The turnaround in the Hong Kong economy and, consequently, the improvement in the asset quality of banks, were made possible by the more favourable global economic environment and by measures taken to strengthen economic ties between Hong Kong and the Mainland.

This was the message from Monetary Authority Chief Executive Joseph Yam speaking today at the HK Institute of Bankers Lunch.

He said Hong Kong's banks have benefited directly from two of these measures. The first was the granting of easier and greater access to the Mainland banking market under CEPA from January 1, and the second the introduction of personal renminbi business in February.

"These will in time help to broaden meaningfully, I am sure, the scope of banking business for banks in Hong Kong. I should add that there are other initiatives being developed, with the aim of positioning the banking system of Hong Kong to take advantage of further financial liberalisation in the Mainland," he said.

"I hope they can be agreed, announced and introduced soon."

Some problems remain

However, he added that the generally good news in recent months should not blind us to the problems that remain in our economy or to the risks facing us.

"While the economy has been recovering strongly, it has not been creating as many jobs as we all would like to see. It is also uncertain to what extent the budget deficit will be reduced, as government revenues recover along with the economy," he said.

"To be sure, the difficult investment environment is not helping us in our attempt to meet the budgeted investment income for fiscal reserves. Disappointments on these fronts may affect market sentiment in the short term, although the determination and ability on the part Government in tackling the remaining, structural components of these problems should not be in doubt.

"Furthermore, there is a risk that our financial markets could over-react to external developments, notably stronger than expected monetary tightening in the US, macro-economic adjustments on the Mainland and sharp increases in oil prices.

"Although it is unlikely these external factors would derail our economy, and so this risk seems small, under extreme market conditions, short-term volatility in financial markets could have a bearing on monetary and financial stability in Hong Kong."

Longer-term risks facing banks

Mr Yam said, apart from the more immediate risks and potential risks, there are longer-term risks facing Hong Kong's banks. They are - structural shift in the banking sector, China risk, technology risk, diversification risk, and changing international standards.

"My main message is that, while banks need to focus clearly on the short-term risks I have already outlined, we should not lose sight of the more fundamental forces that will shape the landscape of the banking sector in the years to come," Mr Yam said, adding if they do not take these forces into account, individual banks not only face growing risks, but could be in danger of losing competitiveness.