1.1 Introduction
The financial sensitivity model (“FMS”) was developed to translate the results of the econometric model into financial terms for the 40 banks holding the large majority of HK$
deposits1 and represents an effort to reconcile the assumptions of the econometric model with the actual financial impact IRR deregulation could have on banks’ interest expense and net interest margins. As with the econometric model, the FSM does not attempt to predict how banks might pass on the higher cost of funds to preserve net interest margins, nor does it attempt to ascertain other income generating strategies that might be deployed to compensate for some of the increase in interest expense that might not be passed on through lending activities. However, the model does point out the initial impact on interest expense (on a weighted average basis for 1997) as a result of higher interest expense associated with differing scenarios.
One base case and ten adjusted scenarios have been devised and reviewed, mostly consisting of the impact of interest rate changes on total interest expense, and the consequent impact on net interest margins. The scenarios are summarised below and the results of the sensitivity analysis follow2. Table 1.2.2 summarises scenario assumptions. Table 1.3.1 provide synopses of results.
1.2 Summary of Scenario Assumptions
Ø Scenario 1 - the base-case assumes that weighted average rates and deposit distributions are unchanged. Weighted average rates on the three IRR deposits were 0% for current accounts, 4.13% for savings accounts and 4.23% for 24-hour call deposits. Key features of the base-case are summarised below:
1
These were the 40 institutions included in the HKMA interest rate survey.
2
Detailed results and the spreadsheet model are with the HKMA. Monetary data supplied by the HKMA has been used in structuring the FSM to ensure that scenarios are reasonable based on current and historical indicators. Monetary data inputs included money supply, customer deposits by currency and authorized institution, yields on Exchange Fund Bills and Notes and interest rates such as Prime and HIBOR.
Table 1.2.1 Base-case scenario overview
HK$million
Interest income 237,336
Interest expense 175,729
Net interest 61,607
Average assets 3,716,057
As a percentage of total accounts under HK$500,000:
Current accounts 16.93%
Savings accounts 54.87%
24-hour call accounts 0.17%
Other 28.03%
Ø Scenario 2 - the second scenario is similar to the base-case, but assumes that weighted average rates on savings and 24-hour call accounts are 50 basis points higher than in 1997. Weighted average rates on the three IRRs deposits were 0%
for current accounts, 4.63% for savings accounts and 4.73% for 24-hour call deposits. Deposit distributions are unchanged.
Ø Scenario 3 - the third scenario is similar to the second scenario, but assumes that weighted average rates on savings and 24-hour call accounts are 100 basis points higher than in 1997. Weighted average rates on the three IRRs deposits were 0%
for current accounts, 5.13% for savings accounts and 5.23% for 24-hour call deposits. Deposit distributions are unchanged.
Ø Scenario 4 - the fourth scenario draws from the econometric model, and assumes that weighted average rates on savings and 24-hour call accounts are 50 basis points below 1997 deregulated interest rates in comparable deposit categories above HK$500,000. One-week time deposits are used as a comparable deposit to savings deposits in the above HK$500,000 category. Weighted average rates on the three IRRs deposits were 0% for current accounts, 5.43% for savings accounts and 4.51%
for 24-hour call deposits. Deposit distributions are unchanged.
Ø Scenario 5 - the fifth scenario follows the logic of the econometric model and Scenario 4, but assigns an even narrower spread between comparable deposits below and above HK$500,000. The scenario assumes that weighted average rates on savings and 24-hour call accounts are 25 basis points below 1997 deregulated interest rates in comparable deposit categories above HK$500,000. Weighted average rates on the three IRRs deposits were 0% for current accounts, 5.68% for savings accounts and 4.76% for 24-hour call deposits. Deposit distributions are unchanged.
Ø Scenario 6 - the sixth scenario follows the logic of the econometric model by assuming the 140 basis point equilibrating differential between savings account rates and 1-month time deposit rates for accounts under HK$500,000. The scenario assumes that weighted average rates on savings accounts are 4.71%. Current
accounts remain at 0%, and 24-hour call account deposits remain unchanged from the base case at 4.23%. This is the first scenario where deposit distributions are changed. The rate change is assumed in this scenario to reconcile with the econometric model, with savings approximating 70% of total non-current account deposits3and 1-month deposits, accounting for about 12% of non-current account deposits in the under HK$500,000 category. This shift in resource flows is based on all 7-day call, 1-week, and 2-week deposits under HK$500,000 moving into savings accounts, as well as 20% of 1-month deposits under HK$500,000 also moving into savings accounts.
Ø Scenario 7 - the seventh scenario is exactly like the sixth scenario, except that it also adds a 2.00% interest expense to current accounts. Thus, the scenario assumes that weighted average rates on current accounts are 2.00%, savings accounts are 4.71%
and 24-hour call account deposits are 4.23%. This scenario assumes the same change in deposit distribution as in the sixth scenario.
Ø Scenario 8 - the eighth scenario assumes virtually no change from the base-case (Scenario 1), except that current accounts receive 2.00% interest. Thus, the scenario assumes that weighted average rates on current accounts are 2.00%, savings accounts are 4.13%, and 24-hour call account deposits are 4.23%. This scenario assumes the same deposit distribution as in the base-case.
Ø Scenario 9 - the ninth scenario assumes rates on current accounts and savings accounts receive the same interest rate (virtually eliminating any financial distinction between them) set at base-case rates for savings accounts in 1997. Thus, the scenario assumes that weighted average rates on current accounts are 4.13%, savings accounts are 4.13% and 24-hour call account deposits are 4.23%. This scenario assumes the same deposit distribution as in the base-case.
Ø Scenario 10 - the tenth scenario assumes the high-cost impact of Scenario 5, plus the additional cost of current accounts receiving 2.00% interest. Thus, the scenario assumes that weighted average rates on current accounts are 2.00%, savings accounts are 5.68% and 24-hour call account deposits are 4.76%. This scenario assumes the same deposit distribution as in the base-case.
Ø Scenario 11 - the eleventh scenario assumes the highest-cost scenario, in which weighted average rates on savings and 24-hour call accounts are 25 basis points below 1997 deregulated interest rates in comparable deposit categories above HK$500,000 (from Scenario 5), and where current accounts receive the same interest rates as savings accounts. Thus, the scenario assumes that weighted average rates on current accounts and savings accounts are 5.68% and 24-hour call account deposits are 4.76%. This scenario assumes the same deposit distribution as in the base-case.
3
The econometric model shows a distribution of 72% savings among non-current account deposits in the < HK$500,000 category.
Table 1.2.2 Overview of FSM rate assumptions by scenario
Scenario Assumptions Scenario 1 No changes
Scenario 2 Savings and 24-hour call deposits under HK$500,000 are 50 basis points above the 1997 weighted average.
Scenario 3 Savings and 24-hour call deposits under HK$500,000 are 100 basis points above the 1997 weighted average.
Scenario 4 Savings and 24-hour call deposits are 50 basis points below 1-week and 24-hour call accounts above HK$500,000.
Scenario 5 Savings and 24-hour call deposits are 25 basis points below 1-week and 24-hour call accounts above HK$500,000.
Scenario 6 Savings rates are 140 basis points less than 1-month rates, savings and 1-month deposit account shares rise to 70% and 12% of non-current account deposits under
HK$500,000.
Scenario 7 Savings rates are 140 basis points less than 1-month rates, savings and 1-month shares rise to 70% and 12% of non-current account deposits under HK$500,000. Current account pays 2.00%.
Scenario 8 Current accounts pay 2.00%, with no change in other rates from 1997.
Scenario 9 Current account interest rates rise to level equal to savings rates.
Scenario 10 Savings and 24-hour call deposits are 25 basis points below 1-week and 24-hour call accounts above HK$500,000, or 5.68% and 4.76% respectively. Current account interest rates rise to 2.00%.
Scenario 11 Savings and 24-hour call deposits are 25 basis points below 1-week and 24-hour call accounts above HK$500,000, or 5.68% and 4.76% respectively. Current account interest rates rise to level equal to savings rates, or 5.68%.
1.3 Summary of scenario results
The major findings from the various scenarios concern the degree to which these assumptions impact interest expense ratios, and the magnitude of interest expense that would have to be recovered (through higher lending rates or incremental fees) to compensate for otherwise foregone net interest income and margins. Table 1.3.1 provides an overview of the financial impact of adjustments made by scenario and summarises the financial impact of key interest expense developments on an aggregate basis, as well as in terms of the impact each scenario’s results would have on the net interest margins of local and foreign banks.
Table 1.3.1 Financial impact of modelled adjustments to interest rate regulations by scenario
(HK$million, %) Scen. 1 Scen. 2 Scen. 3 Scen. 4 Scen. 5 Scen. 6 Scen. 7 Scen. 8 Scen. 9 Scen. 10 Scen. 11 Effective interest rate on:
IRRs current accounts 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 2.00% 2.00% 4.13% 2.00% 5.68%
IRRs savings accounts 4.13% 4.63% 5.13% 5.43% 5.68% 4.71% 4.71% 4.13% 4.13% 5.68% 5.68%
IRRs 24-Hour call accounts 4.23% 4.73% 5.23% 4.51% 4.76% 4.23% 4.23% 4.23% 4.23% 4.76% 4.76%
Financial impact of adjustments:
Total interest expense 175,729 177,487 179,244 180,288 181,167 176,817 178,979 177,891 180,195 183,330 187,310
Int. exp. on HK$ deposits > 500,000 42,100 42,100 42,100 42,100 42,100 42,100 42,100 42,100 42,100 42,100 42,100
Int. exp. on HK$ deposits < 500,000 24,864 26,621 28,379 29,423 30,302 25,951 28,114 27,026 29,330 32,465 36,445
Interest expense on IRRs deposits 14,524 16,282 18,040 19,084 19,963 17,155 19,318 16,687 18,990 22,125 26,105
Net differential in interest expense - 1,758 3,516 4,560 5,438 1,088 3,251 2,163 4,466 7,602 11,581
Net interest income 61,607 59,849 58,091 57,047 56,168 60,519 58,356 59,444 57,141 54,005 50,026
If net interest margin is defined as net interest income/average interest earning assets, the result will be:
Local banks (23 institutions) 2.51% 2.43% 2.36% 2.31% 2.28% 2.43% 2.34% 2.42% 2.32% 2.18% 2.01%
Foreign banks (17 institutions) 1.13% 1.10% 1.07% 1.05% 1.04% 1.10% 1.07% 1.09% 1.06% 1.00% 0.94%