This is being displayed most obviously in the decline in lending margins already mentioned, particularly on residential mortgage lending which is a major part of the loan portfolio of most of the local banks. The margin has recently reached a new low of 2.25% below prime compared with the pre-crisis level of 1.25% above prime. To some extent this reflects the temporary conditions of a depressed property sector, sluggish loan demand and plentiful liquidity. As loan demand picks up, as inevitably it will, the decline in margins will stabilise and may even reverse somewhat. But lending margins are unlikely to get back to where they were before the crisis. Competitive pressures will be further intensified on the funding side when we deregulate current and savings accounts next year. This is due to take place at the end of June 2001, and will only be postponed if the prevailing economic and financial conditions are clearly unfavourable, which we do not expect to be the case. The banks therefore need to prepare for the pressure on margins that this will cause and to be able to quickly introduce new deposit products like interest bearing current accounts. If they do not do so, their competitors will. How do the local banks need to respond to these challenges? Most obviously, the challenges raise the issue of consolidation of the banking sector, through either merger or take-over. This is the trend we have seen happen in other financial centres, including in Japan.
No banks required financial assistance from the Government during the crisis, in contrast to the situation in some of our Asian neighbours where the cost to the public finances of bank rescues and restructuring could reach as much as $ billion. The rapid recovery in the Hong Kong economy is now helping to improve the banks’ performance and to bring down bad debts. In the first half of this year, the pre-tax operating profits of the local banks BIS Review 65/2000  2  from their Hong Kong operations rose in aggregate by more than 50% over the same period of last year. Admittedly, much of this was due to the reduction of 58% in the bad debt charge, which will be a temporary factor in improving profitability. But even at the pre-provision level, profits grew by about 15% compared with 1999. Surprisingly, after the publicity about declining margins on mortgage lending, the growth in profits was helped by an increase in the overall net interest margin. This reflected the fact that funding costs remained low during the period. The position of the local Hong Kong banks is therefore looking better than at any time since the Asian crisis. However, like the Japanese banks, the banks here are also faced by a number of important challenges, albeit on a smaller scale than those in Japan. Foremost amongst these is increasing competition.