The outlook for the banking sector's operating environment for the rest of the year has become less promising although it was generally benign in the second quarter, a Monetary Authority publication says.

In its Quarterly Bulletin September issue published today the authority said the loan portfolios of retail banks continued to expand rapidly in the quarter, but further growth may be limited by sluggish deposit gains.

The aggregate value of classified loans rose 14.3% in the second quarter, following a 1.3% rise in the first quarter. The classified loan ratio grew to 0.88%, up from 0.81%. The ratio of overdue and rescheduled loans continued to fall to 0.53%.

After 6.2% growth in Q1, total loans and advances of retail banks grew 5% further in Q2. Total customer deposits, however, rose 1.4% only, after falling 2.1% in Q1. The overall loan-to-deposit ratio of retail banks climbed to 51.2%, up from 49.4%.

Hong Kong dollar deposits fell 2% in the second quarter, pushing the Hong Kong-dollar loan-to-deposit ratio to 74.9%, up from 71.1% in the first quarter and 65.1% in the fourth quarter of 2007.

Share financing fell substantially by 18.4% after rebounding 11.6% in the first quarter. This is presumably due to the lacklustre performance of the stock market.

Retail banks' total non-bank China exposures continued to grow 9.6% to $689 billion, up from $628 billion at the end of March. For the banking sector as a whole, non-bank China exposures rose 8.7% to $968 billion, up from $890 billion.

The ongoing credit woes continued to undermine the quality of the debt securities held by retail banks. The retail banks' investment in debt securities which were classified as "substandard", "doubtful" or "loss" represented 0.03% of the banks' assets at end-June, compared with 0.1% at the end of March.

Debt securities investment classified as "special mention" rose to 0.28% of the banks' assets at the end of June, from 0.12% at end-March.

The average consolidated capital adequacy ratio of locally incorporated authorised institutions edged slightly lower to 14.2% from 14.3% at the end of March.