetary Authority ROLLOVER RATIO OF CREDIT CARD RECEIVABLES

39. 39 BANKING SECTOR - POSITIVE DATA SHARING AGGREGATE AMOUNT OF NON-CARD CREDITS Source: TransUnion Information Services Limited In HK$ 'Bn 29 40 25 30 35 40 Dec-03Jun-04Dec-04Jun-05Dec-05

40. 40 Building Hong Kong’s financial infrastructure on a multi-currency platform to facilitate domestic and international financial intermediation. –Project Development  Migration to SWIFTNet  RMB Settlement System  RTGS Liquidity Optimiser  Bond Price Bulletin  Functional Improvements for Central Moneymarkets Unit (CMU) MARKET INFRASTRUCTURE (I)

41. 41 –Business Development  Expansion of system linkages A link between the Ringgit RTGS system in Malaysia and the US dollar RTGS system in Hong Kong is being implemented  Promotion of system usage MARKET INFRASTRUCTURE (I) (Cont ’ d)

42. 42 Oversight of the clearing and settlement systems –all local designated systems complying with the safety and efficiency requirements of the Clearing and Settlement Systems Ordinance –continued support rendered to the Process Review Committee in preparing the first annual report for submission to FS in due course –information sharing mechanism with major credit card system operators has been enhanced MARKET INFRASTRUCTURE (II)

43. 43 Renminbi business in Hong Kong Outstanding renminbi deposits reached RMB 22.6 billion yuan at the end of December 2005 The following expansion measures have been implementated on 5 December 2005: –widening the definition of “designated merchants” and allowing such to open renminbi deposit accounts; –relaxing daily limits for conversion of renminbi cash and renminbi remittances; and –removing the cap on credit limit for credit cards HONG KONG AS AN INTERNATIONAL FINANCIAL CENTRE (I)

44. 44 Next steps: RMB cheques will be introduced in March 2006 Continuing discussions with Mainland authorities on proposals for using renminbi to settle cross-border trade and issuing renminbi bonds in Hong Kong HONG KONG AS AN INTERNATIONAL FINANCIAL CENTRE (II)

45. 45 Asian Bond Fund 2 (ABF2) 11 EMEAP central banks and monetary authorities, including the HKMA, have invested a total of US$2 billion in ABF2. ABF2 consists of the ABF Pan Asia Bond Index Fund (PAIF) and 8 Single-market Funds. So far, the PAIF and 3 Single-market Funds in Hong Kong, Malaysia and Singapore have been listed. The other funds will be launched in the next few months. The ABF Hong Kong Bond Index Fund and the PAIF were listed in Hong Kong in June and July 2005 respectively, with asset size having grown by 52% and 9% since launch. HONG KONG AS AN INTERNATIONAL FINANCIAL CENTRE (II)

46. 46 EXCHANGE FUND INVESTMENT INCOME * Including dividends 1 Audited figures; 2 Unaudited figures (HK$ billion) I Full Year Q4 2005 2 Q3 Q2 I Q1 2004 1 Full Year Gain / (Loss) on Hong Kong equities*7.0 (2.7)8.15.1(3.5)12.0 Gain / (Loss) on other equities*20.57.910.13.4(0.9)11.2 Exchange gain / (loss) (19.5)(3.4)(2.4)(10.7)(3.0)8.5 Total return from bonds, etc 30.1 5.8 3.215.85.325.0 Investment income38.1 7.619.013.6(2.1)56.7

47. 47 CHANGE IN ACCUMULATED SURPLUS I 2005 2 I2004 1 (HK$ billion) Full Year Q4 Q3 Q2 Q1Full Year Investment income / (loss)38.17.619.013.6(2.1)56.7 Other income 0.20.1 0.00.10.00.2 Interest, other costs and adjustments (8.5) (2.6) (2.2)(1.8)(1.9)(4.8) Net investment income / (loss)29.8 5.116.811.9(4.0)52.1 Treasury’s share (10.0) (2.3)(4.9)(3.5)0.7(14.5) Revaluation gain on premises affecting accumulated surplus 0.0 0.9 Increase / (Decrease) in EF accumulated surplus19.82.811.98.4(3.3)38.5 1 Audited figures; 2 Unaudited figures

48. 48 YEARLY TREASURY SHARE OF THE EXCHANGE FUND INVESTMENT INCOME VS. TREASURY INCOME PROJECTION

49. 49 VERY VOLATILE FOREIGN EXCHANGE MARKETS

50. 50 10-year UST, Bund and JGB yields UST & Bund yield (%) JGB yield (%) 10-year UST yield (LHS) 10-year JGB yield (RHS) 10-year Bund yield (LHS) BOND YIELDS

51. 51 BOND YIELDS 2-year UST, Bund and JGB yields UST & Bund yield (%) JGB yield (%) 2-year UST yield (LHS) 2-year JGB yield (RHS) 2-year Bund yield (LHS)

52. 52 UNCERTAIN OUTLOOK FOR EQUITY MARKETS

53. 53 UNCERTAIN OUTLOOK FOR EQUITY MARKETS