Interest rates on mortgages in Hong Kong are at historic lows. Have they now reached their minimum level?
Readers are aware of the intensive competition among banks in Hong Kong in recent years following, though not necessarily the result of, the complete liberalisation of interest rates through the phased abolition of the Interest Rate Rules of the Hong Kong Association of Banks. The Interest Rate Rules applied to retail deposits, but the competition appears much keener for lending than for deposit taking. Perhaps this is a reflection of the generally ample liquidity in the banking system, made possible by a much more stable monetary system after the monetary reform measures introduced in 1998, and the sluggish loan demand. So, borrowers have benefited, and this has been particularly obvious in home mortgages. Readers are aware of the fact that, relative to "prime", or the "best lending rate", the mortgage interest rate has come down, over a period of about six years, by a total of about 3.5 percentage points - from around prime plus 1.0% in 1998 to around prime minus 2.6% now. And prime has come down too, by a lot over the same period. For this beneficial effect of competition to occur over a period in which property prices have fallen from peak to trough of over 60% has been most helpful.
Some have asked me whether the mortgage rate has reached equilibrium, or some kind of minimum level, relative to the prime rate. Indeed, the net interest margin of the banks has fallen to below two percentage points, which is historically about the lowest level seen in Hong Kong, and quite low by comparison with other major countries. I do not have an answer that I can confidently offer. The banking system of Hong Kong, particularly in the delivery of retail banking services, is probably one of the most cost- efficient in the world and there is always scope for further improvement, through for example the greater use of information technology. But market players, rather than the banking supervisor, should decide whether or not equilibrium has been reached. In absolute terms the mortgage rate, for new mortgages, is now 2.3% to 2.4%, if one factors in the cash rebate and other benefits. On the funding side, HIBOR funding is a couple of basis points overnight and 50 basis points for three-month money, and deposit rates are equally low. We should of course remember that the very loose monetary conditions, as a result of much of the capital inflow we experienced in the fourth quarter of last year remaining in the banking system, is a temporary phenomenon. It is likely that HIBOR will eventually return to a level close to inter-bank rates of the US dollar, although I make no prediction on the timing. In other words, the spread between the mortgage interest rate and HIBOR of less than 2% now will narrow, other things being equal, and this may lessen the scope for further competitive lowering, if any, of the mortgage rate.
But other things are unlikely to remain equal. US dollar interest rates are heading higher. It is just a matter of when. The discount of HIBOR of different maturity from the corresponding inter-bank rates of the US dollar may, as a result, widen rather than narrow, at least as an initial response. And there may be consequential capital outflow through the Currency Board Account, with self-correcting implications for HIBOR. Meanwhile, if indeed macroeconomic adjustment in the Mainland proves benign and the recovery of our economy gathers pace, attracting renewed inflow of funds to our financial markets, and with our current account balance of payments continuing to be in substantial surplus, the discount may be sustained for a longer period.
What has become an anomaly is the continuing use of the terms "prime rate" and "best lending rate". Residential mortgages are among the best assets of banks, but nothing can be better than best. Ideally banks can just quote a residential mortgage rate of, say, 2.4% now, rather than prime minus 2.6%. In fact, the reference to prime unnecessarily links the pricing of mortgage lending to the pricing of other prime based lending, depriving banks of the flexibility of making independent adjustments to the mortgage rate (or the lending rates for other loans). But these are the terms used in mortgage documents and it would be very tedious to have them changed. Perhaps the banks will come around to considering it, or alternatively just start quoting a mortgage rate without reference to prime, when the need for that flexibility is felt. This is of course a matter for the banks.
Joseph Yam
24 June 2004
Click here for previous articles in this column.
Document in Word format
