Interest Rate Risk in the Pricing of Banks’ Mortgage Lending

Abstract

Intensive competition among banks in Hong Kong has driven the effective mortgage interest rates down to a historic low of around 2.75 per cent below best lending rate (BLR) with cash rebates of 1 per cent of loan amounts in general since early December 2004.² This, together with falling interest rates, has brought the average mortgage rate down gradually from over 11 per cent in early 1998 to just over 2 per cent in December 2004 (see Figure 5.1). One key reason why banks can offer such low rates is their extraordinarily low funding cost. The spread of BLR over 3-month Hong Kong Interbank Offered Rate (HIBOR) has been maintained at around 460 basis points (bps) since September 2003, as a result of the abundance of liquidity in the banking sector. At the same time, customers’ deposit rates have also been at very low levels. On average, the spreads of BLR over the average time deposit rate (TDR) and the effective deposit rate (EDR) have been about 500 bps.³

The analysis of this chapter covers the market situation up to January 2005, and uses data up to that month. Since then the market situation has changed, with banks raising their effective mortgage rates, along with the narrowing of risk premium of Hong Kong dollar over the US dollar to a more normal level.