This can be seen in corporate bond markets, where credit spreads can be decomposed into a component measuring firms’ expected probability of default and an “excess” bond premium. The latter has been shown to be a powerful proxy of the risk-bearing capacity of leveraged financial intermediaries. [27] The evidence shows that changes in the excess bond premium can explain virtually all of the conditional response of credit spreads to a change in monetary policy. [28] The reason is that monetary policy tightening typically reduces intermediaries’ risk-bearing capacity, thereby raising the compensation they require for warehousing risk, over and beyond changes in the quality of borrowers’ balance sheet. [29] This is precisely what we have seen in the euro area. In the first half of 2022, the increase in the excess bond premium accounted for 80% of the total increase in corporate bond spreads (Slide 15). By October, it still accounted for around two-thirds of the rise in credit spreads. Portfolio rebalancing channel in reverse The partial reversal of the portfolio rebalancing channel of asset purchases is likely to have amplified this transmission mechanism compared to previous tightening cycles. Indeed, over the course of last year we observed significant portfolio shifts, resulting in large volumes of securities being sold in the secondary market in a short period of time. Non-bank financial institutions, for example, have offloaded a notable part of their holdings of lower-rated corporate and sovereign bonds that they had acquired during the period of asset purchases (Slide 16, lefthand side).
But banks will need to be careful that this process is handled with tact and sensitivity. Otherwise, they may be open to accusations from sections of the community that they are neglecting their social responsibility by curtailing or increasing the cost of basic banking services to the economically disadvantaged. This was certainly the accusation made against the Australian banks after deregulation there. A further aspect is that the possibility of higher and more extensive charges for banking services will make it all the more important for the banks to deliver sufficient information to their customers about these charges. Let me clarify at this point the HKMA’s attitude to ethical matters and particularly the issue of “fairness” to customers. Our main responsibility under the Banking Ordinance is to promote the general stability and effective working of the banking system. In common with banking regulators in other countries, we interpret this to mean that our principal concern should be to determine that individual banks are financially sound and prudently managed. The aim is to reduce the risk of bank failure that would result in depositors losing money and threaten the stability of the banking system as a whole. We concentrate therefore on checking that the banks have adequate capital and liquidity and effective management and internal controls. However, this is not all that we do.