Enhancing deposit protection in Hong Kong
29 January 2001
Banking Policy Department
Hong Kong Monetary Authority
30/F, 3 Garden Road
ENHANCING DEPOSIT PROTECTION IN HONG KONG
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:
- 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.
- 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.
- 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.
- 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.
- 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.
- Para 5.4. We strongly oppose the use of Government funding to
advance payments to depositors.
- 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.
- 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.
- 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.
- 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
- 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.
- 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.
- 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.
- 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
- 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.
Hong Kong Democratic Foundation
|Policy Paper - page revised 23-09-2002
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