Across The Border

Banks hoping rate rise pace will be ‘just right’

Higher rates good for lazy balance sheets, but if they rise too quickly there is potential for greater defaults, threatening asset quality

PUBLISHED : Sunday, 19 March, 2017, 2:44pm
UPDATED : Sunday, 19 March, 2017, 9:25pm

Like Goldilocks visiting the three bears, banks in Hong Kong will be hoping the pace of interest rate rises will be not too fast, and not too slow, but rather “just right”.

Last week’s interest rate rise was a welcome relief for Hong Kong’s large banks, at least on the surface, following disappointing results for the fourth quarter of 2016.

However, if rates rise particularly quickly there is potential for greater defaults, threatening asset quality.

One reason why banks in Hong Kong do well from rate rises is that they are able to gain better returns on the deposits than they have been unable to lend. In Hong Kong, the loan to deposit ratio was just 68 per cent in 2016, low by global standards.

HSBC makes roughly US$450 million of additional income for each 25 basis point rise in interest rates, and Standard Chartered Group makes an additional US$350-400 million for the first 50 basis point rise in rates, according to calculations by analysts at Bernstein research. The analysts said that the banks’ Hong Kong operations were significant contributors to these figures.

Hang Seng Bank and Bank of China Hong Kong can expect to see their net interest margins rise by 60 basis points in the next two years, analysts at Morgan Stanley estimated in a report from earlier this year which assumed just two rate rises this year and two more in 2018.

So far Hong Kong banks have not really been affected by declining asset quality, though that is now starting to change
Peter Reynolds, partner at Oliver Wyman’s Financial Services in Hong Kong

Interest rates now seem set to rise more quickly than that, with Hong Kong Monetary Authority’s (HKMA) chief executive Norman Chan suggesting that as many as nine 25 basis point rises could be on the cards between now and 2019.

A faster pace of interest rate increases could therefore contribute to an even faster increase in net interest margins.

This is not guaranteed, however, as higher interest rates from banks rising at a faster rate brings with it concerns about asset quality, particularly because Hong Kong’s economy is already slowing.

Last year, Hong Kong’s GDP grew by 1.9 per cent, compared to 2.4 per cent in 2015.

“So far Hong Kong banks have not really been affected by declining asset quality, though that is now starting to change,” said Peter Reynolds, a partner in consultancy Oliver Wyman’s Financial Services practice in Hong Kong.

Bank of East Asia, for example, saw its impaired loan ratio rise to 1.49 per cent in 2016, assigning the increase to a slow down in the macro economy.

DBS Hong Kong also significantly increased its allowances for credit losses in 2016 to HK$1.6 billion from HK$552 million in 2015.

“We are now starting to see loans being extended or being renegotiated and that is going to put pressure on banks’ net interest margins,” said Reynolds.

Speaking on Thursday, HKMA’s Chan also advised individual borrowers to be careful when taking out new loans lest higher rates affected their ability to service their debts.

One other concern for Hong Kong’s banks is whether competitive pressures will force them to cut margins further.

Speaking after last week’s interest rate rise, Dennis Ma, head of research at property consultancy JLL said that he thought that the cost of new mortgages linked to HIBOR (the Hong Kong interbank offered rate) would not rise but rather banks would reduce their spreads – the amount they charge above the benchmark rate.

We expect banks to keep competing for new loans and this will also cause some degree of refinancing of older loans. ... This will reduce the upside to net interest margins” wrote the Morgan Stanley analysts.

This inevitably further eats into banks profit margins.