Enhancing Deposit Protection in Hong Kong October 2000

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Enhancing Deposit Protection in Hong
KongOctober 2000
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Why are we looking at this again?

• Hong Kong banking system is robust and our
  supervision is generally regarded as effective
• But unexpected bank failures can still occur and
  contingency plans are needed in case they do
• The international trend is in favour of explicit
  deposit protection schemes
• The issue can now be considered from a position
  of strength
• Part of an evolutionary process of enhancing
  depositor protection

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Objectives of the Study

• To make a fair, objective and independent
  assessment of deposit protection in HK
• To consider the relative costs and benefits of
  three broad alternatives
• maintain status quo
• enhance current system of priority claims
  protection
• introduce some form of deposit insurance

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Key issues addressed

• Are changes to the current system merited?
• If so, what are the options for change?
• Is it sufficient simply to enhance the current
  arrangements?
• Is deposit insurance more suitable?
• If so, who should bear the cost of insurance?
• Who controls and operates the DPS?
• How much will an insurance scheme cost and how
  should it be funded?
• What should be the main design features of an
  insurance scheme?

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Objectives of deposit protection

• To provide a measure of protection to small
  depositors
• To contribute to the stability of the financial
  system
• To define more clearly the role and extent of
  government support in protecting depositors

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The current system

• Current scheme gives priority to depositors of up
  to HK100,000 in a liquidation
• This has certain limitations
• no certainty of full payment of priority claims
• uncertain timing of payment
• lack of pre-determined contingency plan
• Consultants conclusion
• changes to the current system are merited
• enhancements of the current system are not
  sufficient to meet the objectives of deposit
  protection

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The Consultants recommended option for change

• Deposit insurance scheme (DIS) is considered
  best able to promote depositor confidence and
  system stability
• Moral hazard is a risk, but can be controlled
  through
• good system design
• effective supervision
• high level of financial disclosure
• DIS should be funded by the banks but
  administered by the public sector (public DIS)

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DIS funding

• Need to decide whether the banks contribute to a
  DIS fund upfront (ex ante approach) or only pay
  if a bank fails (ex post approach)
• Even if the former is chosen, not envisaged that
  the fund would be large
• sufficient to meet expected shortfall loss of
  the DIS and its financing costs
• The Exchange Fund would be used to provide
  back-up liquidity to the DIS
• in the form of a loan repayable with interest by
  the DIS from the assets of the failed bank

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Indicative premium

• Under the ex ante approach, the banks would pay a
  regular premium
• This is difficult to estimate with precision
• But based on conservative assumptions, the
  Consultant has indicated that 10 basis points per
  annum seems feasible
• Payment of the premium might be suspended once a
  sufficient fund had been built up

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Main Design Features of DIS

• Only fully licensed banks would be covered
• Foreign banks would be included
• Mandatory participation
• Coverage up to HK100,000 or HK200,000
• Foreign currency deposits would be covered
• No co-insurance (eligible claims met in full)
• Coverage on a per depositor basis
• Limited netting of loans against deposits
• Flat-rate premium to begin with

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Way forward

• The HKMA will seek the views of all interested
  parties before it makes a final recommendation on
  whether and how to proceed
• Further consultation on detailed design features
  may be necessary
• Likely that legislation will be required
• Therefore unlikely to implement before 2002