The HKMA issued a circular earlier this week setting out the treatment of cash rebates within the context of the 70% loan-to-value ratio guideline (70% guideline).
Earlier this week the HKMA issued supervisory guidance to authorized institutions on cash rebates in connection with residential mortgage loans. The details have been widely and accurately reported by the media, and are available in our press release on the subject. So I shall not repeat them here. It would, however, be useful to explain further the rationale behind these measures.
The new measures were released against the background of the intensifying competition for mortgage business. This is not surprising, given the current buoyant state of the property market and the number of new developments on offer. Repayment of outstanding loans arising from the sales of mortgaged properties in a more active secondary property market and increased refinancing activities have also meant that residential mortgage loan books have been running down quickly: banks are therefore trying to find new business, and come up with new attractions, to fill the gap. As a result, there have been a growing number of creative mortgage packages offered by banks, ranging from the offers of large cash rebates to interest or repayment holidays to customers.
Arrangements like these have been causing us concern for a number of reasons. First, there is a possibility that they may be in breach of the spirit of the well-established 70% guideline. At a time when residential mortgages account for more than 30% of lending by retail banks, the loan-to-value ratio continues to be a crucial prudential measure for maintaining the stability of the banking system. We do not wish to see it eroded. Banks should continue to be cautious, as they have been during the difficult years following the Asian financial crisis, and adopt prudent risk management measures to ensure that they are protected in the event of any market correction.
Secondly, while these types of packages make it easier for those wishing to buy a home to do so, they are arguably designed in such a way as to lure homebuyers into committing themselves to obligations that they may have difficulty honouring in the event of an interest rate hike - something that we are likely to see before very long. Because of the large amount of liquidity currently in the banking system, interest rates have been unusually low. But, as we and many analysts have pointed out, the possibility of Hong Kong dollar interest rates rising sharply is quite real. It is only a matter of time, given the Link between the Hong Kong dollar and the US dollar, before they return to normal levels, tracking US dollar interest rates, which are themselves on an increasing trend. And there is the possibility that the process may involve some overshooting.
Thirdly, the creditworthiness or commitment of a borrower who is required to come up with only a nominal down payment is, we believe, not as good as those who can come up with a 30% down payment. Neither is the quality of that loan. Buyers who are required to pay only a small sum upfront may walk away from their mortgages more easily in the event of a significant downward adjustment in property prices.
Fourthly, such creative packages involving only a nominal down payment may encourage speculation in residential property. The dynamics of the property market are a complex subject. What seems to be clear to me, though, is that speculation in residential property has in the past proven to be quite destabilising to our economy and society. While in other more mature and diverse markets, speculation can arguably play a stabilising role, our experience suggests that this is definitely not so for the property market in Hong Kong. Perhaps this is because of the considerable time lag with which supply catches up with demand, and the structure of the market itself, in which there is a virtual oligopoly in the supply of property and the supply of land is controlled by the Government.
I make no comment or predictions on the property market or on property prices. Our concern at the HKMA is with the stability of the banking system. For this reason, the measures introduced earlier this week are not breaking any new ground in terms of policy: they aim at setting out the treatment of cash rebates and interest or repayment holidays within the context of the well established 70% guideline and promoting prudent business practices. Nor should they be interpreted as some form of price regulation for authorized institutions. We have not put a cap on the amount of cash rebate offered by banks. But if the cash rebate is in excess of 1% of the loan amount, banks have to treat it as part of the residential mortgage loan for calculating the loan-to-value ratio in order to protect the integrity of the 70% guideline.
The removal of the Interest Rate Rules of the Hong Kong Association of Banks has had results beyond all our expectations. No one could have predicted that the mortgage rate, relative to prime, could come down by over four percentage points - and with cash rebates thrown in. This has, of course, proven to be a godsend to homebuyers, and a stabiliser following the burst of the property bubble; but we must guard against competitive pressures pushing banks into engaging in imprudent practices.
Joseph Yam
3 March 2005
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