Here's how Hong Kong banks will benefit from lifting of the RMB conversion limit

Is it a positive development or not?.

The HKMA has announced that it is abolishing the daily conversion quota of RMB20,000 per person for Hong Kong residents and banks would be allowed to lend RMB to Hong Kong residents.

According to a research note from Barclays, it is under the impression that the primary purpose of these changes is to support the Hong Kong – Shanghai Connect, which will be launched on November 17.

The report noted that as RMB deposits pay higher interest rates, free conversion could generate higher demand for RMB in Hong Kong.

Thus, Barclays said, RMB deposits may grow at the expense of deposits in other currencies. However, such impact should be minimal.

Meanwhile, more uses of RMB deposits in Hong Kong could have a positive impact on Hong Kong's banking system.

Here's more from Barclays:

Strengthen Hong Kong’s role as a leading RMB offshore centre but the impact to RMB liquidity pool in Hong Kong should be limited: Apart from providing support to Shanghai-Hong Kong Stock Connect, the removal will strengthen Hong Kong’s role as a leading RMB offshore center and will likely to increase the demand for RMB investment products, in our view.

According to the data from the HKMA, RMB deposits in Hong Kong reached RMB944.5bn as of September 2014 and the size of the RMB liquidity pool in Hong Kong is RMB1.1 trillion. The removal of the cap will mainly benefit local residents in Hong Kong because corporate customers were already allowed to exchange RMB with no specific limit on amount.

We do expect an increase in transaction volume of RMB. However, the potential demand from Hong Kong retail customers should be relatively small compared with the RMB liquidity pool and we do not expect the cap removal to have a significant impact to the RMB liquidity pool in Hong Kong.

Minimal impact on deposits in Hong Kong: Lifting of the conversion cap could provide incentive for depositors to convert non-RMB deposits to RMB deposits as RMB deposits pay higher interest rates. Currently, 3-month RMB time-deposits can be paid on average at 2.5% while some banks even offer a rate at above 3.0%.

This compares to the average 3-month HKD time-deposits rate of only 0.95%. The bid-ask spread for RMB-HKD conversion is around 1-2% transaction fee. Excluding the FX conversion fees, RMB depositors still earn higher deposit rates than HKD. As a result, unless there is a strong depreciation expectation on RMB, depositors are more willing to convert non-RMB deposits to RMB deposits.

This may put pressure on non-HKD liquidity and bring negative pressure on HKD funding costs and HKD NIM. However, the removal of the cap brings more liquidity to RMB deposits. Also, as Hong Kong banks will be allowed to lend in RMB, RMB loans are likely to grow and push RMB LDR upward. RMB NIM is likely to benefit, in our view.

Moderate positive impact from increased use of RMB funds in Hong Kong: According to the data from Bloomberg, the average YTD daily turnover for SSE A shares and SEHK were RMB109bn and HK$66bn, respectively.

According to the data from HKMA, the system HKD and USD deposits were HK$7.9tn as of September 2014. Even though the SEHK's trading volume has increased by 20% from the YTD average, the impact to the system deposits should not be material.