The final stages of deregulating the remaining interest rate rules are now in progress. The first phase, which came into effect last week, removes the limitations on time deposits of less than seven days. It will help prepare banks for managing the intensified competition likely to arise from full deregulation in one year's time.
Since the beginning of last week, licensed banks in Hong Kong are now free to quote interest rates for time deposits of duration of less than seven days. This is the first of the two remaining steps in the process of deregulation of deposit interest rates in Hong Kong. This process, involving the gradual and prudent abolition of the Interest Rate Rules (IRR) made by the Committee of the Hong Kong Association of Banks (HKAB), started in 1995, in response to the recommendations of the Consumer Council published a year before.
Earlier, before arriving at the decision to take the first of these two final steps of interest rate deregulation, we asked 44 licensed banks in Hong Kong to conduct a self-assessment of the likely impact of deregulation on their institutions. These 44 banks account for about 94% of the sector's total Hong Kong dollar deposits. The banks in general predict that competition for deposits will intensify after deregulation, adding pressure on their profitability in terms of higher costs of funds, narrower net interest margin as well as higher costs in customer retention and solicitation. However, given that the remaining regulated time deposits only constitute a small fraction of total Hong Kong dollar deposits, the banks generally believe that the impact of the first step of deregulation, which will be implemented on 3 July 2000, will be minimal. But they expect that the second step, which will remove the IRRs on savings and current accounts, will have a more significant impact.
Nevertheless, it is also widely acknowledged that deregulation will provide banks with the opportunity to enlarge their market share of regulated deposits. Small and medium-sized banks, in particular, view this as a chance to compete with large banks for deposits. They consider that a liberalised environment will allow more flexibility in pricing, more room for the provision of innovative banking products and more opportunities to acquire new customers. On a sector-wide level, the banks believe that deregulation will promote greater efficiency in the banking sector and add impetus to the trend towards consolidation in the market.
As the banking supervisor, the HKMA is satisfied with the preparedness of licensed banks in coping with these final steps of interest rate deregulation. There is a high degree of appreciation that competition will intensify and the banks are positioning themselves for meeting this challenge. Indeed, some banks are already exploring new business strategies and building the associated information systems. This is notwithstanding the fact that the second, more significant step concerning savings and current accounts will only take place in July 2001, on the condition that the economic and financial environment continues to be favourable. The banks are also well aware that there will most likely be alterations in the risk profile of their business. The liquidity risk that they face, as deposits become more volatile in a liberalised environment, may increase. So too could interest rate risk, as interest rates on deregulated deposits will likely follow HIBOR rather than the best lending rate. The HKMA will continue to work proactively in partnership with the banks to encourage prudent risk management as the banking sector moves into a more competitive environment.
Separately, the consideration of whether there is a need for a deposit protection scheme - a safety net for depositors - continues. The consultants we have appointed are still working on the subject. We shall consider carefully the report of the consultants when it is available, expected to be at the end of July, deliberate within government and form a view, before public consultation some time in autumn this year.
Joseph Yam
13 July 2000
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