david carse : the state of the banking industry in hong kong speech by mr david carse, deputy chief executive of the hong kong monetary authority, to the hong kong foreign bank representatives association, hong kong, 6 may 2003. * * * ladies and gentlemen, thank you for the opportunity to speak again to the hong kong foreign bank representatives association. i want to use this opportunity to take stock of the state of the banking industry at what is a more than usually uncertain period for hong kong as it battles with the impact of atypical pneumonia. in hong kong you need to be prepared for the unexpected. at the beginning of the year, we were all worried about the looming war in iraq and the damage that it might cause to the global economy and to hong kong. little did we know that the main threat to the people and the economy of hong kong would come from the sars virus. the recent performance of the banking industry the outbreak of the disease is one of a number of shocks that the banks in hong kong have had to cope with over the last five years. i will not dwell on the list, which will be familiar to you, but it includes two recessions, five consecutive years of consumer price deflation, a collapse in property prices of 65 % from the peak in october 1997 and a surge in personal bankruptcies. all this has taken place against the background of various upheavals in the global economic and political environment, the war in iraq being just one manifestation of this. the defining characteristic of hong kong banks during this difficult period has been their resilience. despite the ups and downs, banks ’ balance sheets have remained strong. for the locally incorporated authorized institutions, the aggregate capital ratio remains around 16 %, twice the minimum international standard. many of the smaller banks have ratios well above this. capital strength has not been impaired by losses during this period. the banks have continued to make money and earn a reasonable return on assets from their hong kong operations, averaging around 1. 25 % ( before tax ) over the last three years. however, this has not been easy to come by. growth in mortgage lending, the mainstay of profits in the 1990s, has stagnated, and the spread on new mortgage loans has fallen to 2. 6 % below prime barely enough to earn a decent return on capital employed. other sources of loan demand have also dried up as corporates have deleveraged since the asian crisis. so the banks have had to

about. they also need to take account of regulators in the various jurisdictions in which they operate and the fact that regulatory standards may shift over time. the credit suisse group has, for example, recently run into problems with the japanese regulators because one of its subsidiaries in japan was accused of engaging in window - dressing transactions with japanese banks. these transactions are now deemed by the current regulators to be “ inappropriate ”, though they were apparently not so regarded in the past. this illustrates that banks may encounter what has been termed “ regulatory risk ” not simply when they break the law. it also shows the problems they face in deciding which transactions are indeed “ appropriate ” where the rules of the game in the various markets in which they operate may not be clearly defined, or where the rules are shifting in line with changing standards of what is right or wrong. the global reach of many businesses creates practical problems of control and of enforcement of compliance with regulatory and ethical standards, as the collapse of barings bank clearly showed. but these issues also arise in domestic markets as the banks diversify into fee - related businesses such as the sale of insurance and investment management and advice. leaving aside the possible risks from rogue fund managers, these activities can raise conflicts of interest and the issue of whether particular products are suitable for the needs of their customers. the classic case of how things can go wrong is the recent pension mis - selling scandal in the uk. hundreds of thousands of employees were persuaded by pension salesmen and the companies they represented ( including major banks and insurance companies ) to switch from occupational pension schemes provided by their employers into personal plans provided by the companies. it turned out that in many cases, the employees were much worse off than if they had stayed in their original schemes. the banks and other pension providers stood accused of failing to give their customers suitable advice and sufficient information on the costs and benefits of making the switch. the end - result is that the offending companies have been “ named and shamed ” by the government and pressurised into paying billions of pounds in compensation. the reputation of these firms, many of whom are household names in the uk, has suffered as a result. this comes at an awkward time when banks in the uk and elsewhere are attempting to expand their bancassurance activities and to persuade the public to trust them with their long - term savings. banks in hong kong will need to bear this lesson in mind as we embark upon the mandatory provident fund scheme. they will also