back to the average return on assets over the past ten years by around 2005. obviously, the improvement in the economy would need to materialise for this to happen - and i cannot predict whether it will or not. but at least the banks can take comfort from the fact that the current difficult operating environment may to a large extent be due to cyclical factors, which should eventually reverse. i would stress that this does not mean that banks should simply sit back and wait for the rising tide of the economy to lift them up, or that they should ignore the opportunities that may arise from merger and acquisition. bank - specific factors will still matter in terms of explaining variations in performance across banks, even if their relative importance was less pronounced after the asian crisis. among these bank - specific factors, operational efficiency, as measured by the ratio of non - interest expense to total assets plays the most significant role in determining profitability, at least for the banks in our sample. surprisingly, the effect of credit quality seems to have diminished over time, perhaps reflecting improvements in the banksa€™ ability to manage credit risk. but income diversification has become more important, with banks increasingly having to develop their fee - generating businesses to be more profitable. we are seeing this particularly in the move by a number of banks into wealth management, such as securities, unit trusts, insurance, pensions and private banking. a further opportunity for business diversification for the medium - size banks will come from the ability to branch into mainland following the relaxation of the asset size criterion under cepa. the eight banks that will benefit from this would, according to our calculations, have the scope to open a total of as many as 20 branches in the mainland over the next three years. this would be a significant addition to the 40 or so branches that banks from hong kong already have on the mainland. we should certainly not regard mainland access as a panacea, and the benefits will take time to come through. but the important point is that the medium - size banks now have an alternative avenue to grow their business outside the hong kong market. indeed, more generally, banks in hong kong will benefit from the increasing financial and economic integration with the mainland. in the syndicated loan market, we can see this in the growing trend towards mainland - linked borrowers. one development of this trend is likely to be the growth of the syndicated loan market in rmb. this should create opportunities for foreign as well as domestic banks within the mainland. let me

market. the heavy reliance of the banks on property lending is well known : residential mortgage lending, in particular, accounts for 35 % of the total domestic loans of the retail banks. property prices have fallen sharply since the asian crisis, and the effect of sars was to produce a further downward spiral. in the three months from march to may, property prices are estimated to have fallen by 8 %. it is not surprising therefore that the figures for negative equity reported to the hkma by the banks have shown a significant increase from the 83, 000 cases ( representing $ 135 billion of loans ) recorded at the end of march. the negative equity problem affects the banks in various ways. most obviously, it poses an increased credit risk since loans in negative equity have a greater tendency to go into default ; and if they do, the banks will suffer a loss since the loans are no longer fully covered by the value of collateral. negative equity also has a deterrent effect on the demand for new loans since it makes property a less attractive asset to hold, and by locking in existing homeowners reduces market turnover. more generally, it has a pervasively depressing impact on consumer confidence and is thus a drag on the economy and on loan demand as a whole. what is encouraging however is that despite the current difficulties faced by homeowners most of them have made every effort to continue to service their loans. although the overall mortgage delinquency ratio has edged up in recent months, it remained at a relatively comfortable 1. 16 % at end - may. the arrears for loans in negative equity are higher, as you would expect, but even so the delinquency ratio of around 2. 5 % is reasonable under the circumstances. nonetheless banks need to keep a watchful eye on the situation, and adopt a proactive and helpful approach to restructuring mortgage loans when borrowers start to exhibit signs of financial distress. what they should be trying to avoid is a repeat of the problems with credit cards, where many borrowers chose bankruptcy as a way out of their problems. the dynamics of the two products are different, but the warning signs are there. as might have been expected, credit card charge - offs did increase during the sars crisis as rising unemployment prompted a renewed increase in bankruptcy petitions. but the latest news on this front is somewhat more encouraging. the number of petitions continued to rise going into the first week of june, but has since fallen back and the daily average for june