Background In 2007, the soaring mortgage delinquencies and foreclosures in the United States triggered the sub-prime crisis and soon spread over the world. In this report, major causes of the sub-prime crisis and its impacts on Hong Kong’s economy will be examined. Different measures made by regulators and financial institutions to tackle this crisis will be discussed also. Lastly, evidence about the recovery of Hong Kong will be provided. The sub-prime crisis
In 2007, the collapse of subprime mortgage-backed securities (MBSs) brought to a huge loss among mortgage lenders. Many large financial firms including New Centaury Financial Corporation and Lehman Brothers Holdings Incorporation declared bankruptcy, which resulted in a downturn in the global financial market and a series of chain reactions spreading over the world afterwards. Impact of the sub-prime crisis on the Hong Kong financial institutions After the outbreak of the subprime crisis, the Hong Kong financial market shrank along with the global economic recession.
The stock market in Hong Kong declined from recorded high of 31,000 in October 2007 to 20,700 in March 2008 (Diagram 1) as investors losses their confidence and withdrew money from the market. Moreover, many banks wrote down huge amount of money for numerous sub-prime related securities. For example, HSBC wrote off US$17. 284 billion for potential losses in MBS or MBS related investments (HSBC 2008). Bank of China (Hong Kong) also wrote down HK$550m subprime-linked assets (Liu 2008). Lastly, there was a credit crunch due to the uncertainty about the amount of MBS related assets held by banks and insurance companies.
As a result, many financial institutions reduced loans to each other and increased the interest rate because of high credit risk. Many new companies and corporations were unable to obtain fund to further develop and improve liquidity. Measures undertaken by the regulators and financial institutions In order to strengthen the confidence of the citizens and stabilize the banking system, the Hong Kong Deposit Protection Board strengthened and amended the Deposit Protection Scheme Bill in 2011. The 100 % deposit protection scheme of HK $100,000 was first launched in 2008.
The amount of protection was increased to HK$500,000 in 2011. Besides, the Hong Kong Monetary Authority has made certain measures to deal with the problem. Firstly, HKMA announced a temporary policy which allowed licensed banks to access to liquidity assistance through the Discount Window with US dollar assets and extended the duration of liquidity assistance up to three months on 30th September 2008. These measures helped to improve liquidity within the banking system and further ease pressures in the interbank market (HKMA, 2008).
The Hong Kong Interbank Overnight Offered Rates dropped from 3% to 0. 3% in a few weeks time after the announcement of these measures (HKMA, 2010). Secondly, the HKMA implemented a macro stress testing of the banking sector’s vulnerability to shocks such as the sub-prime crisis. Meanwhile, HKMA used the macroeconomic credit risk models to improve the stress testing of banks’ residential mortgage loans and other loan portfolios (Carse, 2008). The objective of this testing is to help HKMA monitor the banking sector and avoid problems similar to sub-prime crisis from happening in Hong Kong.
Financial institutions wrote off large amount of money and tried to raise money in the market to improve their liquidity. In 2009, HSBC announced a USD$17. 7 billion rights issue. Shareholders were offered five new ordinary shares for every 12 existing shares at a price of HK$28 per new share (HSBC, 2009). This helped HSBC to restore its capital-debt ratio and allowed it to go over bad times without government assistance. Has Hong Kong economy fully recovered? According to the statistic in 2011, the real GDP growth rate was restored to 5% from -2. % in 2009. And the unemployment rate was dropped to pre-crisis level, it decreased from 5. 4% in January 2009 to 3% in December 2011 (Hong Kong Census and Statistics Department , 2012). The supply of money is in an increasing trend as well. Both M3 and domestic credit were having a 10% increase in 2010, compared with a decrease in 2008 and 2009. And the inter-bank offered rate dropped to a very low level of 0. 09% (Hong Kong Census and Statistics Department , 2012). These figures show that Hong Kong economy has restored gradually to pre-crisis level.
However, there are certain hidden problems. Firstly, regulators worry about the inflation problem in Hong Kong after the injection of trillions of funds into the market from the Federal Reserve. Since HK dollar is linked with US dollar, the large increase in money supply in U. S dollar will in turn accelerate the inflation in Hong Kong. Secondly, the case of Lehman Brothers Mini Bond has shown that current regulations on financial products are not sufficient, small individual investors can be misled easily.
Further regulations and monitoring on financial products is necessary. Lastly, after the “lesson” of subprime crisis, many people lost their belief in financial investment which as a result restricted the development of financial market in Hong Kong. To conclude, the subprime does not only cause many adverse consequences to the global financial market including Hong Kong, but also brings some hidden problems. The cooperation between government and financial institutions is vital to help Hong Kong economy recover from the sub-prime crisis.