In response to the above article "Problems and Risks Facing Hong Kong as a Financial Center", the United States has entered a "interest rate hike cycle". Due to the relatively abundant funds in the Hong Kong banking system, the Hong Kong interbank interest rate discount has not y

undertakes the above "Problems and Risks Facing Hong Kong as a Financial Center (1/4)"

3) The risks posed by the US "rate hike cycle" to Hong Kong banks

At present, the United States has entered a "rate hike cycle". Due to the relatively abundant funds in the Hong Kong banking system, the temporary Hong Kong interbank interest rate hike has not yet fully reflected the extent of the US interest rate hike . Market insiders generally believe that when the linkage exchange rate system is effective, no one is worried about the risks brought about by the US dollar's interest rate hike. In addition, considering the lessons learned in 1997 in the last century, the HKMA also imposed a series of supervision and restrictions on banks, and most people do not think that the financial crisis will happen again.

It is definitely a good thing that market participants have confidence in the Hong Kong financial system. But it is worth noting that if the United States continues to raise interest rates sharply, can we effectively deal with the risks?

• Stress test on Hong Kong banks: We have entered a low-interest environment for more than 20 years. Generally, when Hong Kong banks calculate their own or their customers' risks and conduct stress tests, they will not assume that interest rates will rise sharply. If the rate hike is estimated to be 2% to 3%, it is considered very conservative. But now the United States has raised interest rates by 2.25% in just a few months; how long will the US dollar "rate hike cycle" last? What will the final extent? The current stress test of the banking system requires assuming how much interest rate hikes in the United States will eventually be? Or conversely, to what extent will the United States raise interest rates pose a considerable risk to the Hong Kong banking industry? For the time being, there is still no relevant specific research or discussion in the Hong Kong financial industry. Will there still be loopholes in the effective regulatory mechanism of
• ? Since 1997, the HKMA has made some reforms and patches to and contact the exchange rate . At that time, the President of the HKMA was Ren Zhigang, and the relevant reforms were called "Ren Qiying" in the market. In addition to the "Seven Tricks", the HKMA summarized the lessons of the financial crisis in 1997 and carried out a series of supervision of banks' real estate loan business. It launched the "Prudential Measures Guidelines" around 2012, and has been continuously refined and adjusted in the past 10 years. But will the above effective regulatory mechanism still have loopholes? Faced with the sudden sharp interest rate hike in the United States, what else do we have to pay attention to?

At the contact exchange rate, the Hong Kong government has given up the "monetary policy" to a certain extent. The Hong Kong dollar is linked to the US dollar, but it is only naturally adjusted according to the market mechanism. The HKMA can only passively take over the Hong Kong dollar sell orders to maintain the exchange rate . In other words, although the Hong Kong dollar is tied to the US dollar, the HKMA does not have a mechanism to "actively raise interest rates" in actual market operations. Even the "discount window" of the HKMA still has very open and transparent calculation methods. Simply put, everything is left to the market; the HKMA can only "mechanically" hold the exchange rate, but it has no substantial control over the range and timely adjustment of interest rates.

Are the derivatives related to the regulatory contacts related to exchange rate in place? Due to the abundant funds of Hong Kong banks, interbank interest rates have not fully kept up with the pace of the US dollar. But this has created an opportunity for exchange rate to "discard" and allows international hedge fund to make money. If there is enough funds involved in the "home-away" and the funds in the Hong Kong banking system are further reduced, the Hong Kong dollar interest rate distribution is definitely likely to "chase the dragon", and the interest rate hike can exceed the US dollar at any time.

Because the Hong Kong dollar has been linked to the US dollar for a long time, there have always been many derivative instruments in the market for international capital speculation and hedging . It is well known that in the financial world, the market for futures and derivatives can be larger than the spot market; even in the spot market, we have a full US dollar basis, but as long as there is a larger amount of capital invested in those futures and derivatives markets, this force still has the opportunity to in turn affect the spot market.

We must not underestimate the risks just because the spot market is backed by 100% US dollars.Has the policies formulated by the HKMA based on the lessons learned in 1997 been moving forward with the times? Are our supervision of the new generation of financial instruments in place?

Interbank interest rate may exist: Currently, the interest rate on the interbank interest rate on Hong Kong is low compared to the US dollar. Is this worth being happy? The United States has begun to use SOFR rate and deprecate LIBOR rate; the new calculation method is relatively open and transparent. However, under the objective situation, Hong Kong still uses HIBOR rate (Hong Kong Interbank Offering Rate), and the Hong Kong dollar overnight average index (HONIA) is currently only listed as a reference indicator.

Hong Kong interbank interest calculation method is to refer to the borrowing costs of 20 major banks. Let’s focus on the computer system of interbank interest rates regardless of whether the HKMA’s supervision of the quotations of these 20 banks is sufficient.

Currently, there are about 163 licensed banks, 17 restricted license banks and 13 deposit-accepting companies in Hong Kong. In addition, we have 42 foreign banks that have representative offices in Hong Kong. Although the average borrowing costs of 20 major banks are considered representative, the borrowing costs of the remaining more than 100 small and medium-sized banks are obviously different from those of major banks. In the event of an economic recession and a financial outbreak, the cost difference between large banks and small and medium-sized banks will be even greater.

What is the problem with this? Although the average borrowing costs of the 20 largest banks in Hong Kong are still at a low level, the borrowing costs of more than 100 banks have a chance of higher than HIBOR. According to industry practice, banks provide loans to customers, most of which will be based on HIBOR. When there is a relatively shortage of money in Hong Kong, if the borrowing cost of a small and medium-sized bank itself is much higher than that of HIBOR, the loan it provides to customers may lose money.

Hong Kong banks are willing to invest in the bond market, and the interest rate hike period will impact the relevant asset quality: US dollars enters the "interest rate hike cycle", and there is also a chance to directly impact the bank's asset quality. Due to the fierce competition among Hong Kong banks, the profits of the loan business are becoming increasingly meager. Many small and medium-sized banks do not easily "lend" after "absorbing deposits". Because the returns on bank loans are too low, many small and medium-sized banks will invest their deposits in the bond market. For example, participating in syndicated loans to a large company may only earn less than 1%. But the company may have a 3% to 5% return on issuing bonds. Especially small and medium-sized banks with higher capital costs, of course, tend to invest their funds in the bond market.

Referring to the experience in 2008, banks generally tend to buy low-risk international bank and insurance company bonds. They will also purchase bonds from high-quality local businesses. Since banks in Hong Kong all know how to diversify their investment, what is there to worry about?

• Banks have been very relaxed in approving their own investment bonds: Traditionally, Hong Kong banks have been much more rigorous in approving personal loans and corporate loans, and related analysis and research will be more complicated. Relatively speaking, the process of buying bonds is far simpler.

For example, if a bank participates in a company's syndicated loan, the approval process will be more, and it will be approved layer by layer, and it will even report to the credit review committee. The relevant report has at least dozens of pages, and all risks must be taken into consideration and must not be careless.

But what if the bank intends to purchase bonds issued by the same company? The relevant application is not handled by the corporate loan department, but is carried out by the treasurer department, and the required process is much simpler. Do they need to do an analysis report? The style of the Treasury Department is to compete every second, and the application form is usually only one or two pages. To put it bluntly, it depends on the company's international rating and revenue. According to the author's past experience, the treasury departments of many banks often only apply to the credit review department for debt purchases in the form of email, and do not even use a serious written credit review application report. This "easy approval" model of bonds may also make banks unconsciously bear more risks.

• Banks invest in corporate bonds, which is more risky than traditional lending business: Why does the bank's return on buying bonds be higher than bank loans? Ultimately, bank loans are the main business, and bond investment is just a side business to increase returns.Whether it is a bilateral or syndicated loan, the terms involved are all "overlord clauses" mentioned in the market, which will better protect the bank. Since the essence of a bank cannot be regarded as a 100% commercial institution, the deposits held in the hands are an important asset of the people. When banks lend out related loans, they need to protect the interests of depositors, and the loan terms will naturally be relatively "one-sided"; banks will naturally have more restrictions on lenders.

As for the bond investment made by the bank itself, its role will be the same as other bonders and can only be considered one of the investors. The terms of corporate bonds will be fairer, and the relationship between borrowers and lenders will be much more equal. In principle, bondholders enjoy only lower security than bank lenders.

Due to different terms on loan and bond contracts, even if the borrower is the same company, the loan cost will be different. In addition, bilateral or syndicated loans may also have collateral, but bonds generally do not have substantial collateral. In any case, Hong Kong banks tend to buy corporate bonds. Even if their related investments are diversified, the overall risk has been improved compared to focusing on loan business.

• Will Hong Kong banks fully consider the latest interest rate hikes when investing in bonds? bank loans are mostly based on HIBOR base, which is a floating interest rate return. Bonds are mostly fixed interest income, and their value will fall during the "interest rate hike cycle". Banks of all sizes and big banks in Hong Kong have enjoyed a low interest rate environment of more than 20 years. In the past, when investing in corporate bonds, of course, they would not consider the interest rate hikes that only occurred this year.

According to data, from 1953 to 2022, the long-term interest rate in the United States was about 5.02%. Among them, it rose sharply to 15.32% in 1981. If the total interest rate hike of the US dollar this time is not 2% to 3%, but 5% or more, what will the asset quality of Hong Kong banks? When interest rates are raised, bond prices will fall. If the prices of corporate bonds plummeted, will Hong Kong banks all major and small to deal with it?

(The article is the second article, a total of 4 articles, to be continued)

article: Hanbai