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Enhancing deposit protection in Hong Kong

29 January 2001

Banking Policy Department
Hong Kong Monetary Authority
30/F, 3 Garden Road
Central
Hong Kong

Ref: DIS


Dear Sir,

We are writing to submit our comments on the above consultation paper. We thank you for granting us an extension of time to make this submission.

Overall, we oppose the introduction of a deposit insurance scheme (DIS) in Hong Kong. We find that the paper does not sufficiently justify the introduction of a DIS.

In more detail our comments are as follows:

1. In 1992, as the present paper states, the idea of a DIS for Hong Kong was considered through public consultation, and rejected on ground of cost, fairness and moral hazard. One would therefore expect any proposal to reintroduce the idea of a DIS to deal substantially with the previous grounds for rejection. However, the present paper skirts around these issues. It takes as its premise the assertion that deposit protection needs to be enhanced and finds that only a DIS can meet the need for enhancement - a rather circular argument. Notwithstanding the paper’s claims as to the HKMA’s neutrality on the matter, the paper gives the impression that the mind of the authorities has been made up. Public statements by representatives of the HKMA before the consultation period had closed did nothing to dispel the impression that this is a pre-judged issue. We are disappointed that a major policy reversal should be so inadequately justified.
   
   
2. Paragraph 1.4 cites a run in the 1997 financial crisis as evidence of the need for a DIS. However, it would surely be more logical to draw the opposite conclusion: in the space of more than eight years (since the last consultation), which included Hong Kong’s severest economic crisis, there was only one bank run, and that one "short and temporary". All indications are that the present system is working sufficiently well.
   
   
3. Para 2.3. We would also make the point that while bank runs, or crises of confidence in the banking system, may cause difficulties for individual banks, and embarrassment for bank regulators, they can be healthy for the economic system as a whole. It is, unfortunately, necessary for users of a financial system to be reminded from time to time of the consequences of their risk-taking. The introduction of a DPS will tend to prevent this happening, intensifying moral hazard.
   
   
4. Para 3.4. We agree that the present stance of the Government regarding failing banks is ambiguous. However, we would prefer to clarify the ambiguity by reducing expectations of Government support, not increasing them via a DIS.
   
   
5. Para 3.5. It may be the case that the current arrangements do not meet the objectives of a deposit insurance scheme (DPS). However, that is not the primary question that the paper should address. The question should rather be, to what extent, if any, should deposits in Hong Kong be protected? But, as stated above, the paper skirts around this fundamental question.
   
   
6. Para 5.4. We strongly oppose the use of Government funding to advance payments to depositors.
   
   
7. Para 6.2 rightly identifies the major risks of a DIS, namely moral hazard, distortion of inter-bank competition, increased systemic risk. However, the paper does not properly address these risks. The "pre-conditions" referred to in para 6.3 amount to no more than a stable functioning financial system, and do not include incentives to avoid risk. The assertion in the final sentence of para 6.3 - that any scheme should avoid design features that might erode discipline on banks and their depositors - is a pious hope: it is the unavoidable characteristic of a DIS to effect precisely this erosion.
   
   
8. The assertion in para 6.4, that the primary defence against moral hazard is strong supervision and regulatory intervention, is disturbing. Baldly stated, the principle asserted here is that the judgment of regulators should be substituted for the judgement of the market. This appears an unsound principle for any economy, and at variance with the fundamentals of Hong Kong’s success.
   
   
9. In paragraph 6.5, it is acknowledged that a DIS will bring cross-subsidy and distortion in competition, but the point is dismissed with the assertion that "an element of subsidy is inherent in any form of insurance". This may be true if an insurance solution is inevitable, but the paper has failed to make its case that this is so, or even that there is a problem requiring a solution.
   
   
10. We agree generally that if a DIS has to be introduced, it should be run by the executive of an existing regulator, under a distinct legal entity, rather than setting up a new operating body to handle it. The HKMA would appear the best candidate. However, we would respectfully draw attention to the very wide range of functions currently performed by the HKMA - currency board operation, intervention in foreign exchange markets, operation of debt markets, fund management, bank supervision, etc - and suggest that the opportunity might be taken, on adding a further function to this already long list, to consider splitting the HKMA itself into one or more separate independent bodies to reduce the accumulating conflicts of interest between these various functions.
    
    
11. Para 10.3. The proposal to include foreign banks in the DIS should be supported with statistics as to their share of the retail deposit market.
    
    
12. Para 10.11. If there has to be a DIS, we would support the lower, HK$100,000 limit as the lesser of two evils.
    
    
13. Para 10.13. We wonder how practical it will be in the Hong Kong environment to ascertain the identity of depositors who hold accounts with multiple banks.
    
    
14. Para 10.17. We wonder if it is necessary to include foreign currency deposits in any DIS scheme, if such a scheme is introduced. What would be the systemic stability considerations relating to foreign currency, as distinct from local currency deposits? Is there a danger of underwriting retail foreign exchange speculation?
    
    
15. Para 10.25. We believe that flat rate system will equate to a subsidy from depositors at large and foreign banks to depositors at small and local banks. This would be detrimental to Hong Kong’s interests as a financial centre. Therefore, if a flat rate scheme must be introduced, we urge that it move as rapidly as possible to a risk basis.
    

We hope these comments are helpful. We also take the liberty of attaching for your reference a copy of our 1992 submission, which makes similar points.

Yours sincerely,


George Cautherley
Vice Chairman
Hong Kong Democratic Foundation

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