Our Ref. : G12/72C

17 December 1999

The Chief Executive
44 Licensed Banks

Dear Sir/Madam,

Self-assessment for Deregulation
of the Remaining Interest Rate Rules

In July 1999, the Hong Kong Monetary Authority (HKMA) announced a package of policy initiatives to further develop the banking sector. One of the initiatives contained in this three-year programme is to deregulate the remaining Interest Rates Rules (IRRs) of the Hong Kong Association of Banks (HKAB) using a two-phase approach. Subject to a stable economic and financial environment, the IRRs on time deposits with a maturity less than seven days will be deregulated on 1 July 2000 and the IRRs on savings and current accounts will be deregulated twelve months after phase 1.

Interest rate deregulation will clearly have implications for the cost and availability of funds for individual banks. It is therefore important that each institution should conduct a full self-assessment of the likely impact on itself in terms of its competitive position, cost of funds and liquidity management.

The HKMA has developed a list of questions covering both phases of deregulation to assist individual institutions to conduct the self-assessment (see Annex). It should however be noted that this list of questions is by no means exhaustive. Individual institutions can modify the list to include other aspects which they think will impact their own business, competitive position, and business strategy.

To help the HKMA to assess the impact of deregulation on the banking sector as a whole, your institution should complete the self-assessment and submit a report (in a format similar to the Annex) to the HKMA for review on or before 18 March 2000.

If you have any queries on this subject, please do not hesitate to contact Mr Edmond Lau on 2878 8111 or Mr Kim Chong on 2878 1848.

Self-assessment for Deregulation
of the Remaining Interest Rates Rules

[Name of Institution]

(A) Executive summary

1. What will be the overall impact of deregulation on your institution - Phase I and Phase II?
2. Which part of the deregulation will have the most impact (time deposits less than 7 days, savings accounts or current accounts)?
3. How and why will your institution's competitive position change vis-a-vis competitors and what changes to your institution's competitive strategy will be necessary (e.g. will your institution refocus its business to more fee based revenue)?
4. What will be the estimated impact in financial terms e.g. absolute amount of operating profits, basis points of net interest margin?
5. What changes to your institution's risk management processes will be necessary?
6. In summary, do you think your institution is well prepared for the planned deregulation?
7. Will the overall impact of deregulation be positive, negative or neutral for your institution?

(B) Competitive position

1. What opportunities and threats does the planned deregulation create for your institution?
2. What will be the financial impact on your institution if (please show calculation)

1. interest rates for time deposits less than 7 days increase by one per cent;
2. interest rates for savings accounts increase by one per cent;
3. banks in general have to pay two per cent interest on the outstanding balance of current accounts; and
4. (a), (b) and (c) happen at the same time?

3. What types of business strategies does your institution plan to adopt in response to the planned Phase I and Phase II deregulation (e.g. tiering of interest rates, changes in pricing strategies for lending, changes in fees and charges for deposit services, changes in target customers etc?)
4. What new products does your institution plan to offer both for Phase I and Phase II deregulation in order to compete effectively? Will your institution be ready to offer these products in time to meet competition (e.g. tiering of interest rates, interest bearing current accounts etc)? Are the systems and the expertise for managing these products in place or being put in place?
5. To what extent will initiatives in (iii) and (iv) help to offset the impact of higher interest rates which might arise from deregulation (please describe your analysis)?
6. What management information will your institution need for implementing the initiatives in (iii) and (iv) (e.g. profitability reports for individual customers and products)? Is the information already being collected? Are the systems for processing such information already in place or being put in place?
7. What assumptions have been made in the above analysis (e.g. the business strategies of other market players, the interest rate environment etc)?
8. Does the assessment of the impact of deregulation on your institution take account of different scenarios (e.g. for the external environment)? What are these scenarios?

(C) Risk management processes

1. What will be the impact of deregulation in terms of liquidity risk both in respect of Phase I and Phase II deregulation (if deregulated deposits are more volatile)?
2. What changes to your institution's risk management process will be necessary to cope with a possible increase in liquidity risk and higher cost of funds (e.g. associated with plans to seek diversified funding sources, more transaction based services attached to savings and current accounts to reduce these deposits' sensitivity to interest rates, expansion of money market activities etc)?
3. What will be the impact of deregulation in terms of interest rate risk in respect of Phase I and Phase II deregulation (e.g. basis risk may increase because interest rates for deregulated deposits are more likely to follow HIBOR while interest rates for lending in Hong Kong are mainly prime based)? Will it affect your institution's existing process for setting prime lending rate?
4. What changes in your institution's risk management process will be necessary to cope with a possible increase in interest rate risk?
5. What other types of risk may change due to deregulation and how will your institution deal with such changes?