Introduction
The Hong Kong Interbank Offered Rate, commonly known as HIBOR, is the critical benchmark interest rate representing the cost of borrowing and lending between banks in Hong Kong dollars within the local market. HIBOR is pivotal for lenders and borrowers engaged with the Asian economy. By December 2020, plans were already in motion to transition from HIBOR to the Hong Kong Overnight Index Average (HONIA).
How HIBOR Works
Banks employ the interbank market to facilitate the transfer of funds, manage currency, and ensure liquidity. When a Hong Kong bank finds its short-term cash reserves nearing depletion due to withdrawals, it resorts to borrowing in the interbank market at the HIBOR rate, with loan terms ranging from overnight to one year.
HIBOR is calculated every day at 11:00 a.m. local time, based on quotations from 20 selected banks under the Hong Kong Association of Banks (HKAB). To finalize the rate, the highest and lowest three quotes are excluded, averaging the remaining 14.
Practical Applications
HIBOR’s chief function is to serve as a reference rate for various financial products and instruments in the Asian markets. This includes government and corporate bonds, mortgages, and various derivatives such as interest rate swaps.
Example: Interest Rate Swap
Consider an interest rate swap involving two counterparties with strong credit ratings, both issued in Hong Kong dollars. This would typically be quoted in HIBOR plus a designated percentage.
Example: Floating-Rate Note (FRN)
Take a Hong Kong dollar-denominated floating-rate note (FRN). For instance, this could pay coupons based on HIBOR plus a margin of 35 basis points (0.35%) annually. Here, the one-year HIBOR is utilized, with a 35 basis point spread determining the bond yield each year. If the one-year HIBOR rate is 4%, the returns are 4.35% of the par value by year-end. This spread modifies based on the issuer’s creditworthiness.
Critics and Future of HIBOR
The Asian economic kidney since the 1997 crisis bred concerns about HIBOR’s volatility and liquidity, shaking its value as a benchmark. Simultaneously, the global reputative standard LIBOR, tarnished since its 2012 scandal, is phasing out by 2023. Innovations like the Sterling Overnight Index Average (SONIA) employ real transaction data, mitigating potential manipulation—a benefit for future markets.
Although HIBOR had its scandal in 2013 similar to LIBOR’s, its fixing mechanism was eventually deemed reliable. However, the urge for robust alternatives kindles momentum for new benchmarks like the U.S. Federal Reserve’s secured overnight financing rate (SOFR), bolstered with inputs from the Treasury Department.
Conclusion
HIBOR remains an essential financial instrument within the Asian market context. While poised for transition toward new benchmarks, it serves as a historical linchpin for liquidity and borrowing standards within Hong Kong, influencing a plethora of financial instruments and derivatives.
Related Terms: HONIA, LIBOR, SOFR, interest rate swap, floating-rate note.
References
- Hong Kong Monetary Authority. “Reform of Interest Rate Benchmarks”.
- Intercontinental Exchange, Inc. “ICE LIBOR”.
