The net interest margin of the retail banks in Hong Kong as a whole has substantially declined from over 2.19% in 1997 to an annualised level of 1.67% for the first quarter of 2004. The new sources of income include most notably the sale of investment and insurance products. The key challenge for banks is simply whether they are capable of managing the risk arising from these new intermediary activities. This is particularly so when, encouraged by advanced technology, the range of products being offered to customers expands from plain vanilla types to more complex structured instruments. Furthermore, the awareness of customers about their consumer rights has increased, thus exposing banks to greater compliance, legal and reputation risks when venturing into these new areas of activities. We have seen in recent years an abundance of cases against the misselling of products by banks even in jurisdictions with more developed financial markets. Banks will need to properly equip themselves, including substantially upgrading their compliance and internal audit processes, in order to rise to this challenge. International standards The fifth set of influences affecting the banking industry is the number of key international standards that will be introduced over the next few years. These include regulatory and accounting standards, and Basle II is the standard most prominent in our minds. Another example is the implementation of IAS 39. The adoption of these standards will have profound implications for the operation of banks in Hong Kong.
Time is limited, and this is, after all, a luncheon speech, so I shall not go into detail about these standards. The point to make here is that, as an international financial centre, we have no alternative but to implement these standards as fully as we possibly can and as soon as international agreements have been reached on them. Many of these standards will be, to put it mildly, quite onerous. In this connection, I wish to ensure you all that the HKMA has been adopting a proactive approach in participating in the relevant international standard setting forums and in influencing the standard setting processes in the best interests of Hong Kong. We have also consulted widely in Hong Kong. Insofar as the banks are concerned, there is a clear need for bank management to allocate adequate resources to the process of implementation, which will involve substantial changes to IT systems and compliance arrangements. For Basle II, for example, banks should not be acting under the misapprehension that they can simply sub-contract the implementation processes to third party service vendors, such as their external auditors. Active involvement of bank management is crucial in ensuring that most, if not all of these international standards are properly incorporated into the daily operations of banks, especially since each bank may face different focuses and challenges in the process.