Hong Kong Interbank Rate Jump Allows for Arbitrage, Calyon Says

By Bob Chen

Sept. 25 (Bloomberg) -- A surge in Hong Kong's interbank loan rates, stemming from concern the U.S. Congress will delay a proposed $700 billion bank bailout, has opened up an arbitrage opportunity for lenders, Calyon said.

The three-month Hong Kong interbank offered rate, or Hibor, the benchmark for what Hong Kong banks charge each other for loans over that period, rose 36 basis points yesterday to this year's high of 3.66 percent as investors cut holdings of riskier assets financed via the city. That's 18 points above the cost of U.S. dollar loans over the same timeframe, making it worth borrowing the greenback and receiving a higher yield on Hong Kong dollar assets. A basis point is 0.01 percentage point.

Hong Kong's currency board links the exchange rate to the U.S. dollar, meaning the city's interest rates follow that of the Federal Reserve. The currency, which is allowed to trade 5 cents either side of HK$7.8, was little changed at HK$7.766 as of 9:14 a.m. in Hong Kong.

``I think the currency board is going to stay, so in a few months, you can make a risk-free profit,'' said Sebastien Barbe, a currency strategist in Hong Kong at Calyon, the investment banking unit of France's Credit Agricole SA. ``These days, the market is not convinced that the U.S. plan will go through quickly, so you may see a bigger spike in Hibor. But on a mid- term basis I'm convinced the spread over Libor will close.''

The three-month London interbank offered rate for dollars rose 27 basis points to 3.48 percent yesterday, the highest since Jan. 22. The Hong Kong rate rose exceeded Libor on Sept. 23 for the first time since October 2007.

Volatile Markets

``The normal pattern is not being followed right now because of all the volatility in money market rates,'' said David Cohen, an economist at Action Economics in Singapore. ``If the exchange rates between Hong Kong and the U.S. are going to be so closely linked, then the short-term interest rates have to be directly linked. Or there'll be arbitrage opportunities.''

Hibor is climbing as concern banks may fail prompts investors to shun riskier assets. A seizure of credit markets has so far this month forced Lehman Brothers Holdings Inc. to file the biggest bankruptcy in history and prompted the U.S. government to take over the nation's biggest insurer and two largest mortgage-finance companies.

Bank of East Asia Ltd., Hong Kong's third-largest lender, yesterday faced Hong Kong's first bank run since the 1997/98 Asian financial crisis after cell-phone text messages questioned its viability. The bank issued statements saying its financial position is ``sound and stable'' and asked police to investigate the ``malicious rumors.''

``Hong Kong is a platform for global investors to invest in the rest of emerging Asia,'' Calyon's Barbe said. ``When risk aversion increases, it means money will leave Hong Kong and go back to the U.S. or London or Switzerland, for instance.''

Congressional leaders in Washington are weighing new ways to revise a rescue plan for U.S. financial companies after it became clear that U.S. Treasury Secretary Henry Paulson's proposal faces resistance from both Democrats and Republicans.

To contact the reporters on this story: Bob Chen in Hong Kong at bchen45@bloomberg.net;