Mortgage Lending

The HKMA welcomes competition between banks but has reservations about mortgage schemes that might involve a bank in taking excessive risks.

Competition for mortgage business continues to be fierce and recently some banks have even started offering mortgages with interest rates well below prime in the first year or so (and close to prime thereafter) in order to attract more business. With penalties clearly laid down for prepayments within the first four or five years, a mortgage rate close to prime after the first year is at least assured. Thus, taking the four or five years as a whole, banks may consider that the "blended" mortgage rate will still give them a reasonable rate of return.

It is, of course, for the banks, and not the Monetary Authority, to decide how they price their business, having regard to the risk, return, liquidity and funding of the business concerned. The Monetary Authority supports competition in this and other areas of banking business, which is beneficial to the consumer and plays a role in making the banking system more efficient. But it is legitimate for the Monetary Authority, as the banking supervisor, to ask whether, in conducting their business according to whatever competitive strategy, the banks are taking excessive risks or engaging in imprudent practices that may be harmful to banking stability in Hong Kong. This, precisely, has been our approach in our discussions with banks on the issue.

We focus on two points. The first is whether a blended interest rate for at least four or five years at prime, or marginally below prime, is prudent pricing. Here, a few factors are relevant. Hong Kong's experience during the Asian financial crisis suggests that the funding cost of banks, using HIBOR as a proxy, could in unusual times temporarily exceed prime. However, with more stable interest rates, made possible by the measures to strengthen our monetary system, the likelihood of such unusual times recurring is now indeed lower. Prime is in any case not fixed, although it would be a brave move for an individual bank to adjust its prime rate ahead of others. The scheduled further liberalisation of the Interest Rate Rules of the Hong Kong Association of Banks may also lead to the spread between deposit and lending rates narrowing. But presumably banks are fully aware of these factors and have taken them into account in arriving at their pricing decisions. Our attitude is therefore to maintain a watching brief over developments on this front.

The second point concerns the up-front concessions granted by banks. These amount to postponing profits from the current year to future years. Indeed, losses may be incurred in the current year as a result. We feel that this would be imprudent, in that banks may have ignored or underestimated the impact of reporting lower profits or losses on market confidence and therefore on their funding cost in the future. Moreover, if the loan goes bad, or if it is refinanced or repaid without the bank enforcing the prepayment penalty, the bank may not recover the value of the up-front concession. The threshold beyond which confidence deteriorates and funding premiums rise sharply needs to be guarded most carefully by banks. It would be very difficult for a bank under pressure on its bottom line to raise prime in isolation. This seems a slippery slope.

Joseph Yam
9 March 2000

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