1.8 Interest Rate Rules .1 Background
1.8.4 The impact of partial deregulation
Following partial deregulation, the HKMA has been monitoring the impact that this has had on the market. A report37 prepared by the HKMA in August 1995 reviewed the impact of the first two phases of interest rate deregulation on deposit movements, interest rates, banks funding costs and profitability. The principal conclusions of the report were that:
Ø deregulated time deposits increased significantly during the first nine months following deregulation (October 1994 to June 1995);
Ø following sharp fluctuations in January 1995, deposit movements between types of deposits (i.e. between different maturities or from swap deposits to deregulated HK$
deposits) stabilised from February to June 1995;
Ø most of the 40 banks included in the survey maintained their market share in HK$
deposits;
Ø interest rates on non-regulated time deposits moved closely in line with the interbank rate (HIBOR);
Ø the effect of deregulation on banks’ interest expense was not significant, but might become so if competition for HK$ deposits intensified; and
37 The report surveyed the deposit structure and interest rates offered by the 40 active deposit taking banks.
Ø the net interest margin of banks surveyed dropped only slightly, which suggested that deregulation did not have a significant impact on profitability.
It was noted, however, that these results should be viewed in the context of the less competitive environment for HK$ deposits in the first half of 1995. We have reassessed these conclusions in the context of the period from June 1995 to June 1998, in terms of HK$ deposit growth and volatility, interest rate volatility, net interest margins and profitability.
Deposit growth
The trend that the HKMA had noted in its report regarding the rapid growth of deregulated time deposits has continued. Growth over the period from September 1994 to June 1998 was 950%, or HK$210billion. In contrast, deposits that had never been subject to the IRRs (i.e. principally those of HK$500,000 or more) grew at a much slower rate (65%) over the same period. Those deposits still covered by the IRRs (i.e.
current accounts, savings accounts and short-term time deposits less than 7-days) have increased slightly (4%), but at a much slower rate relative to the overall growth of the deposit base (61%) over the period. Swap deposits have continued to decrease since the HKMA review in 1995, registering a drop of HK$27billion (44%) between June 1995 and June 1998. IRR deposits at present account for HK$387billion (approximately 27%
of total HK$ deposits for these institutions), compared to HK$372billion (42% of total HK$ deposits) in September 1994 (see Table 1.8.2):
Table 1.8.2 Growth of HK$ deposits for 40 surveyed authorized institutions
Sept 1994 HK$m
June 1995 HK$m
June 1998 HK$m
% change to June
1995
% change to June
1998
Current accounts 92,184 86,489 79,870 -6% -13%
Savings accounts 279,329 274,899 305,919 -2% 10%
Other IRR accounts 741 784 1,041 6% 40%
Total IRRs deposits 372,254 362,172 386,830 -3% 4%
Deregulated time deposits 24,723 105,782 234,812 428% 950%
Swap deposits 101,439 62,741 35,177 -38% -65%
Other non-regulated deposits 389,471 456,127 808,716 6% 65%
Total non-regulated deposits 515,633 624,650 1,043,528 21% 102%
Total HK$ deposits 887,887 986,822 1,430,358 11% 61%
Source : HKMA survey of 40 authorized institutions
Deposit volatility
Deposit volatility can be assessed through three principal measures:
Ø deposit movements between different maturities of deposits (i.e. change in the term structure of the deposit base);
Ø deposit movements between banks; and
Ø deposit movements between currencies (i.e. HK$ and foreign currencies).
Movements between maturities
Deposit movements (between different maturities of HK$ deposits) continued to remain relatively stable until September 1997, the start of the Asian crisis. During this period, all types of deposits grew but time deposits grew at a faster rate than savings accounts or demand deposits (principally current accounts). Since then, there has been a shift of deposits from savings and demand deposits into time deposits. For example, the level of savings accounts grew steadily from January 1995, reaching a peak total of HK$381billion in June 1997. Since then, savings balances have decreased in a volatile manner, by HK$71billion to HK$310billion at the end of September 1998. Demand deposits show a similar picture, reaching a total balance of HK$128billion in July 1997 but decreasing by HK$39billion to HK$89billion as at the end of September 1998.
Conversely, time deposits have increased in the period from July 1997 by HK$152billion (see Chart 1.8.1). This has reduced the stability of the deposit base as deposits have moved into more interest sensitive and mobile deposits (time deposits are typically more mobile between banks than savings accounts).
-2 0 0 , 0 0 0 4 0 0 , 0 0 0 6 0 0 , 0 0 0 8 0 0 , 0 0 0 1 , 0 0 0 , 0 0 0 1 , 2 0 0 , 0 0 0 1 , 4 0 0 , 0 0 0
Sep-94 Dec-94 Mar-95 Jun-95 Sep-95 Dec-95 Mar-96 Jun-96 Sep-96 Dec-96 Mar-97 Jun-97 Sep-97 Dec-97 Mar-98 Jun-98 Sep-98
HK$ million
Demand Savings T ime
Source: HKMA Monthly Statistical Bulletin
Chart 1.8.1 Customer deposits by type (HK$)
Mobility of deposits between banks
Based on the survey of deposits taken by the 40 main deposit-taking banks, there has not been any significant change to the market share held by individual banks since June 1995. However, this does not necessarily imply that deposits are less mobile because market share does not necessarily capture the dynamics of deposit movements between banks. It only indicates that banks have been able to maintain market share, which could have been the result of competing aggressively to attract deposits to replace those that have been lost.
In fact, in interviews with banks, many indicated that they have experienced significant deposit mobility and have needed to increase interest rates substantially to attract new deposits to maintain market share. This deposit mobility has been most pronounced in the market for larger deposits (i.e. over HK$500,000) and this has been demonstrated by the substantial premium over HIBOR (sometimes 2% or more) that banks have been prepared to pay in order to attract or retain deposits. Preferential rates have also been offered on smaller deposits, although to a lesser extent. This competition has come from all banks irrespective of size, although it is the smaller banks that have experienced the most strain.
HK$ versus foreign currency deposits
Prior to partial deregulation of the IRRs, foreign currency deposits represented approximately 48% of total deposits and were reasonably evenly divided between US$
deposits and other foreign currency deposits. This position had not changed up to June 1995. However, since then, although foreign currency deposits have continued to grow, they have decreased relative to HK$ deposits, and by June 1998 their share had dropped to 43% of total deposits (see Table 1.8.3):
Table 1.8.3 Growth of foreign currency deposits
Sept 1994
US$ deposits 475,328 504,671 729,779 6.2% 53.5%
Other foreign currency
Total HK$ deposits 983,724 1,108,159 1,641,444 12.6% 66.9%
Foreign currency deposits as a % of total deposits
48% 48% 43% -
-Source : HKMA Monthly Statistical Bulletins
This increase in the proportion of HK$ deposits relative to total deposits has occurred over the whole period, as the HK$ deposit base has grown. However, in the period since September 1997, total HK$ deposits (HK$1,563billion as at the end of September
1997) decreased by 6% in the period to January 1998, but have been growing again since then and, at the end of September 1998, totalled HK$1,607billion.
The picture regarding foreign currency deposits is not as clear. Although in this period, US$ deposits increased reasonably steadily up to the start of the Asian crisis, since then, their growth has accelerated, while other foreign currency deposits have decreased. For example, in the period from September 1997 to January 1998, HK$ deposits decreased by HK$98billion, whereas US$ deposits increased by HK$102.7billion. Therefore, it appears that depositors shifted HK$ deposits into US$ deposits. However, in the period since then up to September 1998, HK$ deposits increased by HK$142billion and US$
deposits increased by HK$94.8billion, while deposits in other foreign currencies have decreased by HK$24.2billion. This decrease in other foreign currency deposits reflects declines in the value of currencies in relation to the HK$ over this period (e.g. the Japanese Yen), as well as deposit movements.
The overall movement of deposits between currencies has had an impact (from time-to-time) on the availability of HK$ deposits, further intensifying competition during times of HK$ shortages. This movement, to an extent, reflects the changing levels of confidence in the HK$/US$ peg and interest rate differentials between US$ and HK$.
Impact on deposit volatility
Deregulation has had an impact on volatility in that it increases the potential for movement of deposits between different maturities, different banks and different currencies. This potential is often realised at times of uncertainty as has been evidenced during the Asian crisis. In contrast, prior to the Asian crisis, there had been a relatively long period of stability in banks’ deposit bases, even though deposits had been deregulated. While the majority of deposit volatility (since the Asian crisis began) has occurred in deposits that were never subject to the IRRs (i.e. over HK$500,000), deregulated deposits have also become more volatile.
The main conclusion that can be drawn is that the extent of deposit volatility and its relationship with deregulation (i.e. allowing free competition) involves complex interactions between a number of wide-ranging variables (e.g. interest rates, amount of competition in the sector and levels of depositor uncertainty).
Interest rate volatility
Following partial deregulation of the IRRs, banks adjusted their interest rates on the newly deregulated accounts to closely match HIBOR rates. This has continued to be the situation even during the Asian crisis, although the difference between the rates quoted for deregulated deposits and HIBOR has at times increased and the volatility of all HIBOR-based deposit interest rates has increased substantially.
As an example, prior to deregulation in January 1995, the 1-month time deposit rate increased in stages as HIBOR increased but with a time lag. At deregulation, the rate spiked to closely match HIBOR. Thereafter, the 1-month time deposit rate has settled to closely track below the 1-month HIBOR at a spread of around 0.75% until the start of
the Asian crisis. Since then, both the 1-month time deposit rate and the 1-month HIBOR rate have shown considerable volatility (see Chart 1.8.2):
The interest rates shown in the chart above are average board or quoted rates for the sector. The range of rates quoted by individual banks for time deposits varies and this variation is not reflected in sector averages. For example, at the end of September 1998, the 1-month time deposit rate quoted by individual banks ranged between 7.00% to 8.13%. Additionally, individual banks have at times been prepared to pay preferential or unquoted rates to attract deposits, which, at times, have been in excess of HIBOR.
This implies greater volatility than is evidenced by the quoted rates of individual banks.
Net interest margins
In August 1995, the HKMA noted in their report that the effect of deregulation on banks’ interest expense was not significant and that deregulation did not have a significant impact on banks’ profitability overall. These trends continued until June 1997 and interest margins of banks increased over this period (see Table 1.8.4). It should be noted that this increase in interest margin occurred during a period of stable or slightly declining interest rates and was also the result of strong loan growth. In particular, this growth has been in more profitable mortgage loans, which increased the yield from banks’ loan portfolios and consequently produced better profitability and margins.
0 2 4 6 8 10 12
Sep-93 Dec-93 Mar-94 Jun-94 Sep-94 Dec-94 Mar-95 Jun-95 Sep-95 Dec-95 Mar-96 Jun-96 Sep-96 Dec-96 Mar-97 Jun-97 Sep-97 Dec-97 Mar-98 Jun-98
%
1 mth time deposits 1 mth HIBOR Chart 1.8.2 1-month time and HIBOR interest rates
Source: HKMA Monthly Statistical Bulletin
Table 1.8.4 Average net interest margins
Jun 1998 Dec 1997 Jun 1997 Dec 1996 Jun 1996 Dec 1995 Jun 1995 Average net interest
margin for local banks 2.31% 2.39% 2.48% 2.55% 2.62% 2.57% 2.40%
Average net interest
margin for the sector 1.10% 1.03% 1.14% 1.15% 1.12% 1.06% 0.98%
Note: Annualised average figures for the preceding six months.
Source : HKMA (internal)
Profitability of banks continued to be strong and record profits were witnessed at some banks in the period from June 1995 up to the interim results for June 1997. However, the extreme conditions and volatility experienced since then have seen competition for time deposits intensify as banks competed for deposits which were growing at a much slower rate. To illustrate this, total HK$ deposits have only increased by 2.6% in the year to September 1998, against an increase of 22.6% in the year to September 1997.
This competition for deposits was exacerbated with foreign banks actively competing for HK$ time deposits in order to avoid reliance on the interbank market.
Increased competition for deposits has affected funding costs and therefore net interest margins for all banks. The picture for local banks over the last year has been one of stagnant loan growth, with higher interest expense and declining interest margins (see Table 1.8.4). In 1998, net interest margins for local banks have decreased by approximately 7% or 17 basis points compared with the first half of 199738. However, this overall percentage conceals wide variations among banks, depending on funding costs, deposit bases and loan portfolios.
Impact on bank profitability
Therefore, in contrast to the conclusion of the HKMA in August 1995, the increased competition for HK$ deposits during the Asian crisis (principally reflected in the volatility of deposits and interest rates) is having a significant impact on banks’
profitability.
This provides good evidence to support the HKMA’s current concern over increased interest expense and decline in profitability when competition for deposits intensifies.
This competition, coupled with declining asset quality has raised some concerns over the stability of the sector as a whole. However, this should also be viewed in the context of the exceptional situation caused by the Asian crisis, where there has been a substantial slowdown in growth in all aspects of the Hong Kong economy and spikes in interest rates caused by speculative attacks on the currency.
Nevertheless, the potential impact of further deregulation of the IRRs on the profitability of the banks (therefore increasing potential systemic risk) is one of the most important issues in the assessment of the IRRs in the current environment and warrants in-depth and careful analysis. Further analysis has been conducted by way of models
38 Source: KPMG Banking News September 1998, Listed banks’ 1998 interim results
designed to provide an indication of the impact of further deregulation (see Section 1.8.8 Modelling change).
1.8.5 Assessment of the interest rate rules