Good afternoon ladies and gentlemen. I am pleased to address you on a subject that obsesses banks today - how to survive in a rapidly changing environment for financial services.

Banks are shifting their emphasis from expanding franchise size to effectively developing the franchise.

They have to. The bottom line is that, to maximise market potential, banks have to establish customer relationships and manage those relationships so that they are economically viable.

With an increasing number of customers diversifying their asset portfolio, banks are strengthening their capabilities in insurance and wealth management, to give customers what they want. The focus is on gaining a high share of customer wallet penetration to increase profitability.

I would like to look in turn at:

Tough banking environment

Operating conditions are difficult for banks as they contend with margin pressure, intense competition, the need to create value and more sophisticated customers.

The margins of traditional interest income products are under strain. Nowhere is the margin squeeze more obvious than in mortgage pricing. In Hong Kong, mortgage pricing has fallen from P+1.75% in 1995 to P-2.25% today. There is also downward repricing pressure on the existing mortgage portfolio as banks compete to maintain market share.

Growth in bank lending has been sluggish in recent years. According to the Hong Kong Monetary Authority, in the six years from 1992-97, domestic lending by the locally incorporated banks grew at an average rate of 21% per year. In contrast, the equivalent annual figure for the three years to mid-2000 was 1.25%. The slow growth, coupled with the fierce competition for new lending business, has pushed down lending margins.

In July 2001, the remaining interest rate rules covering savings and current deposits in Hong Kong are scheduled for removal. Following full interest rate deregulation, banks will have to compete on pricing as well as services.

The intense competition among banks is compounded by pressure from non-bank entrants and other sources of finance. There is also pressure from shareholders and customers.

In today's banking world, the creation of shareholder value has become the ultimate performance measure. Banks have to focus on the best ways to maximise shareholder value and move towards higher-margin businesses.

Customers too are demanding greater value. Increasingly sophisticated, they are more demanding and price-sensitive - but less loyal. No longer satisfied with traditional deposit and loan products, they are looking for one-stop services to protect and grow their assets.

All these factors highlight why banks have been increasing their capabilities in insurance and wealth management. By providing a wider product range, there is less chance of losing a customer to a competitor. Insurance and investment services bring in higher-margin non-interest income, reducing reliance on the traditional products. Cross-selling these products also helps to lock customers in and deepen the overall relationship.

Huge market potential

Insurance, especially life insurance, and investment services offer huge potential.

According to the Office of the Commissioner of Insurance, total premiums from the long term insurance business came to HKD41.3 billion and represented 3.3% of Hong Kong's GDP in 1999. The annual growth rate of the long term business was 13.9%.

The launch of the Mandatory Provident Fund (MPF) offers the investment market great opportunities. MPF contributions are expected to reach HKD10 billion in the first year. Much of that money is expected to find its way into the investment fund and securities markets.

At the end of 2000, about 8% of the adult population in Hong Kong invested in funds, according to the Hong Kong Investment Funds Association. This figure is expected to rise significantly in a few years.

About 21% of the adult population were stock investors, according to a survey at the end of 2000 by Hong Kong Exchanges and Clearing Limited, compared with 16% a year earlier. Banks currently account for about 40% of the turnover of the retail securities market and the figure is also expected to grow.

While insurance companies and investment fund houses have their own strengths - including know-how in product development, underwriting and long-term investment - banks are increasing their expertise in these areas. In addition, they have their own competitive advantages, including:

• A sizeable customer base and the advantage of knowing them better. Throughout the relationship with their customers, banks are gathering information to understand their customers' needs, allowing them to tailor products to service their different life-stage requirements. Banks are in a better position to follow up on sales opportunities.
• Banks can offer a full range of financial solutions. As financial supermarkets, they can attract customers seeking convenient, one-stop solutions.
• Banks can complement their offerings by distributing third party products such as investment funds. They can also act only as agents for insurance companies without bearing the underwriting risk.
• Banks offer a convenient payment infrastructure, with direct debit and deposit services to customers' bank accounts for sales.
• Banks offer a strong multi-channel delivery network, including branches, the internet and phone banking.
• Banks offer customers a solid institutional relationship that lasts through time. When customers buy from an insurance company, they tend to build up a personal relationship with its agent.

The Hang Seng experience

Hang Seng Bank's insurance and investment services, which we describe as our wealth management business, are growing solidly. We offer a trusted brand, which is important to customers planning for their longer-term security. Before I describe our approach, I'd like to present a brief overview of the Bank.

Hang Seng is the second-largest locally incorporated bank in Hong Kong and serves more than one-third of its population. Our business focus is Hong Kong and mainland China.

We announced a record attributable profit of over HKD10 billion for 2000, an increase of 20.5% from a year earlier.

Hang Seng is a principal member of the HSBC Group, 62.14% owned. We contributed 24% of the Hongkong and Shanghai Banking Corporation's attributable profit and 12% of the HSBC Group's after goodwill amortisation in 2000.

Under our Managing for Value strategy, our target is to at least double shareholder value in five years. An important focus area in achieving that target is wealth management.

Income from insurance and investment services grew impressively by 43.7% in 2000 compared with the previous year. By expanding these services, the ratio of other operating income to total operating income increased by 2.2 percentage points to 23.4%.

Increasing franchise value

Our one-stop wealth management initiatives are designed to strengthen the total customer relationship and the value of our franchise. They target both our affluent and mass integrated account customers and businesses.

Customers are segmented according to their potential and needs in a process that helps the Bank to tailor value-added products for them and increase its share of their financial spending. At the lower end, customers can open a Bank-In-One integrated account with a minimum total relationship balance of only HKD5,000. At the higher end, the minimum balance for a Prestige Banking customer is HKD500,000.

With a comprehensive customer database, we can identify customer needs based on life-event triggers such as the purchase of a home, marriage and the birth of a child.

Because our wealth mangement initiatives are integrated with our retail banking operations under a single management, there is better co-ordination in product design and development, sales and distribution, and administration.

Leveraging distribution channels and the sales force

Hang Seng is also able to leverage on its extensive distribution channels and general sales force to offer convenient and cost-efficient wealth management services.

Our e-Banking services, launched in August 2000, have become a major channel to grow our wealth management business. About 47% of our securities trading transactions by count are now conducted over the internet. Online investment fund transactions, introduced in December, make up about 10% of total fund transactions by count. Basic insurance products including travel, accident and home care insurance are also offered through the internet.

We have re-configured our branches as financial advisory and sales centres, with customer service officers focusing on cross-selling financial solutions to personal customers. Business banking managers and officers act as relationship managers for our company customers and specialist staff are available to help sell general insurance to them.

Last month, we opened 26 Prestige Banking Centres for our high-end customers. Each customer is assigned a Customer Relationship Manager, who keeps track of the customer's asset portfolio and takes care of his or her wealth management needs.

A mobile team of financial services executives reaches out to customers who seldom visit branches. Included in the team are specialist insurance staff.

Because we have a large sales network of about 150 branches and do not have to maintain a separate agent sales force for our wealth management services, we are able to maintain low costs. Our cost-to-income ratio fell to 24.4% in 2000, the lowest since it was first published in 1989 and among the lowest in the banking world.

Insurance services

Hang Seng was one of the earliest banks in Hong Kong to venture into bancassurance. We went into general insurance about 35 years ago and diversified into life insurance in 1995. Hang Seng Life Limited, set up as a joint venture between Hang Seng Bank and HSBC, has been a great success story.

Hang Seng Life was the fastest growing life insurer and sixth in Hong Kong in 2000 in terms of annualised new premiums, according to the Hong Kong Federation of Insurers. The size of annualised new premiums increased by more than 12 times from 1996 to 2000, and grew by 51% last year.

Major reasons for our success have been our high quality service, trusted brand, reasonable pricing, comprehensive product range, and fair and efficient claims policy.

Our sales force of registered agents grew from 440 in 1996 to 1,530 in 2000, but the majority is part of the Bank's general sales force. As its own sole agent, the Bank is also able to structure its life insurance commission more evenly, instead of paying a large sum upfront to other agents for first-year business.

Investment services

Hang Seng has been offering securities trading for a long time. We were among the first batch of brokers to offer straight-through securities trading when AMS/3 became available in 2000. Our securities trading volume increased by 77.2% in 2000.

We make every effort to be innovative and to meet changing customer needs as part of our quality service. In 1998, we introduced the first automated securities trading system in Hong Kong, allowing customers to buy and sell stocks directly through automated phone banking.

In 1995, we entered the fund management business and launched the first tracker fund in Hong Kong - the Hang Seng Index Fund. There are now 20 sub-funds under the Hang Seng Investment Series, which is the umbrella brand for the Bank's managed portfolios, and sale of the Series has been extended to Macau. Since the start of 2001, the total fund size of the Investment Series has increased by 65% to HKD6.6 billion as at 22 March. We also offer our customers about 300 third party funds.

In the volatile and low interest rate environment, we are capitalising on new customer investment sentiments. The Hang Seng Capital Guaranteed Technology Fund Series was launched in February 2001 for customers seeking capital appreciation in the technology sector with minimal risk. The Series attracted HKD2.8 billion and 12,000 new investment fund customers. The Hang Seng Managed Forex Fund Series was launched last month to meet the different risk appetites of customers seeking opportunities in the international foreign exchange markets.

Future challenges

We are not complacent in our success. Financial markets and customer needs are changing rapidly and banks have to stay a step ahead. The challenges include:

In the age of globalisation, banks can no longer just focus on their local market. They need strong infrastructure and speedy and efficient delivery channels, to increase the range of their transactions and sell global products.

The internet has been very popular for securities trading and online investment fund trading is expected to grow. However, technology is advancing rapidly and we have to keep up. Hang Seng continues to expand its range of e-services and is preparing to launch wireless banking when the platform becomes mature.

Ensuring staff professionalism is another major challenge. The increasing sophistication and differentiation of products has created the need for raising the quality of staff in terms of product knowledge and service standards.

The Insurance Authority has launched a quality assurance scheme requiring insurance intermediaries to be properly trained and qualified through public examinations. Insurance intermediaries will also be required to satisfy a continuing professional development requirement for renewal of their registration or authorisation. Banks are facing new regulatory requirements for staff selling securities.

Staff training has to be constantly reviewed and kept up-to-date to meet these developments. Highlighting our Bank's commitment to staff development, Hang Seng is a founding member of the newly set-up Institute of Financial Planners of Hong Kong, which aims to promote professional standards in personal financial planning.

Banks also have to keep enhancing their services if they are to retain their customers and attract new ones. As customers become increasingly demanding and price-sensitive due to greater transparency, higher customer acquisition and retention costs and higher lapsation rates are likely. The average lapsation rate in the life insurance industry was 15.85% in 2000, according to the Hong Kong Federation of Insurers. Hang Seng plans to set up after-sales teams and loyalty programmes to improve after-sales service.

After its entry into the World Trade Organization, mainland China will offer vast potential in insurance, securities and fund management. Local involvement in these industries in the Mainland is limited at present. As an initial step in developing our insurance business in the Mainland, the first representative office of Hang Seng Insurance Company Limited is expected to open in Shenzhen later this month. Our Shenzhen Branch has also applied for an insurance trade-related agent licence.

Conclusion

In conclusion, banks are increasingly aware that their bottom line depends on their ability to capitalise on customer relationships to increase sales of financial products.

By maximising the potential of their customer database, devising the right product mix for customers, offering extensive and convenient distribution channels, and achieving synergies from their one-stop operations, banks have many competitive advantages in providing wealth management products and services.

Thank you.