The Role of the Institute in Promoting Sound Management

Ladies and gentlemen,

1. I am honoured to be here this evening to deliver the inaugural lecture at the opening of the Institute's new premises. This must be a proud moment for all of those at the Institute who have worked so hard to bring this about. I would like to congratulate the executive committee and its chairman Ron Carstairs, as well as the Institute's CEO, Cecilia Ting, on this great achievement.
2. Special thanks on this occasion must go to Dr Lee Quo-wei for all his work for the Institute since its birth in 1963, originally as an offshoot of the Institute in London. He must feel that these new premises are quite a contrast from the Institute's first home. I understand that these were 578 square feet of rented premises in Central. It must have been quite difficult to fit everybody in! In those early years the finances of the Institute were quite precarious. Indeed during the period 1968-1975 the Institute had to give up its rented premises due to lack of funds. I am glad that the Institute is now on a much firmer footing.
3. These new premises are a far cry from where the Institute started. Regrettably, as Dr Lee has mentioned, the cost of the premises has gone up along with the quality and the size. The rising price of office space in Hong Kong is something about which we should have mixed feelings. Obviously it adds to the cost of doing business in Hong Kong. But looked at from another point of view it is an indicator of Hong Kong's success as an international financial centre. It reflects in part the fact that so many financial institutions have wanted to set up in Hong Kong. The rise of Hong Kong to its present pinnacle of success has coincided with the development of the Institute itself. And I do not think that it is going too far to say that the Institute has played an important part in that success.
4. I say this because of the role the Institute has played in promoting education and training for the banking profession. This effort has the strong support of the Hong Kong Monetary Authority as shown by the presence of Joseph Yam and myself on the Council of the Institute, and K F Li's membership of the Executive Committee.
5. Let me explain more precisely why the HKMA values the work of the Institute:
   • first, as the de facto central bank of Hong Kong, the HKMA has a particular interest in promoting Hong Kong as an international financial centre in accordance with the Basic Law. One of the reasons why financial centres are successful is the availability of an educated and sophisticated work force. As I have already mentioned, the Institute plays an important role in helping to provide this in Hong Kong;
   • second, as an employer, the HKMA itself has an interest in having well-qualified staff. The professional qualifications of the Institute have long been recognized by the HKMA for entry into our bank examiner grade;
   • third, as the banking supervisor of Hong Kong, the HKMA has a strong interest in ensuring that authorized institutions are prudently managed by fit and proper persons. Fitness includes having the necessary professional training of the kind which the Institute can provide.
6. I would like to elaborate on the importance of sound management in banks. This is vital for any company but particularly so for banks. This reflects the fact that banks are in the risk business. It is their task to intermediate between savers and borrowers. This means taking on short-term, capital certain liabilities and transforming these into medium to long term assets which are by no means always capital certain. Unlike other companies, when a bank makes a sale - in other words, puts on a loan - its problems are only just beginning. It must rely on that loan continuing to be serviced through ups and downs in the economy over a period of what may be some years.
7. In the light of this, it is surprising that more loans do not go wrong. As it is, the borderline between success and failure is quite thin in banking. The local banks in Hong Kong are consistently among the most profitable in the world with a post tax return on assets of about 1.8%. But what this means is that the bad debt charge only needs to rise to about 2% of assets for profits to be entirely wiped out. In general, if the bad debt charge rises to over 8%, a bank is on its way to becoming insolvent.
8. Of course, a bank may run out of liquidity long before it runs out of capital. Any hint that a bank has problems may lead to depositors rushing to take out their deposits - for which there are precedents in Hong Kong. This loss of confidence may then spread to other banks by contagion, leading to a full-blown systemic crisis.
9. If this were not enough, globalization of financial markets can lead to contagion from abroad. Loss of confidence in the banking system can lead to a run on the country such as we have seen in the case of Mexico and Thailand. Because markets are now closely interlinked, external shocks can then be transmitted to other financial markets - even those such as Hong Kong whose fundamentals are sound.
10. New financial products such as derivatives can play a part in spreading financial disturbances, for example by making it easier to take on speculative positions. These new products can fundamentally alter the risk profiles of the banks which use them, putting greater pressure on management to measure and monitor the risks.
11. Given the complexities with which they have to grapple, it is not surprising that bank management sometimes get it wrong. Indeed a recent study by the Bank of England of bank failures in the UK concluded that mismanagement was present in 18 out of the 22 two cases considered. This took the form of poor strategy and/or poor systems and controls. This is borne out by the experience of the last banking crisis in Hong Kong during the early 1980s. That crisis took place against an extremely unfavourable macroeconomic and political background which affected all authorized institutions. But I think that it is fair to say that in the case of all the banks that failed at that time, poor management and sometimes even outright fraud were evident. This included insider lending to parties connected with the owners and directors of the failed banks.
12. The current management of banks in Hong Kong is of high quality. The robust profitability of Hong Kong banks and their good asset quality bear this out. But the challenges facing bankers in Hong Kong are undoubtedly going to increase in the post-Handover environment.
13. In one sense, this might seem quite a surprising comment. After all, the run-up to the Handover was as smooth as we dared to hope. There was no attack on the Hong Kong dollar and no capital flight. Since the Handover, the main impression on the minds of most people is how little has changed. While it is early days, confidence in the future is running high. The fall-out from the Thailand crisis has been unsettling, but Hong Kong seems to have emerged largely unscathed.
14. What came to be termed "Hong Kong risk" is therefore now much less of a factor for foreign banks. The basic strengths of Hong Kong now have the chance to shine through. This will be good for Hong Kong as a financial centre. However, it will also mean more competition for the local banks as foreign banks will feel less inhibited about putting on Hong Kong dollar assets. We have already seen the impact of this in the residential mortgage market and in syndicated loans where margins have come down.
15. The local banks are also likely to see more competition coming over the border from the Mainland. More Chinese banks are likely to want to establish presences in Hong Kong. We are also seeing the injection of new capital into locally incorporated banks linked to Mainland entities. This helps to strengthen the capital position of the banks concerned. But one of the side-effects will be to further ratchet up the level of competition in Hong Kong as these banks make use of their greater financial muscle.
16. Some banks have expressed concern to me about the impact on their competitive position from these developments. I understand some of this apprehension. The HKMA is concerned that foreign entry and investment into the Hong Kong market should be conducted in an orderly and prudent manner. However we must remember that Hong Kong is a free market and that being a financial centre imposes obligations in terms of openness. Thus provided that individual banks or investors from outside Hong Kong can satisfy us that they are fit and proper to enter the market here, we cannot impose artificial barriers on their ability to do so.
17. Increased competition for the local banks is therefore a fact of life for the future. In order to cope with this they will need to further sharpen their strategic and management skills. This brings me back to the role of the Institute in helping bankers to develop these skills. The Institute's role will also increasingly develop into providing this training to bankers from the Mainland. This will benefit Hong Kong by helping banks in China to commercialize their activities in a safe and prudent manner. But it will also help Mainland banks to compete more effectively - and as I have already indicated this will include competing with banks from Hong Kong.
18. Local banks cannot therefore afford to be complacent. Neither can individual banking staff in Hong Kong. There is a huge pool of talent on the Mainland and a great thirst for training and qualifications. I have noticed when attending prize-giving ceremonies at the Institute that an increasing number of candidates from the Mainland are being awarded top scores in the Institute's examinations. Hong Kong candidates need to respond to this challenge. I would therefore encourage all those who wish to pursue a successful banking career in Hong Kong to make the maximum use of the facilities provided by the Institute. The need to constantly improve oneself through training and education has never been more important than it is today.
19. Thank you very much.