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The retreat in interest rates set in train by the dramatic events on domestic financial markets this week will lower the funding costs of smaller local banks and hence modestly improve their profit margins, while it nibbles at the revenues earned from surplus funds placed on the interbank market by their bigger rivals.
If that sounds like a break for beleaguered small banks, it is. But the jury is out on how long the relief will last. And, meanwhile, a raft of far more enduring competitive pressures in the industry remain, all of which collectively spell danger for small lenders in an environment in which scale is becoming steadily more important.
Such cautions aside, however, one outcome of the latest turmoil on markets has been the collapse of interest rates on the wholesale money market to all-time lows since data records have been maintained. Three-month Hong Kong Interbank Offered Rates (Hibor) plunged to just 0.88 per cent. That is good for small banks who raise a higher proportion of their deposit funding on the wholesale Hibor market, or by offering time-deposits that earn interest rates that are linked to Hibor. Lower Hibor rates will translate into lower interest rates paid by the banks on those deposits.
But it is not good for big banks that have a higher proportion of their deposits in current or savings accounts which already cost them zero or close to zero (0.01 per cent on savings deposits). In the absence of much loan demand, these big deposit banks must try to earn money on their surplus funds by offering them to smaller rivals, who come for their funds to the wholesale market where rates are now tumbling. That is one side of the interest rate story that unfolded on the market this week. Another side to the story, however, is that across the board, lenders in Hong Kong have managed to insulate themselves to some degree to the retreat in interest rates that has been under way for two years now, by reducing their benchmark prime, or best lending rate - the rate they charge a mythical best borrower - at a slower pace than they have reduced the rates they pay their depositors. Since prime rates remained at 5 per cent this week, and are unlikely to go lower even if the latest interest rate settings remain in place, the funding ``spread widened to 4.1 per cent - a level last seen more than 11 years ago. Why are banks unlikely to respond to latest falls in interest rates by cutting prime? Firstly, they may argue with some justification that Hibor rates are extremely volatile, and what comes down in such a sudden rush, can be expected to go back up again - if not in quite such as rush, at least gradually.
More importantly, however, home loans float at a discount to prime, and many lenders are earning close to zero net interest income on a sizeable portion of their mortgage portfolios. Any further cuts to prime could put these loans close to red-alert territory.
Those home-buyers postponing their plans in the hope of even lower funding costs in the wake of the latest fall in interest rates should weigh these unlikely expectations against the mounting evidence that the property market is turning.
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