The banking sector achieved another year of solid results in 2006 despite the operating environment remaining intensely competitive, mainly because of abundant liquidity. Profitability was supported by improved net interest margins and sustained loan growth, which led to an increase in net interest income. This, together with an increase in income from fees and commissions, more than offset a contraction in treasury income, increased operating expenses and an increase in new provisions for bad and doubtful debts.

Overall asset quality remained good despite the increase in new debt provisions. Although the quality of the credit card portfolio weakened slightly alongside higher levels of personal bankruptcies, the increase in impairment allowances was small by historical standards. With the rise in property values, the number of negative-equity residential mortgages has declined further.

Sound profitability and asset quality, combined with high levels of liquidity and high levels of capital suggest the banking industry is well placed to continue to support economic growth.

While Hong Kong dollar interest rates increased in 2006, ample liquidity in the banking system meant they did not reflect the full extent of the increases in the US Fed funds target rate during the year. One-month Hong Kong Interbank Offer Rate (HIBOR) rose to an annual average of 4.12% from 2.91% in 2005 and the one-month time deposit rate rose to 2.70% from 1.26% (Table 3). However, after raising their best lending rates by 25 basis points in the first half of the year, banks reversed this rate increase in the fourth quarter to leave their best lending rates at either 7.75% or 8.00% — the same level as at the beginning of the year. Nevertheless, the average best lending rate was higher for the year as a whole resulting in the spread between the annual average best lending rate and the annual average one-month HIBOR widening to 378 basis points compared with 320 basis points in 2005. In addition, the spread between the annual average best lending rate and the average one-month time deposit rate expanded to 520 basis points from 485 basis points.