Competition among banks for residential mortgage business is benefiting homebuyers, and banks are managing the related risks effectively.
We have been monitoring closely the competition among banks for residential mortgage loans. This appears to have intensified recently, with some banks quoting a mortgage rate of prime minus 3.15% and others promoting a hybrid-mortgage-pricing product at, for example, three-month HIBOR plus 50 basis points subject to a cap of prime minus 3%. A few others use the Composite Rate that we publish, pricing mortgages at, for example, the lower of C plus 2.4% or prime minus 2.5%.
There is no doubt that competition among banks for residential mortgage loans is benefiting homebuyers. Our concern, as banking supervisor, in accordance with the requirements of the Banking Ordinance, is to promote the general stability and effective working of the banking system. In our monitoring we focus on whether banks are forced by competition to take excessive or new risks that they are not in a position to manage and whether banks have adopted prudent risk management and complied with our prudential guidelines (for example, the 70% loan-to-value ratio guideline) for their residential mortgage business. I am pleased to say that we have not identified any serious supervisory concern regarding residential mortgage business generally.
Readers may not be aware that the proportion of residential mortgage loans to total loans to customers in Hong Kong has in fact been falling, to around 25% at the end of June from about 30% at the end of 2002, although for individual banks this proportion may still be higher. The decline is smaller if loans for property investments are included, but there is still a decrease in the proportion of property-related lending compared with other lending.
Looking at the profitability of new residential mortgage loans, the banks still seem to be doing all right in the prevailing interest rate environment with ample interbank liquidity. Depending on the cost of funding, which differs from bank to bank, the current pricing of new residential mortgage loans offered by banks still allows them to make a reasonable return after taking account of other costs. In terms of return on capital, some banks are still finding the return from residential mortgage loans worthwhile, particularly since residential mortgage loans will qualify for a lower risk weighting under the new capital adequacy requirements, which will apply next year as part of Basel II. We also note that the banks are generally mindful of the effect of more aggressive pricing of their residential mortgage business on their profitability and have been continually assessing and managing the related risks, in particular credit risk and interest-rate risk.
We observe that the pricing for residential mortgages for primary-market transactions in some cases appears to be a bit more aggressive than for secondary-market transactions. But we also notice that this might only be a reflection of marketing incentives or subsidies offered by the developers. The banks are effectively adopting more or less similar pricing strategies for primary and secondary market transactions.
In terms of interest-rate risk, especially what we call basis risk, arising from, for example, a sudden and significant narrowing of the prime-HIBOR spread, the banking sector as a whole remains resilient. This view is based on stress tests that we conduct regularly for banks. We assess the impact on individual banks of various stress scenarios including those involving basis risk. According to the recent test results, the banking sector would be able to withstand the impact arising from a number of stress scenarios. But obviously, basis-risk stress scenarios would adversely affect the financial positions, especially the operating profits, of the banking sector. In certain cases, individual banks might incur operating losses under adverse assumptions. In theory, banks could take remedial actions, such as raising their prime rates, and pass on all or part of the higher funding costs to the borrowers, who should be able to cope with the consequential increase in mortgage payments, with the economy continuing to be robust and, the unemployment rate continuing to come down. If, however, the flexibility for banks to raise their prime rates is limited by market competition, and if the compression of the prime-HIBOR spread were associated with an economic downturn or an adjustment in residential property prices, then the situation might be different. As I have said several times recently, it is important for both the banks and their customers to be aware of this risk and to manage it carefully.
The impact on banking stability of intensifying competition for residential mortgage loans seems benign so far. But we will continue to monitor the situation closely and will not hesitate to take supervisory measures if necessary. We will also maintain continuous contact with the banks.
Joseph Yam
23 November 2006
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