Prudent practice: Monetary Authority Deputy Chief Executive YK Choi urges the banking sector to remain prudent in loan underwriting.

Monetary Authority Deputy Chief Executive YK Choi says although Hong Kong's banking system is strong it faces challenges from the intense competition and potential volatility in global financial markets as a result of the sub-prime fallout and possible economic slowdowns in the US and UK.

He urges the sector to remain prudent in loan underwriting and to ensure the use of loans is consistent with the borrowers' declared loan purposes.

Speaking at a press conference today Mr Choi said the banking sector remains highly liquid, well capitalised and profitable. The liquidity ratio rose from 50.7% in December 2006 to 51% in September last year. The loan-to-deposit ratio for all currencies rose from 47.9% to 48.6%.

Deposit growth strong

Bolstered by strong fundraising activities in the stock market, deposit growth was strong. Deposits for all retail banks rose 19.5% in last year's first three quarters while domestic loans grew 21.3%.

The classified loan ratio fell from 1.11% in 2006 to 0.89% in September while the mortgage delinquency ratio dropped to 0.11%. The number of negative equity mortgages also fell from 8,400 in 2006 to 1,900 in December.

The net interest margin rose from 1.80% to 1.86%, the cost-to-income ratio dropped from 42.7% to 39.9%, and the average consolidated capital adequacy ratio fell from 14.9% to 13.6%.

Mr Choi said net interest margins improved amid sharp increases in operating costs, adding strong profit growth more than offset higher operating costs. However, profitability of individual banks may be affected due to exposure to sub-prime related issues or the widening of credit spread.

He said challenges for the sector remain due to keen competition, the impact of sub-prime issues and volatilities in global financial markets.

Sub-prime impact

He said the first-wave impact of the sub-prime problem is still filtering through the system while the second wave will also affect the global economy and financial markets.

Noting macroeconomic adjustments on the Mainland could increase market volatility Mr Choi warned credit quality may worsen.

He said the authority will closely monitor the impact of US sub-prime fallout on individual authorised institutions and will watch their asset quality and review the adequacy of their systems in managing credit risk.

On the review of the authority's work on banking stability, Mr Choi said it will make recommendations on focus and priorities of the authority's banking supervisory functions and policies to be developed in the next five years.

To enhance technology risk management the authority will ensure authorised institutions have adequate resources for capacity planning for Internet banking and online securities trading systems.

It will also work with the Association of Banks and Police to develop an effective customer education programme to promote sound control practices and awareness of emerging fraudulent techniques on Internet banking.