The key indicator of interest rates in Hong Kong is not the Best Lending Rate, which is increasingly becoming a misnomer, but the Base Rate, which is automatically determined by movements in the US Fed Funds Target Rate.
With competition driving lending rates, in particular mortgage interest rates, down substantially in the past few years, the so-called Best Lending Rate charged by licensed banks in Hong Kong has become a misnomer. Mortgage interest rates, currently at around 4.5%, are substantially below the Best Lending Rate at 6.75%. It sounds as though those servicing mortgages are, to the licensed banks, better than their "best" customers, although I have no doubt that, with the very low default rate even at the worst of times, they are indeed very good customers. But this misnomer will probably remain in view of the fact that some significant lending businesses are still priced against this Best Lending Rate. And it is something that people do look at and are used to, and has long been recognised as the indicator of the level of interest rates in Hong Kong. I have no difficulty with that, notwithstanding the fact that it is, at least from the point of view of the maintenance of monetary stability, not particularly meaningful.
What influences the market exchange rate of the Hong Kong dollar is, of course, the interbank interest rates, particularly those for short term Hong Kong dollar interbank liquidity, in the form of the clearing balances held by licensed banks in their clearing accounts maintained with the Exchange Fund. I am sure readers interested in the subject are familiar with this very important element of the monetary base, which is the total sum in those clearing accounts, and the automatic mechanism in which it may be varied. But I wonder whether readers are familiar with the fact that the interbank interest rates, again particularly those for short term Hong Kong dollar liquidity, are in turn influenced by the level of the Base Rate advertised in the market by us. The Base Rate is the interest rate that we charge licensed banks when they come to the Discount Window operated by us, with Exchange Fund paper, at the end of the day when they find themselves short of liquidity. So the Base Rate is really the meaningful indicator of the level of interest rates in Hong Kong.
Readers may be aware of the fact that the Base Rate is set by us mechanically through the use of a transparent formula, which is the Fed Funds Target Rate plus 150 basis points. With the Fed Funds Target Rate now at 3.75%, our Base Rate is 5.25%. However, even though our Base Rate is 150 basis points higher than the Fed Funds Target Rate, it does not mean that Hong Kong dollar interest rates are necessarily higher than US dollar interest rates. The "premium" of 150 basis points is designed to encourage licensed banks in Hong Kong to manage their interbank liquidity prudently, through imposing a small penal element when they access the Discount Window. Indeed the short term interbank interest rates, under normal circumstances, follow closely those for the US dollar. In fact, the Hong Kong dollar interbank interest rate for overnight money is almost identical to the Fed Funds Target Rate for the US dollar, except that there is in the Hong Kong market no such target.
An important aspect to notice is also that our Base Rate, since its introduction as part of the seven technical measures to strengthen our linked exchange rate system, is automatically determined whenever there is a change in the Fed Funds Target Rate, without any discretion on our part. Even before its introduction in 1998, when we had instead the Liquidity Adjustment Facility, the bid and offer rates of that facility were also automatically determined in a similar way without discretion. (We did, however, initially use the US Discount Rate as reference, but later in September 1996 switched over to using the Fed Funds Target Rate instead, after the US Federal Reserve decided to make timely announcements on changes in the Fed Funds Target Rate. See our paper published in our Quarterly Bulletin of November 1996.)
The interest rate structure in Hong Kong is now very simple, particularly after the final steps taken on 3 July to remove the remaining Interest Rate Rules of the Hong Kong Association of Banks. At the wholesale level, the Base Rate, determined automatically by reference to the US Fed Funds Target Rate, is the key interest rate for Hong Kong dollar funds. It is against the Base Rate that interbank interest rates are in turn determined, having regard to the supply and demand of interbank funds, or the element of the Monetary Base represented by the total of the clearing balances of licensed banks. At the retail level, all interest rates are now freely determined by the licensed banks, but the wholesale interbank rates will continue to have a strong influence. Nevertheless, in terms of interest rates that attract the attention of members of the public, I expect the so-called Best Lending Rate, the mortgage rate and the new basic savings rate to remain rather prominent indicators.
26 July 2001
"Reference Rate for LAF Rates", HKMA Quarterly Bulletin, November 1996 (PDF File, 1115KB)
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