Banking and operational risk

inSight

09 Dec 2004

Banking and operational risk

An improving economy and the recovery in loan demand give banks the opportunity, and the resources, to conduct comprehensive reviews to identify and control operational risk.

Competition among banks in Hong Kong has been keen in recent years. This is largely attributable to the earlier, phased abolition of Interest Rate Rules of the Hong Kong Association of Banks and sluggish loan demand after the Asian financial crisis. With the greater use of information technology, this deregulation has been highly beneficial to the efficiency of banks in delivering services. It has also benefited borrowers. One clear measurement of the benefit to borrowers is the reduction in mortgage rates. Before the abolition of the Interest Rate Rules, mortgage rates were priced at about 1.5% above the best lending rate. This was still the case at the height of the property bubble in the second half of 1997, even though a large part of the Interest Rate Rules had been abolished by then: no doubt the significant speculative element in the demand for mortgages at that time played a role in this. But since the beginning of 1998, mortgage rates have, under competitive pressure, fallen to about 2.75% below the best lending rate now. This fall of 4.25% relative to the best lending rate is very substantial indeed. Meanwhile, the best lending rate has also fallen, along with the successive cuts in interest rates in the United States. In total, the mortgage rate has fallen from 11.5% at the beginning of 1998 to about 2.25% now, providing much relieve to mortgagors in servicing their mortgages and enabling them to retain their homes in difficult economic circumstances, including the sharp drop in property prices.

And competition has forced efficiency gains out of banks. Banks are delivering better services to customers, and Hong Kong enjoys one of the most efficient and safest banking systems in the world. Yet the questions arise about whether there is a possibility that competition-induced cost-saving measures might have led to management thinning to the extent of impairing the ability of individual banks to manage risk generally and operational risk in particular. In short, are there adequate management resources to oversee the bank's operations? I hope that with an improving economy and a recovery in loan demand banks can seize the opportunity and make special efforts to strengthen their management capacity, operations and remedy any deficiencies in their risk control.

Banks are also facing new challenges, that require close management attention. Basel II is one and the provision of more integrated financial services is another, not to mention the whole new area of renminbi business, which is likely to make quantum jumps as financial liberalisation on the Mainland continues apace. It is of course for bankers to manage commercial banks, and every bank has its own characteristics and management style. As a banking supervisor, we can only offer our views, from a rather more general point of view, as we see the situation develop in and around Hong Kong. We may find it necessary at times to be more assertive providing supervisory guidance and statutory guidelines, and we shall do so as usual after consultation with the banking industry. But these challenges also provide good opportunities to conduct check-ups. And if there is a choice of conducting one that is routine and one that is more thorough, I definitely recommend the latter.

We in the HKMA are doing the same. The difficult economic environment in the past few years has exerted unusually strong demands for economising on the use of public funds. This is despite the fact that it is precisely in difficult times that those responsible for monetary and financial stability have to be vigilant and well equipped to pre-empt or deal with crises. And with the human resources market for financial expertise tightening, we too are facing similar management challenges in relation to the work at hand, and operational risk.

 

Joseph Yam

9 December 2004

 

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