Sunday, February 20, 2005

HK interest settlement rate grows up while regulator urges the surge of interest rates

HK interest settlement rate
Originally uploaded by bigkoala.
The Hong Kong average interest settlement rates has grown up above 50 per cent two weeks after the first surge of the US interest rate this year. The regulator has obliged the banks to raise the interest rate as soon as possible to avoid more outflow of the capital in the market.

But banks are still cautious at raising up the interest rate, though the rising settlement rate makes them earn less from the borrowers under the current agreement

Under the Forward Rate Agreement, or FRA, Hong Kong banks and the borrowers has locked in an interest rate for a stated period of time starting on a future settlement date. The borrowers could use FRA to protect itself from a future increase in interest rates. The banks could protect itself from a future decline in interest rates. When the settlement rates, which is updated by the Hong Kong Association of Banks every day, is higher and the interest rates remains unchanged, banks have to pay the interest differential to borrowers. Further details and calculating methods could be reached here.

Hong Kong Monetary Authority, has urged banks to raise the interest rate to peg the growth of the US interest rates, in order to prevent the sudden and large amount of capital outflow when bank raise the rates. Joseph Yam Chi -kwong, Chief Executive of HKMA, hinted of future interest rates rise on Feb 4 and more directly urged banks to rise their interest rates on Feb 17. The settlement rate stopped rising for several days after his first speech(see the grid marked black in the picture), but continued rising shortly.

The authority wants the market acting in a gradual and soft way, while banks are going after the profit as most as they could. It is like a pull-and-push game, where borrowers need to pay close attention to win.


Victor said...

Hi Amy,

I am not familiar with the HK interest settlement rate mechanism. I think, however, whether banks need to increase their interest rates depend on themselves.

Unlike the central bank, banks are profit-oriented. They rely on several income sources, and which can be classified as net interest income and non-interest income. For the former, it is interest-rate related based mainly on HIBOR and prime. For example, SHKP (16) has recently closed billions worth of syndicated loans in terms of HIBOR. Additionally, our mortgage rates are prime-based. So, are low interest rates or high interest rates more beneficial to banks? The answer is obvious, in light of the low loan-to-deposit ratio environment.

If it is so, why they are not willing to increase interest rates? This is because funds had been moving into HK since November 2004. This was exemplified by the plunge in 3M-HIBOR to as low as 0.2% from over 1% in October. The ample liquidity pushed down interest rates, and this explained why HK banks didn't follow the latest US rates hike. Now, funds start moving out, and the 3M-HIBOR rockets to around 1.7%. Local banks may start increasing interest rates soon. The extent, however, may not be significant.

On top of operating income, provisions for bad and doubtful debts also deeply impact bank's profitability. Banks reported disappointing results in 2002 and 2003 due to mounting provisions and deteriorating asset quality. In 2004, banks are likely to post decent recent results in light of over-provisions in previous years and sizable write-backs.

Some are worried about that hiking interest rates would be detrimental to the local economy. I disagree. This depends on the pace and the economic growth. Take a look at the interest rate trend from 1993 to 1998 and from 2000 to 2003 will tell you everything. The movement of interest rates is not necessarily negative related to the general economy and the stock market.

Interestingly, when you look at the abnormal movement of the 10-year US Treasury Note and the 30-year US Treasury Bond yields, you can certainly discover something. When everyone is expecting interest rates to rise, why the yields for these long-term treasuries remain subdued? The expectation of inflation over the long-run is low, and this is perhaps an important argument suggesting that interest rates will not rise substantially from the current level in the future. I think the PRC is exporting deflation (low manufacturing costs I mean), and the huge competition also pushes down average selling prices.

Even if interest rates rises, this is not necessarily a bad thing. We should think about real interest rates instead of nominal interest rates. This goes back to the asset quality question.

Amy or koala said...

Yes, I believe, in some extent, HKMA couldn't force the banks to grow up interest rates, though it is willing to. You give a good reason why the banks haven't done it yet. I guess they also would like to increase it after they announce their annual reports. Big banks want to have a good share price when the reports are given. Small banks may wait for big banks' action. Something may happen after HSBC and Hangseng's reports on Feb 28. Hehe, I guess

Amy or koala said...

I totally agree what you said PRC's cheap labor and low price product have pulled down HK's inflation these days. See many HK people buying properties, daily stuffs and enjoying cheap living expense in Guang Dong province. Inflation is struggling with so-called "deflation" now:)

Victor said...

When you look at the results of Wing Lung Banks (96) announced today, its net interest income retreated 4% compared to 2003. Why? On top of rock-bottom interest rates, stagnant loan growth also attributed to the decline. This is the major reason why banks have been reluctant to raise their interest rates, as increasing the cost of capital may further adversely impact loan growth.

Whether corporations borrow or not do not depend on the interest rates. The key is that whether they can profit from it. As long as the return of the project is greater than the cost of capital, corporations will take the leverage. If the economy continues to improve, interest rates will surely rise. This is simple because loan demand picks up. As long as the loan-to-deposit ratio remains subdued, it is still not very likely for HSBC to sharply increase its prime rate. It may be interest to see the differential between prime and the deposit rates.

In fact, the view on whether the PRC is creating deflation or inflation is polarized. It is exporting low-cost products; on the other hand, its insatiable demand for natural resourse in particular oil is creating inflation. The 1.3B-populated internal consumption market is another factor. This is a very interesting issue.

Inflation or deflation? There is no easy answer.

One thing is clear is that M2 in the PRC has slowed to around 14%, in-line with the PBOC's target. While the slow in growth rate signals that the PRC is "landing softly," 14% year-on-year growth is still quite remarkable. Will the PRC reinforce another round of austerity measures?

Amy or koala said...

Yes, I think so. That's why central government are making policies on pushing the loans to SMEs. In fact, most of them are suffering from the tighter financial policy.