2004 End-Year Review and Prospects and Priorities for 2005 William Ryback Deputy Chief Executive Hong Kong Monetary Authority 2 February 2005

1 Performance of the banking sector in 2004 (1) Banking system remains in sound condition Pre-tax operating profits recorded strong growth –lower credit costs through reduction in bad debt charges and credit recoveries, strong treasury gains, increase in non-interest income –partly offset decrease in net interest income and increase in operating expenses Customer deposits grew by 7.4% Domestic loans increased by 7.2%

2 Performance of the banking sector in 2004 (2) Overall asset quality (good and improving ) –Classified loan ratio –Mortgage delinquency ratio –Credit card charge-off ratio (annualised) –No. of negative equity mortgages Average consolidated CAR Net interest margin (annualised) Cost-to-income ratio % (Sep 04) 3.94% 0.38% (Dec 04) 0.86% 4.51% (Q3/04) 10.02% 25,400 (Sep 04) 67, % (Sep 04) 15.3% 1.65% (Q1-Q3/04) 1.91% 41.6% (Q1-Q3/04) 38.6%

3 Banking sector issues arising in 2004 RMB business Interest rate environment Internet banking frauds Safe deposit box (control issues / Code of Banking Practice issues) Risks & Challenges review

4 Outlook for the banking sector in 2005 Overall - More difficult operating environment in 2005 but banks are resilient to challenges ahead Profitability –Narrowing interest margins –Continuous cost pressure –More volatile on wider use of fair value accounting Asset growth - Moderate increase in loan demand Asset quality - Steady improvement Risks and challenges –Interest rate and market risks –Implementation of Basel II and new accounting standards –China-related issues –Technology issues –Consumer protection issues

5 HKMA priorities for 2005: banking supervision Refine the risk-based supervisory approach along the lines of complex institutions, local institutions, Mainland related institutions and foreign institutions under the re-organised Dept. structure Focus on non-banking risks, such as those associated with securities and insurance activities Maintain strong emphasis on supervision of e-banking and technology risk management Continue to monitor and counter Internet banking frauds Focused examination of key business operations and develop best industry practices Review CAMEL rating in support of the implementation of DPS

6 HKMA priorities for 2005: banking policy(1) Banking (Amendment) Bill aim to introduce the Bill into LegCo in Q2/2005 Development of capital and disclosure rules and related guidance in close consultation with industry Monitoring of AIs’ implementation plans Development of validation process Pillar 2 - developing policy framework for supervisory review Pillar 3 -continuing discussion on disclosure framework Liaison with overseas supervisors –discussion of home/host issues arising from cross-border implementation of Basel II –enhance regional supervisory co-operation to facilitate implementation efforts Basel II – revised capital adequacy framework & incentives for improved risk management

7 HKMA priorities for 2005: banking policy(2) Anti money laundering & control of terrorist financing –monitor compliance with and effectiveness of new AML requirements through self-assessment and on-site examination –collaborate with relevant government departments in the drafting of an omnibus bill to put customer due diligence and record-keeping requirements into law International and Hong Kong Accounting Standards –assessing implications of new standards on regulatory reporting and providing guidance to the industry Review of Basel Core Principles –leading a drafting team to revise these international standards for banking supervision Active role in regional supervisory forums (e.g. CPLG and EMEAP)

8 HKMA priorities for 2005: banking development (1) DPS  Continue to make preparation for the launch of DPS in H2/06 if the external environment at that time permits. Major tasks include : development of an efficient payout system; and specification of a set of rules governing the scheme’s operation CCRA  Monitor the operation as well as AIs’ compliance with the relevant SPM module  Explore extending the coverage to sole proprietorships and partnerships and review the adequacy of information covered in the database

9 HKMA priorities for 2005: banking development (2) Consumer Issues and Code of Banking Practice  Complete the review of the terms and conditions for other banking services  Promote good banking practices through on-going review of the Code  Monitor AIs’ compliance with the Code Enforcement Effort concerning AIs’ Securities Business –Ensure that investigation work is handled efficiently –Introduce necessary legislative changes (e.g. specific power to disclose disciplinary actions) and procedural arrangements to ensure a consistent enforcement approach with the SFC

10 Concluding remarks Banking sector remains strong in terms of capital & asset quality Risks & challenges: asset growth; increased competition / reducing margins; exploiting China opportunities; increasing interest rates Areas to enhance: strategic direction; income generation / diversification; risk management; corporate governance / management strength International standards: regulatory; accounting; risk management Regional / international cooperation