Hong Kong has a banking system that is both prudent and efficient. However, banking involves risks, and no amount of care and prudence will prevent the occasional problem from arising.
The fact that banking business involves risk is probably not something that is recognised widely enough in the community. As an important channel of financial intermediation, through channelling savings into investment, and in the process promoting economic growth and development, banks take risks all the time. Credit risk is the better known type of risk that a bank takes when lending to a customer: this is the risk that the customer may fail to repay the money. There are others - settlement risk, "Herstatt" risk, exchange rate risk, interest rate risk, legal risk, reputation risk, for example - and many of these are only talked about among bankers and bank supervisors. Good banking involves the judicious taking of risks, managing and pricing them properly, rather than avoiding or hiding them, and in the process making the banking system work for the economy and to the benefit of the community.
It is in the nature of risk-taking that some risks will inevitably materialise - a loan may turn bad, a holding of debt securities may depreciate in value because of an interest rate hike, a long position in foreign exchange may involve book losses when the domestic currency strengthens. However skilful a bank is in the assessment and management of risks, losses may still occur. Non-performing loans (NPLs), for example, are invariably an item on the balance sheets of all banks. So are provisions for bad and doubtful loans. That is why you need capital for running a bank, or indeed for running any business. And for banks the adequacy of capital is so important that there are sophisticated supervisory requirements written in law, giving risk weightings to different types of bank assets and relating these quantitatively to capital, in the form of the Capital Adequacy Ratio (CAR).
While the assessment, pricing, taking and management of banking risks are the responsibility of individual banks, the HKMA, as banking supervisor, works closely with the banks to promote prudence in the performance of this task. There is of course the crucial consideration that risk taking is not so excessive as to undermine the interests of the depositors who have entrusted their money to the banks. There is also the wider consideration of promoting the general stability and effective working of the banking system, which is so important to the economic well-being of the community and which requires the taking of risks. We do so, at the macro level, by being forthcoming when necessary in our views on our perception of risks in a particular sector of the economy or a type of activity. These macro views (not opinions on the creditworthiness of a particular bank customer) are supported by objective analysis. Sometimes we have concerns, and these may be so strong as to require supervisory guidelines to be issued, exercising the authority vested in us in the Banking Ordinance. Readers are of course familiar with our stance, fully supported by the banks, on the extent of risk that banks should assume in residential mortgage lending. There are other areas in which we have also advised caution in the past. There was, for example, the direct or indirect, domestic or cross-border, exposure to Mainland enterprises, the businesses of which, and therefore banking requirements, have been growing at such an attractive pace as to risk the adequacy of corporate governance and financial backing being overlooked by lenders. At the individual bank level, we also issue supervisory guidance on the prudent running of banking business and examine the adequacy of risk management systems that promote such conduct.
I believe that we have got it right, through this important partnership between the banks and the HKMA, in producing a banking system that is prudent and efficient in serving the needs of the economy and robust in its stability and integrity. The evidence is clearly there. Total assets of the banking system as a percentage of GDP, at around 500% are among the highest in the world, and the NPL ratio, at less than four per cent is among the lowest in the world. This is notwithstanding the banking system having been through a most difficult period involving the Asian financial turmoil, the bursting of the domestic property bubble and of the global IT bubble, continuing deflation and SARS.
But the NPL ratio may never be zero. There may sometimes be developments that are beyond the expectation of bankers, however knowledgeable and prudent they are. No one is able to predict accidents. And there will be those high profile, specific, but hopefully isolated cases that occur, for whatever reason - fraud that regrettably may escape watchful eyes, error of judgement that is a part of life in everything - that hit the headlines of the press. It is a matter of degree. I am sure it is in the interests of Hong Kong and particularly the banking system for these to be minimised, as far as possible, so that the undoubted integrity of our banking system will not be undermined.
Joseph Yam
30 October 2003
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