1 Enhancing Deposit Protection in Hong Kong October 2000

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

3 Objectives of the Study n To make a fair, objective and independent assessment of deposit protection in HK n 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

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

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

6 The current system n Current scheme gives priority to depositors of up to HK$100,000 in a liquidation n This has certain limitations –no certainty of full payment of priority claims –uncertain timing of payment –lack of pre-determined contingency plan n Consultant’s conclusion –changes to the current system are merited –enhancements of the current system are not sufficient to meet the objectives of deposit protection

7 The Consultant’s recommended option for change n Deposit insurance scheme (“DIS”) is considered best able to promote depositor confidence and system stability n Moral hazard is a risk, but can be controlled through –good system design –effective supervision –high level of financial disclosure n DIS should be funded by the banks but administered by the public sector (“public DIS”)

8 DIS funding n 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) n 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 n 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

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

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

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