Interest rate fears triggered an exodus from listed bank stocks yesterday, as investors braced for a possible 50 basis point rise in corporate borrowing costs. Concerns that a confidence-sapping increase may throw the brakes on loan demand and erode bank profit margins hammered the Hang Seng finance sub-index down 364.55 points, or 2.07 per cent, to 17,245.68. Leading the retreat was Dao Heng Bank Group, which fell 5.97 per cent to HK$31.50, on a volume of 1.88 million shares, compared with a daily average of 1.05 million shares over the past three months. Other banking blue chips were also not spared, with HSBC Holdings slipping 1.74 per cent to $84.25, Hang Seng Bank shedding 2.88 per cent to $67.25 and Bank of East Asia tumbling 3.59 per cent to $16.10. In the process investors brushed aside a solid 31 per cent quarterly increase in net income, to US$121 million, reported yesterday by HSBC's United States operation. 'As of [yesterday] our house view is that the US Federal Reserve will raise its Fed funds rate by 50 basis points, rather than 25 basis points,' said Mehdee Reza, a regional banking analyst at Credit Suisse First Boston. 'That means a higher cost of capital, and banks are always perceived as rate-sensitive because in such an environment demand for loans will fall and margins will get squeezed,' he said. However, Mr Reza agreed with a number of analysts that the knee-jerk reaction of investors might have been overdone. 'The market reaction is not unexpected. But I do believe if we have this same discussion 12 months from now that margins have held up - because banks remain flush with liquidity and funding costs remain relatively low.' Dao Heng Securities banking analyst Emerald Kwai forecast a 50 basis point rise in rates by the Fed at its May 16 meeting, which would be 'fully matched' by an equivalent rate increase in Hong Kong to maintain the currency peg against the US dollar. 'Normally you would expect banks to underperform quite substantially when interest rate concerns are heightened, but they look fairly valued at present levels,' Mr Kwai said. 'This is why we see some analysts picking the sector to outperform, despite the rate cycle.' Core Pacific-Yamaichi bank analyst Bonnie Lai said local rates looked poised to rise 50 basis points and this would lift lending rates to almost 14 per cent in real terms, after taking into account price deflation presently running at about 4 per cent. Hong Kong interbank rates and forward dollar rates have moved up recently on rate concerns, cross-strait tension and a sell-down in the stock market.