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Enhancing Deposit Protection Enhancing Deposit Protection in Hong Kongin Hong Kong

October 2000October 2000

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Why are we looking at this again?Why are we looking at this again?

Hong Kong banking system is robust and our Hong Kong banking system is robust and our supervision is generally regarded as effectivesupervision is generally regarded as effective

But unexpected bank failures can still occur and But unexpected bank failures can still occur and contingency plans are needed in case they docontingency plans are needed in case they do

The international trend is in favour of explicit The international trend is in favour of explicit deposit protection schemesdeposit protection schemes

The issue can now be considered from a position of The issue can now be considered from a position of strengthstrength

Part of an evolutionary process of enhancing Part of an evolutionary process of enhancing depositor protectiondepositor protection

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Objectives of the StudyObjectives of the Study

To make a fair, objective and independent To make a fair, objective and independent assessment of deposit protection in HKassessment of deposit protection in HK

To consider the relative costs and benefits of three To consider the relative costs and benefits of three broad alternativesbroad alternatives– maintain status quo maintain status quo

– enhance current system of priority claims protectionenhance current system of priority claims protection

– introduce some form of deposit insuranceintroduce some form of deposit insurance

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Key issues addressedKey issues addressed

Are changes to the current system merited?Are changes to the current system merited? If so, what are the options for change?If so, what are the options for change? Is it sufficient simply to enhance the current Is it sufficient simply to enhance the current

arrangements?arrangements? Is deposit insurance more suitable?Is deposit insurance more suitable? If so, who should bear the cost of insurance?If so, who should bear the cost of insurance? Who controls and operates the DPS?Who controls and operates the DPS? How much will an insurance scheme cost and how How much will an insurance scheme cost and how

should it be funded?should it be funded? What should be the main design features of an What should be the main design features of an

insurance scheme?insurance scheme?

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Objectives of deposit protectionObjectives of deposit protection

To provide a measure of protection to small To provide a measure of protection to small depositorsdepositors

To contribute to the stability of the financial To contribute to the stability of the financial systemsystem

To define more clearly the role and extent of To define more clearly the role and extent of government support in protecting depositorsgovernment support in protecting depositors

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The current systemThe current system

Current scheme gives priority to depositors of up Current scheme gives priority to depositors of up to HK$100,000 in a liquidationto HK$100,000 in a liquidation

This has certain limitationsThis has certain limitations– no certainty of full payment of priority claimsno certainty of full payment of priority claims

– uncertain timing of paymentuncertain timing of payment

– lack of pre-determined contingency planlack of pre-determined contingency plan

Consultant’s conclusionConsultant’s conclusion– changes to the current system are meritedchanges to the current system are merited

– enhancements of the current system are not sufficient to enhancements of the current system are not sufficient to meet the objectives of deposit protectionmeet the objectives of deposit protection

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The Consultant’s recommended The Consultant’s recommended option for changeoption for change

Deposit insurance scheme (“DIS”) is considered Deposit insurance scheme (“DIS”) is considered best able to promote depositor confidence and best able to promote depositor confidence and system stabilitysystem stability

Moral hazard is a risk, but can be controlled Moral hazard is a risk, but can be controlled throughthrough– good system designgood system design

– effective supervisioneffective supervision

– high level of financial disclosurehigh level of financial disclosure

DIS should be funded by the banks but DIS should be funded by the banks but administered by the public sector (“public DIS”)administered by the public sector (“public DIS”)

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DIS fundingDIS funding

Need to decide whether the banks contribute to a Need to decide whether the banks contribute to a DIS fund upfront (“ex ante” approach) or only pay DIS fund upfront (“ex ante” approach) or only pay if a bank fails (“ex post” approach)if a bank fails (“ex post” approach)

Even if the former is chosen, not envisaged that Even if the former is chosen, not envisaged that the fund would be largethe fund would be large

– sufficient to meet “expected shortfall loss” of the DIS sufficient to meet “expected shortfall loss” of the DIS and its financing costsand its financing costs

The Exchange Fund would be used to provide The Exchange Fund would be used to provide back-up liquidity to the DIS back-up liquidity to the DIS

– in the form of a loan repayable with interest by the DIS in the form of a loan repayable with interest by the DIS from the assets of the failed bankfrom the assets of the failed bank

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Indicative premiumIndicative premium

Under the ex ante approach, the banks would pay Under the ex ante approach, the banks would pay a regular premiuma regular premium

This is difficult to estimate with precisionThis is difficult to estimate with precision But based on conservative assumptions, the But based on conservative assumptions, the

Consultant has indicated that 10 basis points per Consultant has indicated that 10 basis points per annum seems feasibleannum seems feasible

Payment of the premium might be suspended once Payment of the premium might be suspended once a sufficient fund had been built upa sufficient fund had been built up

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Main Design Features of DISMain Design Features of DIS Only fully licensed banks would be coveredOnly fully licensed banks would be covered Foreign banks would be includedForeign banks would be included Mandatory participationMandatory participation Coverage up to HK$100,000 or HK$200,000Coverage up to HK$100,000 or HK$200,000 Foreign currency deposits would be coveredForeign currency deposits would be covered No co-insurance (eligible claims met in full)No co-insurance (eligible claims met in full) Coverage on a per depositor basisCoverage on a per depositor basis Limited netting of loans against depositsLimited netting of loans against deposits Flat-rate premium to begin withFlat-rate premium to begin with

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Way forwardWay forward

The HKMA will seek the views of all interested The HKMA will seek the views of all interested parties before it makes a final recommendation on parties before it makes a final recommendation on whether and how to proceedwhether and how to proceed

Further consultation on detailed design features Further consultation on detailed design features may be necessarymay be necessary

Likely that legislation will be requiredLikely that legislation will be required

Therefore unlikely to implement before 2002Therefore unlikely to implement before 2002