Monetary Authority Chief Executive Joseph Yam says although 2006 promises to be a complex and challenging year on the monetary and financial fronts, Hong Kong's monetary system should be able to cope with any swings.

He anticipates more competition in the banking sector next year, a situation that will eventually benefit both depositors and borrowers.

In his Viewpoint column posted on the Monetary Authority homepage today, Mr Yam said the strengthening trend of the renminbi and the apparent sentiment that the Hong Kong dollar will strengthen along with it may keep the Hong Kong dollar at the strong end of the range.

Market sentiment to swing sharply

"Higher interest rates, a slower economy and the associated dampening effects on asset prices may provide some counter-balance, although this may be limited if US dollar interest rates stabilise or even peak during the year," Mr Yam said.

"Market sentiment will oscillate quite sharply as usual, possibly producing financial market volatility. In our case this will take the form of volatility in money market conditions rather than in the exchange rate."

Mr Yam said that in the coming year Hong Kong could face periods of both easy monetary conditions and inflationary pressure, and periods of tight monetary conditions and a slowing economy.

Hopefully, these swings would not be too severe, he said, adding the clarity of the monetary policy objective and the transparency with which the Monetary Authority operated the monetary system should help.

Keen competition in banking sector expected

Keen competition in the banking system will probably persist, particularly if loan demand slows along with a slower economy. The banks should therefore be mindful of the risks arising from more intense competition, he said.

"Our risk-based supervision, which the banks are coming to understand and support, should hopefully increase vigilance against the risks that come with greater competition. The confident pace at which the banking system is moving in implementing Basel II suggests that this should be the case," Mr Yam said.

"I expect that there will be further innovation in the delivery of banking services and consolidation. As revenue comes under pressure, banks will no doubt have to review their cost-benefit analyses and this may lead to further reduction in branch networks.

"As supervisors we have a clear role, defined in the Banking Ordinance, to provide a measure of protection to depositors and to promote the general stability and effectiveness of the banking system.

Greater competition brings about more benefits

"But we will certainly also provide any assistance required of us in the deliberation of these delicate social issues, noting of course that greater competition, brought about through the phased liberalisation of interest rates, has brought tremendous benefits to both depositors and borrowers."

On his earlier alert about the possible changes in the Mainland's policy views concerning the continuing need to attract foreign savings through, for example, overseas IPOs by Mainland enterprises, Mr Yam said his team would pay greater attention to the long-term sustainability of such activities in the capital markets.