The banking sector has performed impressively during the last six very difficult years. The turnaround in the economy has brought some relief. But it also carries challenges and risks.
The number of negative equity bank mortgages has continued to come down in the first quarter, to around 40,000 cases, compared with over 100,000 at the end of June last year, when residential property prices were, we all hope, at a cyclical low point. Indeed, the recent recovery in residential property prices is a welcome change in many respects. The feeling of being stuck with what, ironically, must be, for many, the most "valuable" asset held in their lifetime, at a value that is less than the amount of money borrowed to finance its purchase, is a heavy and depressing one. Even if the ability to service the mortgages is not in doubt for most people, given job security (for most) and very low interest rates, that feeling has affected consumption spending. The occasional indulgence in entertainment - a vacation overseas, a more lavish meal out or a punt on a favourite horse - has been brutally suppressed. A considerable restraint has been put on "consumer therapy", which had been such a common feature of life for relieving stress.
For the bank supervisor, the recovery in property prices has brought tremendous relief, as the asset quality of the banks, in terms of the extent to which mortgage loans are fully secured, has improved. Residential mortgages are by far the largest area to which the banks are exposed in their loan business. Continuous erosion over a period of six years in the value of the security of these loans, amounting to almost 70%, has been quite worrying. This is particularly so when, alongside with this erosion, borrowers have been hit by a slow economy, which has produced the highest unemployment on record in Hong Kong. The influence of the Asian financial crisis, the bursting of the IT bubble and the structural adjustment arising from economic integration with the Mainland have been debilitating for many, and their combined effects have led to a worrying surge in personal bankruptcies. We are therefore pleased to see the continuing decline in personal bankruptcies. The latest number of petitions for bankruptcy in April has for the first time come under 1,000 ever since mid-2001. The banking system has itself been undergoing reform, with increasing competition arising from, among other things, interest rate liberalisation. The banks in Hong Kong have done extremely well. Although the absence of a bank failure, no matter how difficult the environment has been, is not exactly newsworthy, and therefore has understandably gone largely unnoticed, the performance of the banking system of Hong Kong in the past six years is an impressive one by any standards.
But there is no room for complacency. While the familiar risks to banking stability in the recent past have been subsiding, we - the banking supervisor and the banks - should be alert to the possibility of such risks taking other forms, as the economy and the associated markets in which the banks are actively involved turn around. As a general point, the turning points of financial markets - the peaks as well as the troughs - always present larger risks than the other cyclical phases, not least because of the uncertainty in the timing of the turns. As an example, the sudden turn of sentiment in the Hong Kong dollar exchange rate in September last year, from weakness to strength, notwithstanding our strong commitment to stability, came at a time when the banking system was short in the Hong Kong dollar to an unusually large extent. Although this has not been a big issue for those concerned, unwinding a large position that has been proved wrong by the market can be quite costly.
Structural changes in the banking industry, changes in the composition of balance sheets and market pressures for more efficient use of capital have resulted in the average consolidated capital adequacy ratio of the locally incorporated banks falling over the past six years. However, while the current figure of 15.3% is somewhat below that before the financial turmoil, it is still comfortably above the international (and in Hong Kong the statutory) minimum of 8% and the position of banks in many other financial centres. Increasing competition within the banking system, brought about by banking reform, has also compressed margins, as seen in the recent lowering of the net interest margin, to less than 2 percentage points now, with implications for its profitability. What all this means is that the banks in Hong Kong, while still of good health, are lean and hungry, and are keen to jump at lending opportunities, or into other areas of business. It is of course for the banks themselves to run their business. But I am sure the very useful and close dialogue between the banking supervisor and the banks in Hong Kong will continue to enable views on the changing profile of risks to be exchanged and the appropriateness of risk management mechanisms to be discussed.
Joseph Yam
27 May 2004
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