It is not surprising therefore that the figures for negative equity reported to the HKMA by the banks have shown a significant increase from the 83,000 cases (representing $ billion of loans) recorded at the end of March. The negative equity problem affects the banks in various ways. Most obviously, it poses an increased credit risk since loans in negative equity have a greater tendency to go into default; and if they do, the banks will suffer a loss since the loans are no longer fully covered by the value of collateral. Negative equity also has a deterrent effect on the demand for new loans since it makes property a less attractive asset to hold, and by locking in existing homeowners reduces market turnover. More generally, it has a pervasively depressing impact on consumer confidence and is thus a drag on the economy and on loan demand as a whole. What is encouraging however is that despite the current difficulties faced by homeowners most of them have made every effort to continue to service their loans. Although the overall mortgage delinquency ratio has edged up in recent months, it remained at a relatively comfortable 1.16% at end-May. The arrears for loans in negative equity are higher, as you would expect, but even so the delinquency ratio of around 2.5% is reasonable under the circumstances. Nonetheless banks need to keep a watchful eye on the situation, and adopt a proactive and helpful approach to restructuring mortgage loans when borrowers start to exhibit signs of financial distress.
Banks of all shapes and sizes have the opportunity to benefit from the recovery in the Hong Kong economy when it comes. Some banks will however do better than others, and our research indicates that a more efficiently operated and diversified bank will achieve higher profits. I hope that all the banks sitting here today will be among those that fall into this category. BIS Review 32/2003  3