ENG-2008 — Page 137

Financial and Monetary Affairs 93

Kong Interbank Offered Rates (HIBORS) rose in late May and June. From May to August, the overnight HIBOR gradually climbed. After the collapse of Lehman Brothers, heightened concerns on credit risks and the desire to preserve liquidity resulted in banks refraining from lending to each other. Hong Kong-dollar interbank interest rates increased sharply in tandem with the soaring US-dollar interest rates. Interest rate volatility also rose, and the HIBOR-London Interbank Offered Rate differentials fluctuated sharply, with discounts occasionally turning into premiums suggesting the interbank market was not functioning normally.

A small-scale, rumour-driven run on a retail bank occurred on September 24, 2008 leading to further tightness in the domestic money market. At around the same time, strong demands of Exchange Fund paper by banks for liquidity management purposes drove the (implied) yields of short-dated Exchange Fund paper to very low levels, resulting in a divergence between interbank interest rates. and yields of the corresponding Exchange Fund paper.

The HKMA introduced a series of measures to help contain liquidity and solvency risks in the banking system. It injected liquidity into the banking system by operating within the Convertibility Zone in September and October, purchasing US dollars against Hong Kong dollars. The Aggregate Balance increased to a record high of HK$158 billion on December 31, 2008. It introduced five temporary measures on September 30, 2008 (and two refinements on November 6, 2008) to provide individual banks in need with collateralised liquidity through or outside the Discount Window. On October 14, 2008, the Financial Secretary announced the introduction of 100 per cent deposit guarantee and a Contingent Bank Capital Facility to bolster public confidence in the banking system - both measures will remain in force until the end of 2010. The HKMA lowered the price of liquidity by adjusting the formula for determining the Discount Window Base Rate on October 9, 2008. As the US Federal Funds Target Rate was lowered from 2 per cent to 0-0.25 per cent in the last quarter of 2008, the Base Rate declined to 0.5 per cent at the end of the year.

Following the introduction of these measures since September, the interbank credit market generally stabilised and local interbank rates declined across the board. Efforts around the world to provide liquidity to the markets and an improvement in market sentiment also helped the recovery of the wholesale funding market. The injection of Hong Kong-dollar liquidity by the HKMA also creates an opportunity to provide an accommodative monetary environment to support general economic activity, helping borrowers to overcome the challenges caused by the global financial turmoil.

Exchange Fund

The Exchange Fund was established by the Currency Ordinance of 1935 (later renamed the Exchange Fund Ordinance). Since its establishment, the fund has been responsible for backing Hong Kong dollar note issues. The role of the fund was

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The rate of interest offered on Hong Kong dollar loans by banks in the interbank market for a specified period ranging from overnight to one year.