A
It is therefore not certain whether the outright abolition or the gradual erosion of the IRA would lead to higher interest rate costs for Hong Kong dollar borrowers. Indeed it is not even certain whether the net interest revenue received by banks on their Hong Kong dollar loans need be affected by these changes. The net revenue received on lending activities can be defined as:
Loans x (Interest on Loans - Interest on Deposits)
For the net revenue to decline it would be necessary for the percentage increase in loans following the lower interest charges to be smaller than the percentage fall in the interest rate differential (margin) caused by the declining interest on loans and the rising interest paid on deposits. This however would imply that depositors are interest rate insensitive, so that banks do not attract additional funds as they offer higher interest rates. Equally, demand for loans would also need to be interest rate insensitive so that the lower charges do not attract additional borrowing. In an extreme, and hypothetical, case banks could end up lending as much as they did before but receiving a lower interest rate differential (margin) because the changes in interest rates did not attract more depositors or borrowers.
The little econometric evidence which exists for the Hong Kong dollar interest rate responsiveness (elasticity) for Hong Kong dollar loans and deposits points towards relatively low values. In technical terms this means that both borrowers and lenders do not respond to any significant extent when interest rates change, neither however are they completely insensitive to these changes as assumed in the extreme version of events used as an example above. As markets develop and new instruments of borrowing or lending are introduced (low denomination CDs, flexible foreign currency deposits, commercial paper etc.) these elasticities can be expected to increase over time.
Finally, it is important to note that the absolute size of the foreign currency denominated assets or liabilities of the banks can be overestimated in terms of Hong Kong dollars at times when the US dollar is declining against other currencies. For example, estimates for the latter half of 1985 have indicated that this "valuation effect" accounted for nearly 14% of the rise in foreign currency deposits during that time. In addition to this problem there is also the issue of swap deposits which are ultimately payable in Hong Kong dollars. As there is no direct information of the size or the direction in terms of currencies of the swap deposits there is considerable difficulty in adjusting the data in order to arrive at a reasonable estimate. Recent calculations for the local, as opposed to foreign, banks suggest that swap deposits may now account for as much as 54% of the total foreign currency deposits and hence the true (i.e. non-swap) foreign currency deposits represent only 25% of the total deposit base of these banks. Adjustment of this type, including the "valuation effect", do not affect, however, the overall conclusions regarding the increases of the proportion of foreign currency assets and liabilities in the banking and DTC sector in Hong Kong.
January-February 1990
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Asian Monetary Monitor
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