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Deposit insurance no answer to banking problems

TO: THE NEWS EDITOR

FROM: HONG KONG DEMOCRATIC FOUNDATION

RE: DEPOSIT INSURANCE NO ANSWER TO BANKING PROBLENS

DATE: 4TH SEPTEMBER 1991

The Hong Kong Democratic Foundation cautioned today against the proposals by Martin Lee and the Consumer Council to insure bank deposits.

The Foundation believes that a deposit insurance scheme is likely to lead to less rather than more stability in the banking system. Instead, Chan Ying Lun, the Foundation's spokesman, presented an alternative package of proposals to strengthen confidence in Hong Kong's banks.

The Foundation acknowledges that in the wake of the BCCI crisis deposit insurance is likely to be popular with depositors. However the potential costs of deposit insurance are enormous.

It is quite misleading to suggest, as the Consumer Council does, that such a scheme could be self-financing. Because of the scale of a large bank collapse the agency offering the insurance would have to be underwritten by the Government and supported by taxpayers' money. This is the experience in the United States, which has such a deposit insurance scheme.

Moreover, the existence of deposit insurance actually makes it more likely that banks will fail. If depositors know that they are insured, they will place their money with the bank offering the highest interest, regardless of the risk. And the least profitable banks will be encouraged to take riskier business in order to improve profits, knowing that they will have no problem raising funds.

"The problem with deposit insurance is its moral hazard," said Chan Yin Lun. "Deposit insurance encourages risk-taking. The United States' deposit insurance scheme is the prime cause of the collapse of so many savings and loans institutions there, and the large number of US bank failures."

In recognition of this, the US Congress in its current review of the banking system is likely to restrict the deposit insurance scheme. The Foundation feels strongly that the US example of deposit insurance is not one to follow.

"The essential thing is to prevent bank failure," said Chan Ying Lun. "This can only be done through better regulation and the encouragement of sensible attitudes among depositors. Deposit insurance would actually increase the likelihood of bank failure, at immense cost to the taxpayer."

The Foundation has the following alternative proposals to restore confidence in Hong Kong's banking system:

• An independent enquiry into the BCCI affair, as is being conducted in the UK;
  
  
• A review of the adequacy and independence of the Office of the Commissioner of Banking. It is not at present clear whether it was naivety or political pressure that caused the Commissioner to give BCCI a clean bill of health on 5th July, after regulators had closed the bank down in other centres. In either case, a thorough review is necessary to restore confidence. It may be appropriate to set up a Banking Commission as a separate agency, rather than as a Government department, like the Securities and Futures Commission for the securities industry;
  
  
• The abolition of banks' right to maintain inner reserves and manipulate their profits Accounting disclosure for banks should be improved. This would bring Hong Kong into line with practice in other financial centres such as London, and would enable depositors to judge bank's strength for themselves;
  
  
• Abolish the interest rate agreement that allows weaker banks to compete for deposits on equal terms with stronger ones;
  
  
• The Commissioner of Banking should ensure that all banks arrange adequate credit lines to meet reasonable liquidity needs.
  

Much of the adverse public reaction to the Government's handling of the BCCI affair is due to its not having used the Exchange Fund to rescue the bank, when in all previous recent cases of bank failure it had done so.

The Foundation believes that the taxpayers' money should not be used indiscriminately to buy out failed banks. However the Government should demonstrate its readiness to help in other ways to assist a private sector buyer. It can, for example, provide full information to such potential buyers, including the results of the Banking Commissioner's own investigations into the bank, and reports received from auditors.

STOCK MARKET REFORMS

The Foundation also voiced its support for the reform of the Stock Exchange.

It is essential that corporate members of the Exchange, who provide most of the turnover, and users of the market such as listed companies and investors, have more representation on the Exchange's Council. At present, the individual members are over-represented, and block efforts at reform.

"It the Stock Exchange cannot reform itself, we would support statutory action to push reform through," said Chan Ying Lun. "Hong Kong will decline as an international financial centre if we cannot bring on regulations up to international standards"

The Foundation also noted that vested interests have held up the stock market Central Clearing and Settlement System. "Again, this automation project is essential to keep up with other stock exchanges in the region," said Chan. "We would support Government intervention to speed things up if necessary."