Introducing Deposit Insurance in Hong Kong
Consultation Paper
March 2002
HONG KONG MONETARY AUTHORITY
30/F, 3 Garden Road, Hong Kong Telephone : (852) 2878 8222 Facsimile : (852) 2878 1887
Introduction
1 The question of whether to introduce a deposit insurance scheme (“DIS”) in Hong Kong was the subject of an extensive public consultation in late 2000. The results of the public consultation indicated that there was broad public support for establishing such a scheme in Hong Kong. On 24 April 2001, having considered the results of the consultation exercise, the Chief Executive in Council approved in principle the establishment of a DIS in Hong Kong and requested the Hong Kong Monetary Authority (“HKMA”) to work out the detailed design features of the scheme.
2 The HKMA has now substantially completed consideration of how the DIS should be structured. The purpose of this second consultation paper is to present the HKMA’s proposals on the salient features of the DIS1 and to seek the views of interested parties on these proposals. After receipt of comments, the HKMA will proceed to prepare the relevant legislation for the implementation of the DIS.
3 The HKMA’s detailed proposals on how to set up the DIS are split into 8 chapters and cover:
Chapter 1: Establishment of the Deposit Insurance Board (P.3 – 8) Chapter 2: Membership of the DIS (P.9 – 12)
Chapter 3: Coverage under the DIS (P.13 – 20)
Chapter 4: Depositor priority, set-off and assignment of rights (P.21 – 24) Chapter 5: Funding and premium assessment (P.25 – 30)
Chapter 6: Premium collection, refund and management of the DIS Fund (P.31 – 33) Chapter 7: Trigger criteria for DIS payout (P.34 – 35)
Chapter 8: Relationship between the Deposit Insurance Board and the HKMA (P.36 – 40)
4 A summary of these proposals is set out in a table at Annex A to this paper.
1 This paper does not deal with the detailed organisational and logistical issues relating to the setting up and operation of the DIS such as the management structure of the DIS and the procedures whereby claims would be made under the DIS. These would be a matter for the Deposit Insurance Board subject to the powers provided in the DIS legislation.
5 A set of draft Rules (“Rules”) governing the setting up and operation of the DIS has also been prepared at Annex B. These Rules would be used as the basis for preparing the relevant legislation.
6 Members of the public are welcome to submit their comments to the HKMA before 31 May 2002 through any of the following channels:
By mail: Banking Development Department Hong Kong Monetary Authority 30th Floor
3 Garden Road Central
Hong Kong (Reference: DIS) By fax: 2878 1887
By email: dis@hkma.gov.hk
7 In the interests of transparency, it is the HKMA’s practice, as appropriate, to reproduce, quote from, or summarise the submissions received during its public consultation exercises in its published reports on those exercise. Where appropriate, it is also the HKMA’s practice to attribute such reproductions of, quotations from, or summaries of, views received to the relevant organisations or individuals unless expressly requested in the submissions not to do so.
Chapter 1 – Establishment of the Deposit Insurance Board
1.1 This Chapter will consider the following in relation to the Deposit Insurance Board:
(i) the structure and organisation;
(ii) the governance arrangements;
(iii) the functions; and
(iv) the powers required to discharge the anticipated responsibilities of the Board.
1.2 The choice of an appropriate structure and organisation for a DIS is heavily influenced by its mandate, roles and responsibilities. The majority of the opinions received from the previous consultation exercise supported the idea that the DIS in Hong Kong should confine its role to that of a “pay-box” to reduce the cost of deposit insurance and to avoid duplication of functions with the regulator. There was also support for the view that the DIS should be administered by a separate legal entity to offer greater accountability and transparency to the public. Care should be taken, however, to ensure that the proposed entity is as lean and cost-effective as possible.
The establishment of the Deposit Insurance Board
1.3 In view of the above, it is proposed that a statutory body should be established by legislation, which might be called the Hong Kong Deposit Insurance Board, to administer the DIS in Hong Kong.
1.4 The functions of the Board should be clearly defined in legislation so that the Board has a clear mandate from the legislature. Given the Board’s role as a “pay- box”, its principal functions should be confined to the following:
(i) collecting premiums from participating banks in accordance with the rules established pursuant to the DIS legislation;
(ii) managing the funds of the DIS (“the DIS Fund”);
(iii) assessing claims made against the DIS Fund and determining the eligibility and entitlement of claimants;
(iv) making compensation payments to eligible depositors as determined; and
(v) recovering any amount paid out to a failed participating bank’s depositors from the assets of the failed bank.
1.5 The DIS Fund should also be established by legislation, and should, as far as practicable, be financed by the banking industry2. The DIS Fund should consist of:
(i) premiums collected from participating banks;
(ii) amounts recovered from the estate of a failed participating bank;
(iii) investment returns;
(iv) amounts borrowed for the DIS Fund as permitted under the DIS legislation; and
(v) any other amounts that are lawfully paid into the DIS Fund.
Structure and organisation of the Board
1.6 The Board should comprise not less than 7 but not more than 10 members appointed by the Chief Executive of the HKSAR (“CE/SAR”). Its composition is proposed as follows (with a majority of lay members over ex-officio and executive members to ensure sufficient independence):
(i) Secretary for Financial Services or his representative (ex-officio member);
(ii) Monetary Authority (“MA”) or his representative (ex-officio member);
(iii) the Chief Executive Officer of the Board (executive member to act as the link between the policy making process and the implementation process); and
(iv) 4 to 7 lay members.
1.7 The Chairman of the Board should be appointed by CE/SAR from among the lay members to ensure the Board’s independence.
2 This would be consistent with the provisions relating to the establishment of the Investor Compensation Fund under the Securities and Futures (“SF”) Ordinance – see clause 236(4) of the SF Ordinance. The intention is to ensure that funding should, as far as practicable, follow the user-pays principle.
1.8 Appointment of members should be for a fixed term of 3 years or a shorter term as CE/SAR thinks appropriate. Each member should be eligible for re-appointment upon expiry of his term.
1.9 If a member is unable to perform his duties for any reason, CE/SAR should be able to appoint another person to take the place of such member.
1.10 The Board should have the power to set up any sub-committees to consider and make recommendations relating to the operations of the Board and the management of the DIS Fund.
Governance arrangements Annual accounts / report
1.11 To promote accountability and transparency of the operations of the Board, the Board should be required by law:
(i) to keep proper books and accounts of the DIS Fund;
(ii) to prepare an audited statement of accounts for each financial year;
and
(iii) to prepare and publish an Annual Report (including the statement of accounts) within four months after the end of each financial year and to lay this report before the Legislative Council.
Audit and budget
1.12 The Board should prepare an annual budget for approval by the Financial Secretary (“FS”).
1.13 FS should have the power to approve the appointment of the Director of Audit or an external auditor to perform an audit of the DIS Fund or the operations of the Board.
Powers of the Board
1.14 The Board should have the following powers which are considered necessary for the discharge of its functions:
(i) to assess premiums payable by each participating bank and to levy such premiums as assessed on the bank;
(ii) to collect premiums from all participating banks;
(iii) to borrow from the Government or any third party to discharge the obligations of the Board3;
(iv) to make payments out of the DIS Fund in connection with the exercise of its functions and to recover any payment (or any part thereof) made to any person from the DIS Fund to which such person is not entitled;
(v) to obtain information from any participating bank that is necessary for the exercise of its functions under the DIS legislation;
(vi) to demand payment from the liquidator (or provisional liquidator) of a failed participating bank out of such bank’s available assets in respect of the amounts it has paid to the eligible depositors of such bank;
(vii) to give an indemnity to the liquidator (or provisional liquidator) of a failed participating bank with a view to obtaining early repayment after the Board has made payouts to eligible depositors;
(viii) to accept a compromise from the liquidator (or provisional liquidator) of a failed participating bank or any other party as full payment of the amount claimed by the Board on the relevant bank’s assets where the Board thinks fit, and to enter into any agreement or arrangement in respect of the same;
(ix) to specify the requirements of the information systems to be maintained by all participating banks so as to facilitate payment to eligible depositors;
(x) to invest the DIS Fund in the manner specified in the DIS legislation;
(xi) to appoint agents, or authorize any third party, to perform any of the functions of the Board under the DIS legislation;4
3 This power is essential to enable the DIS to meet its liquidity needs in a payout as the DIS Fund cannot be self- sufficient in terms of the money required on a temporary basis to effect the necessary payout.
4 Such a power would help the Board to avoid the need for a large standing staff.
(xii) to hold, acquire, lease, sell, dispose of or otherwise deal with all kinds of property whether movable or immovable;
(xiii) to have all the necessary and incidental powers of a commercial entity in respect of its administration and management; and
(xiv) to make rules5, after consultation with the FS, relating to the procedures for making claims and payouts.
Confidentiality
1.15 As the Board would have access to sensitive information about individual participating banks, it would be important for the Board and its staff members to keep confidential any information obtained from the MA and the participating banks in the course of carrying out its functions. Exceptions would be where disclosure of such information is required by law or where such information is framed in a summary form so as to prevent particulars relating to the business of any particular institution or person being ascertained from it.
1.16 This requirement should also apply to any third party appointed or authorized by the Board to perform any of its functions under the DIS legislation.
1.17 Any person who has breached the secrecy provision above should be guilty of an offence.
Immunity
1.18 Like other statutory offices, it is proposed that neither the Board nor any person who is, or is acting as, its board member, member of staff or its agent should be liable in damages for anything done or omitted to be done in the discharge, or purported discharge, of the Board’s functions under the DIS legislation unless the act or omission is shown to have been in bad faith.
Exemption from taxation
1.19 Since the Board would not be a profit-making body, it is proposed that the receipts of the Board would not be subject to taxation under the Inland Revenue Ordinance.6
5 These rules should be subsidiary legislation which would be subject to negative vetting by the Legislative Council.
6 Similar exemption is granted to other statutory bodies such as the Hospital Authority and the Securities and Futures Commission under the Hospital Authority Ordinance and the Securities and Futures Commission Ordinance respectively.
Appeal
1.20 The Board’s administration of the DIS Fund and, in particular, its decision on payment or refusal to make payment to depositors should be subject to review by a separately constituted tribunal. It is proposed that the tribunal should be presided over by a chairman, preferably a judge (or a retired judge) appointed by CE/SAR sitting with a number of lay members, say, 2-3 persons, who possess the necessary expertise in dealing with the issues that would be likely to be reviewed by them. Appointment should be on a fixed-term basis, but any member of the tribunal should be eligible for re-appointment.
1.21 It is proposed that the tribunal should have the power to confirm, vary or set aside the Board’s decision, or substitute it with the tribunal’s own decision. The tribunal should have the same powers as the Court of First Instance to punish for contempt. This would strengthen the authority and ability of the tribunal in enforcing its own procedures. It should also have the power to receive and consider any material that would not be admissible in evidence in civil and criminal proceedings in a court of law.
Finally, the tribunal’s decisions should be final and should not be subject to further appeal except on point of law.
1.22 Detailed rules relating to the setting up and operation of the tribunal should be specified in the DIS legislation.
Chapter 2 – Membership of the DIS
2.1 This Chapter will consider:
(i) which types of authorized institutions should be required to become members of the DIS;
(ii) how membership of the DIS should be granted and terminated;
and
(iii) whether there should be any exemption from participation in the DIS.
Participation by restricted licence banks (“RLBs”) and deposit-taking companies (“DTCs”)
2.2 It was proposed in the previous consultation paper that membership of the DIS should be confined to licensed banks, whose participation should be mandatory.
During the consultation exercise, the DTC Association suggested that RLBs and DTCs should not be excluded from the scheme but should have the option whether to join. The Association considered that certain RLBs and DTCs would be disadvantaged if they were excluded from the scheme.
2.3 The HKMA remains convinced that there is not a strong case to extend membership of the DIS to these two tiers of authorized institution. Under the current three-tier system of authorization, RLBs and DTCs are not permitted to take small deposits. It is therefore doubtful whether RLBs and DTCs should join a DIS designed to protect only small depositors. Furthermore, participation in the DIS would be mandatory for all licensed banks. This is essential to ensure the viability of the scheme and to avoid the problem of adverse selection. It would therefore be undesirable and unfair to have a scheme in which participation is mandatory for banks but voluntary for RLBs and DTCs.
Furthermore, the recent proposed relaxation of the market entry criteria for full licensed banks should reduce the need to cover RLBs and DTCs in the DIS. They may seek to be upgraded to the status of licensed bank should they wish to become protected under the DIS.
Granting and termination of membership
2.4 Following from the above, the HKMA maintains its recommendation that membership of the DIS should be mandatory and should be confined only to licensed banks. However, two issues concerning entry and exit from the scheme need to be addressed:
(i) whether membership should be automatically granted to all licensed banks without the need for the Board to make a separate determination; and
(ii) whether the Board should have the power to terminate the membership of any participating bank.
2.5 Given the narrow mandate of the Board, the HKMA sees merit in linking DIS membership directly to an institution’s licence. Effectively, this would mean that DIS membership would be automatically granted to an institution which has been granted a banking licence by the MA, and its DIS membership would be automatically withdrawn if its banking licence is revoked. It would thus not be necessary to confer a separate power on the Board to grant or terminate membership of the DIS.7
2.6 In view of the above, it is proposed that provisions should be included in the DIS legislation to provide that:
(i) membership of the DIS would be automatically granted to an institution which is licensed as a bank under the Banking Ordinance;
(ii) in the case of banks licensed before the establishment of the DIS, the date on which DIS membership is granted would be the date of commencement of the DIS legislation8;
(iii) in the case of banks licensed after the establishment of the DIS, the date on which DIS membership is granted would be the date on which the banking licence is granted8; and
(iv) the DIS membership of a participating bank would be automatically revoked upon revocation of its banking licence9.
7 This would be consistent with the advice of the Financial Stability Forum (“FSF”) Working Group on Deposit Insurance that the power to control entry and exit is less relevant to a DIS which does not have a broader mandate to ensure insured institutions’ compliance with its rules to minimise loss.
8 Sub-paragraphs (ii) and (iii) would be relevant to the determination of the amount of premiums payable by existing banks in the first year of establishment of the DIS and by new entrants in the future (see para. 2.4 in Schedule 2 of the Rules).
9 This would be relevant to the calculation of the premium that should be refunded to such an institution (see para.
2.8 in Schedule 2 of the Rules).
Exemption of Hong Kong branches of foreign banks covered by a comparable scheme in the home jurisdiction
2.7 During the previous consultation exercise, some foreign banks suggested that overseas incorporated banks should be exempted from participation in the DIS in Hong Kong if the deposits placed with their Hong Kong branches were already protected by a DIS in their home jurisdictions which provided a comparable level of protection.
2.8 The HKMA has considered whether it would be desirable to introduce an exemption arrangement for such institutions.
2.9 In principle, it would be desirable to introduce an exemption arrangement for foreign bank branches in Hong Kong covered by a comparable scheme in their home jurisdiction. This would avoid double charging of premiums and help to maintain Hong Kong’s attractiveness as an international financial centre. It would also be consistent with the recommendation of the FSF Working Group on Deposit Insurance that “the deposit insurance already provided by the home country system should be recognised in the determination of levies and premiums”.
2.10 However, introducing an exemption arrangement would entail certain practical problems for the DIS. One problem would be for the DIS to regularly assess the adequacy of funding of the exempted schemes and changes in the coverage policy of such schemes so as to satisfy itself that deposits with the exempted banks in Hong Kong remained adequately protected.
2.11 The HKMA considers that there is a case for introducing an exemption arrangement for Hong Kong branches of the relevant foreign banks given that a similar arrangement exists in other schemes (e.g. in the UK) and that there is clear guidance by the FSF Working Group in favour of recognising the protection offered by home country schemes. The impact of such an exemption arrangement on the DIS in Hong Kong should be minimal.10 However, given that the proposed arrangement would entail additional recurrent expenses for the DIS, it would be reasonable to require the exempted banks to share some of the cost of processing these applications and monitoring the scope of coverage of the exempted schemes, e.g. by charging the relevant banks an annual exemption fee.
2.12 Accordingly, it is proposed that the exemption arrangement should be structured along the following lines:
10 According to a recent IMF survey of the 67 explicit protection schemes in the world, only the schemes in Belgium, Denmark, Germany, Greece, Bahrain, Lebanon, Ecuador and El Salvador cover deposits with domestic banks’ branches abroad (this does not include those schemes in the EU which only cover domestic banks’
branches in other EU member states). Except for Germany and Belgium, banks in these countries do not have a presence in Hong Kong. In addition, since the scheme in Belgium only covers deposits denominated in EU currencies, Belgian banks would not be eligible to seek exemption from the Hong Kong scheme.
(i) the Board may exempt a foreign incorporated bank from participating in the DIS if it is satisfied that the deposits with the Hong Kong office(s) of the bank are protected by the scheme in the bank’s home jurisdiction and the scope and level of protection afforded by the bank’s home jurisdiction scheme are not less than that afforded to such deposits by the DIS in Hong Kong;
(ii) the Board may require a bank applying for exemption to provide relevant information to facilitate the consideration of its application;
(iii) where an exempted bank becomes aware of any development which may affect its exemption (e.g. change in the protection level of its home jurisdiction scheme), it should forthwith notify the Board of such fact. The Board may require an exempted bank to provide any information so as to allow the Board to determine whether the bank should continue to be exempted;
(iv) where a bank is exempted from participation in the DIS, it should pay an annual exemption fee as specified by the Board from time to time; and
(v) a bank exempted from participation in the DIS should inform its depositors:
(a) that the bank is not a member of the DIS in Hong Kong and therefore any deposits with the Hong Kong office(s) of the bank are not protected by the DIS; and
(b) of the details of the protection offered by the bank’s home jurisdiction scheme, including but not limited to, the name of the organisation which provides the protection, the level of protection and the types of deposits protected.
Chapter 3 – Coverage under the DIS
3.1 This Chapter will consider:
(i) what an insurable deposit is including, in particular, what types of deposits and depositors should be excluded from coverage under the DIS;
(ii) the appropriate limit of coverage (“coverage limit”) under the DIS;
(iii) whether interest accrued on insurable deposits should be covered by the DIS, and if so, how this should be determined;
and
(iv) how the agreed coverage limit should be applied to special types of accounts such as trust accounts, client accounts, foreign currency accounts, etc.
Definition of “insurable deposits”
3.2 A clear definition of “insurable deposit” is important as it gives certainty to depositors as to their eligibility for protection under the DIS.
3.3 It is proposed that the following definition should be incorporated into the DIS legislation: “An “insurable deposit” is any sum of money denominated in any currency which meets the definition of “deposit” under section 2 of the Banking Ordinance11 and maintained with a participating bank with the exception of the following:
(i) a term deposit where the current term agreed to by the depositor at the most recent time it was negotiated12 exceeds 5 years;
(ii) a deposit charged, mortgaged or pledged (as appropriate) as collateral;
(iii) a deposit that is secured on the assets of the bank;
11 This would be consistent with the advice of the IMF that the definition of deposits under the deposit insurance legislation of a jurisdiction should preferably be consistent with that adopted under its other banking laws and regulations.
12This is consistent with section 265(5D) of the Companies Ordinance. According to the record of the Government, the policy intention is that this refers to the original term to maturity of the deposit.
(iv) a bearer instrument;
(v) a deposit booked with a foreign office of the bank;
(vi) a deposit held for the account of the Exchange Fund;
(vii) a deposit held by a multilateral development bank as defined in para. 1 of the Third Schedule to the Banking Ordinance;
(viii) a deposit held by a holding company that holds all of the shares13 of the bank, a subsidiary of the bank or a subsidiary of the holding company;
(ix) a deposit held by a director, controller, chief executive or manager of the bank, a subsidiary of the bank, a holding company that holds all of the shares of the bank or a subsidiary of the holding company;
and
(x) a deposit held by an authorized institution.14”
3.4 The proposed exclusions from the definition of “insurable deposit” are largely the same as those proposed in the previous consultation paper, which were largely based on the exclusions under the priority claim provisions in the Companies Ordinance.
Among the items that are not excluded under the Companies Ordinance are “deposits secured on the assets of the bank” and “bearer instruments”. The former is based on a similar exclusion in the UK scheme. The latter is based on the advice of the IMF and the FSF Working Group on Deposit Insurance which support the exclusion of certain instruments such as certificates of deposits so as to avoid abuse of the coverage limit on a per-depositor basis.
Coverage limit
3.5 There was support for the proposed coverage limit of the DIS to be set at
$100,000 per depositor per institution in the previous consultation exercise. It is therefore proposed that this proposed limit should be adopted. As in other schemes, such as the Federal Deposit Insurance Corporation (“FDIC”) and the Canadian Deposit
13 It is for consideration whether the threshold of shareholding of the holding company should be reduced so that the exception would also apply to deposits held by a majority shareholder controller of the participating bank.
If so, appropriate amendments would then need to be made to the relevant provision in section 265 of the Companies Ordinance.
14 Deposits referred to in sub-paragraphs (vii)-(x) are deposits in which any of the parties referred to have beneficial interest, whether such deposits are held in that party’s name or not.
Insurance Corporation (“CDIC”), the coverage limit can be reviewed and adjusted as appropriate in the future.
Accrued interest
3.6 It is proposed that the coverage limit of the DIS should apply to both the principal amount of an insurable deposit and the interest accrued on that deposit. Thus, if the principal is $95,000 and the accrued interest is $7,000, the depositor should be entitled to a payment of $100,000 (the coverage limit) rather than $102,000. This would be consistent with the treatment of accrued interest and the calculation of priority claims by a bank liquidator under the present insolvency law (see analysis of the relevant provisions in the Companies Ordinance at Annex C).
3.7 The next question to decide is the period up to which accrued interest should run. It is proposed that for the purpose of determining the amount covered under the DIS, the interest accruing and payable in relation to a deposit should normally be calculated up to the date of appointment of a provisional liquidator. This would be consistent with the period of interest accrual under the insolvency regime15 and would avoid any mismatch between the amount paid out by the DIS and the amount that it could recover from the liquidator. However, there may be circumstances where application of this proposal would be inappropriate, e.g., when the Board is uncertain whether a provisional liquidator will be appointed or where to wait for such appointment would unduly delay payment by the DIS. In such circumstances, it is proposed that the Board should have the discretion to proceed to make payment to eligible depositors, which should cover interest accrued only up to the date on which payout by the DIS is triggered (see Chapter 7 for discussion on the trigger criteria). The first two examples in Annex D illustrate how these proposed rules would work.
3.8 In the event that payment has been made by the DIS before the appointment of a provisional liquidator, it would be necessary to determine who – the DIS or the depositor – should be entitled to claim in the liquidation the interest accrued on the amount of the payment made by the DIS between the date on which the DIS payout was triggered and the date on which the provisional liquidator was appointed (the “twilight period”). The HKMA believes that since a depositor is required to assign to the DIS all his rights and remedies in respect of the payment received from the DIS (see Chapter 4 for discussion on assignment of rights), any interest accrued on the deposit (up to the extent of the payment made) during the twilight period should be for the account of the DIS.
15As shown in Annex C, “the relevant date” for the purpose of calculation of dividend payment in bank liquidations refers to the date of appointment of a provisional liquidator, or if no such appointment was made, the date of the winding-up order issued by the Court. However in this context, the date of the winding-up order is irrelevant because if no provisional liquidator was appointed, it is likely that the DIS payout would be triggered prior to the making of a winding-up order. The payout by the DIS would cover interest accrued only up to that date.
3.9 In the case where the depositor has only one deposit with the failed bank, it is expected that the liquidator would not have any difficulty in determining the respective entitlements of the DIS and the depositor to the interest accrued during the twilight period. However, a complication would arise if the depositor has more than one deposit (each bearing a different interest rate) and the aggregate amount of such deposits and accrued interest exceeds the coverage limit. In these circumstances, it would be necessary to determine how the compensation payment by the DIS (which would be
$100,000 in this case) should be apportioned to the depositor’s different accounts so that the liquidator could determine the respective entitlements of the DIS and the depositor in the liquidation. One option to address this problem would be to specify clearly in the DIS legislation that the compensation payment by the DIS should be apportioned among the different deposit accounts of the depositor on a pro-rata basis (Example (iii) in Annex D shows how this would work).
3.10 The above option appears to be fair to depositors, but it might increase the liquidation costs as the liquidator would have to perform additional work in apportioning deposits and calculating interest entitlement. An alternative would be to amend section 227E of the Companies Ordinance so that in the event that payment was made by the DIS before the appointment of a provisional liquidator, the date on which the DIS payout was triggered would be taken to be the “relevant date” for the purpose of that section. This would fully align the respective treatments of accrued interest by the DIS and the liquidator (see Example (iv) in Annex D). The drawback is that this might prejudice the interests of other uninsured depositors (typically large depositors) who would receive a smaller interest payment from the liquidator as a result of this change. However, it could be argued that they would benefit from the cost savings in the liquidation as a result of the alignment of the treatment on interest accrual. The HKMA would welcome views on which of the two options identified above would be a better solution to address the issue.
Applying the coverage limit to special types of accounts
3.11 Providing cover on a per-depositor basis requires consideration of how the limit should be applied to multi-beneficiary accounts such as joint, partnership and trust accounts.
3.12 The crux of the issue is how to balance equitable treatment of depositors against the practical considerations of maintaining a simple and effective system. The proposals in respect of each type of these accounts are set out below.
Trust accounts
3.13 Where persons are entitled to a deposit as trustees, the Board should treat any claim they make in respect of such a deposit as trustees as being separate from any claim they make in respect of deposits to which they are entitled in their own right.
3.14 In the case of a bare trust16, i.e. where a trustee holds property for a beneficiary who is absolutely and solely entitled to that property, the Board should treat the beneficiary, and not the trustee, as the claimant in respect of the trust monies held on deposit.
3.15 If a group of persons has a claim as trustees, the group should be treated as if it were a single entity separate from the individuals constituting the group so that any change in the membership of the group would not affect any such claim.
3.16 If a trustee has a claim as trustee for different trusts, the trustee should be entitled to make separate claims for each of the trusts he represents and the Board should treat those claims as if they were made by different persons.
Client accounts16
3.17 If a person (e.g., a solicitors’ firm or a brokerage firm) has a claim as agent for one or more principals, the Board should treat the principals as having the claim, not the claimant, provided that the agent -
(i) has declared to the relevant bank that the relevant accounts are held for the benefit of its principals and that it maintains proper records of the identities and entitlements of its principals in respect of such accounts at all times; and
(ii) makes an annual disclosure to the relevant bank regarding the number of beneficiaries and their respective entitlements underlying such accounts to facilitate premium assessment in respect of the bank.17
3.18 Para. 3.17(ii) above would help the participating banks to calculate the amount of insured deposits they hold for the purpose of premium assessment in each year. However, this may result in some inflation of the size of insured deposits of a participating bank because it might not be possible to aggregate a deposit in a client account with the other deposits made by the same beneficiary in the bank if the information provided by the agent was on an anonymous basis. One way to address this problem would be to allow the bank an option to request the agent to provide information detailing the identities and entitlements of its clients in respect of such accounts and use
16For bare trust and client accounts, the entitlement of each underlying beneficiary in such accounts would need to be aggregated with the balances in the other accounts of the beneficiary with the same bank to determine the amount covered.
17 The CDIC has a similar disclosure requirement. For certain specified categories of agents (such as solicitors and stock brokers) whose clients change frequently, the agent is allowed to provide an alpha-numeric code identifying each beneficiary if it maintains records of each beneficiary’s identity and proportionate interest.
this information to determine the size of insured deposits for the purpose of premium assessment.
Partnership and joint accounts
3.19 If two or more persons have a joint beneficial claim, the claim should be treated as a claim of the partnership if they are carrying on business together in partnership.18 Otherwise each of those persons should be taken to have a claim for his share, and in the absence of satisfactory evidence as to their respective shares, the Board should regard each person as entitled to an equal share. The allocated amount would then be aggregated with the balances in any other accounts of each of the persons to determine the amount covered.
Consistency with section 265 of the Companies Ordinance
3.20 The proposals in paragraphs 3.13 to 3.19 above are largely consistent with the approach under the UK scheme. Other schemes may offer a more generous arrangement, e.g. the CDIC treats a joint account deposit as a deposit separate from any deposit of the account holders acting in their own right. However, the HKMA believes that the above proposals strike an appropriate balance between prevention of possible abuses (e.g. persons seeking multiple coverage through setting up a number of joint accounts) and the practical difficulties of obtaining the information required to identify the depositors’ shares and performing account aggregations for premium assessment purposes.
3.21 It is noted that the priority claim provisions under section 265 of the Companies Ordinance are silent on these issues. It is therefore unclear whether the liquidator of a failed participating bank would apply similar rules as proposed above in determining the priority claim entitlements of such bank’s depositors.19 It would be preferable if the DIS and the liquidator were to adopt the same set of rules so that the DIS would avoid shortfall risk20 as a result of any mismatch between the payout rules adopted by each of them. It is proposed therefore that section 265 of the Companies Ordinance should be amended to spell out the treatment that would apply in a bank liquidation to the
18 It is proposed that the deposits of individual partners should not be aggregated with the partnership accounts as the latter are normally held exclusively for the purpose of the business under partnership.
19The existing provisions seem to be lacking clarity as indicated by divergent views among the insolvency practitioners as to how they should be interpreted. For example, one firm indicated that it would treat the deposit of a joint account as a deposit separate from any deposit of the individual depositor in his own right. Another firm indicated that it would treat each of the persons owning the joint account as having a claim for his share of the joint deposit and aggregate this share with any other deposits he has with the bank in determining his priority claim entitlements.
20 Shortfall risk is the risk that the assets realised in a bank liquidation may be insufficient to meet depositors’ claims of that failed bank.
relevant types of deposits held by it and to make these consistent with the treatment that would be applied by the DIS.
Foreign currency deposit accounts
3.22 Given the substantial amount of foreign currency deposits in Hong Kong, it would be necessary to include such deposits in the coverage of the DIS.
3.23 Accordingly, two decisions have to be made. The first is whether foreign currency deposits should be repaid in the relevant foreign currency or in Hong Kong dollars. As noted by the FSF Working Group, a scheme that offers to repay depositors in foreign currencies must have access to sufficient foreign assets or other sources of foreign currency funding to make this commitment credible. On the other hand, if the payout is made in local currency, transparent rules should be set out in advance with respect to the choice of the exchange rate used to calculate the amount to be compensated.
3.24 Given that the funding of the DIS and the dividend payment from the liquidator of a failed bank would be in Hong Kong dollars, it is proposed that the DIS should make all payments in Hong Kong dollars, irrespective of the currencies in which the deposits are denominated.21 This would place some foreign exchange risk on the depositors but they should be no worse off than they would be if they were paid out in a liquidation.
3.25 If this proposal is accepted, the rules should be clear with respect to the exchange rate that would be used for the calculation of the payout. The HKMA believes that it would be appropriate to choose the date on which the DIS payout is triggered as the valuation date since this would be the same for all claimants. Accordingly, it is proposed that the exchange rate to be used for converting a foreign currency deposit into Hong Kong dollars should be the midpoint between the selling and buying telegraphic transfer rates of exchange quoted by the Hong Kong Association of Banks on the day the DIS payout is triggered or, where no such rates are quoted, an exchange rate determined by the Board.22
3.26 Under this proposal, the DIS would be exposed to certain level of foreign exchange risk because the exchange rate used by the DIS to convert foreign currency
21 This would be consistent with the insolvency practice in Hong Kong whereby liquidators would generally convert foreign currency debts of the insolvent entity into Hong Kong dollars when making dividend payments.
22This would be similar to section 34(3B) of the Bankruptcy Ordinance, which provides that where a debt provable in bankruptcy is payable in a currency other than Hong Kong dollars, the debt shall be converted from the foreign currency into Hong Kong dollars at the midpoint between the selling and buying telegraphic transfer rates of exchange quoted by the Hong Kong Association of Banks on the day the bankruptcy order is made or, where no such rates are quoted, at an exchange rate determined by the Court.
deposits may differ from that used by the liquidator. However, it should be possible for the DIS to hedge this risk.
3.27 To address the situation where a depositor has insurable deposits denominated in different currencies, it is proposed that the Board should be given the discretion to decide the order in which deposits in different currencies should be paid out subject to the principle that this would help to minimise the DIS’ potential exposure to foreign exchange risk. This means that deposits in Hong Kong dollars and US dollars would normally be paid out first. Examples (v) and (vi) in Annex D show how this proposal would work in practice. The latter example also illustrates how this would interact with the proposal in para. 3.9 above for the purposes of interest accrual (i.e., compensation payment by the DIS should be apportioned among different accounts of a depositor on a pro-rata basis).
Chapter 4 – Depositor Priority, Set-off and Assignment of Rights
4.1 This Chapter will consider:
(i) whether the DIS should set off a depositor’s liabilities to a failed participating bank in determining the payout to depositors; and (ii) measures that would help the DIS minimise its shortfall risk or
speed up reimbursement from the liquidator.
Netting
4.2 The decision whether to set off a depositor’s liabilities to a failed participating bank in determining his deposit insurance entitlement is an important consideration which not only affects the payout to depositors but also the cost of the DIS.
4.3 This was the subject of a separate consultation in October last year. The relevant Discussion Paper can be accessed from the HKMA’s website. The paper already sets out the detailed arguments for and against different options for netting.
4.4 The two main options that were considered in the Discussion Paper are:
(i) Partial netting23 - the DIS should only set off contractually due and past due liabilities of a depositor against his deposits in determining the amount of his entitlement; and
(ii) Full netting24 - a depositor’s liabilities would be completely set off against his deposits before his entitlement is determined.
4.5 The results of the consultation indicated that the banks’ views were mixed on this issue. However, there was greater support from the insolvency practitioners for adopting a full netting approach in determining deposit insurance payouts, which is consistent with the current insolvency law. It would also reduce the risk that the DIS would pay out more to depositors than it could recover in a liquidation (owing to differences in its netting approach from that of the liquidator) .
4.6 Partial netting would probably serve the objectives of a DIS better since it would involve less disruption to depositors’ cash flow (i.e. there would be greater scope
23 This is the approach recommended by the Consultant who undertook the study on Enhancing Deposit Protection in Hong Kong in 2000.
24 This would be consistent with the insolvency law in Hong Kong whereby mutual credits and debts between the insolvent entity and its creditors/debtors would be set off against each other in a liquidation.
for them to receive payment from the DIS without deductions from their deposits of liabilities that are not yet due). However, for this approach to be feasible, it would appear that changes to the insolvency legislation would be required in order to align the approaches towards netting of the DIS and the liquidator of a failed bank. Otherwise, the DIS would face greater shortfall risk and the costs of the scheme would be likely to be increased. Given the general importance attached to minimising the costs of the DIS, this is not desirable.
4.7 Nor does it seem feasible in this case to amend the insolvency legislation.
This would be controversial and is not supported by the insolvency practitioners with whom the HKMA has discussed the issue, or by the Standing Committee on Company Law Reform. In view of this, it is proposed that the DIS should apply full netting in determining the payout to depositors, in accordance with the current insolvency law and practice. This means that the DIS would set off a depositor’s liabilities to a failed participating bank (including particularly liabilities arising from any credit facilities) against his deposits with the bank in determining his entitlement under the DIS.
Interim payment
4.8 A related issue to be considered is whether the Board should have the option not to apply netting in certain circumstances. In the UK scheme, such a discretionary power was previously given to the Deposit Protection Board under the UK Banking Act. However, this provision has not been carried forward to the rules promulgated by the Financial Services Authority in relation to the setting up of the Financial Services Compensation Scheme. Instead, a new provision for reduced or interim payments has been added to these rules which would enable the Scheme Manager to pay an appropriate lesser sum in settlement if he considers that immediate payment in full would not be prudent because of the uncertainty as to the amount of the claimant’s overall net claim.
4.9 The HKMA believes that it would be desirable for the Board to have a similar flexibility because there might be some uncertainty as to how the liquidators would apply netting in practice.25 From the perspective of restoring depositors’
confidence in the banking system and averting a banking crisis at an early stage, it is also desirable for the Board to be able to make a quick payout to depositors. This might take the form of an interim payment consisting of the lesser of a certain percentage (say 25%) of the principal of an insured deposit or a specified absolute amount. In the interests of speed, adjustments to the principal balance would be kept to a minimum and there would be no accrual of interest. The interim payment might be made within, say, 10 days, with final settlement of the insured claim being made at a later date after all the various adjustments, including interest accrual, had been made. The HKMA is still considering
25 For example, some liquidators may sell off the mortgages of a failed bank as a portfolio of assets whereas others may sell off mortgages only after setting off the deposit balances of the customers concerned.
this proposal in the context of a separate study it is presently conducting on the payout strategy and procedures of the DIS.
Assignment of depositors’ rights to the DIS
4.10 As noted, the DIS would pay an insured depositor only after the depositor has assigned all his rights and remedies in relation to the deposit (up to the amount of the payment made) to the DIS. It would be cumbersome, and could undermine the efficiency of payout, if the DIS has to approach all eligible depositors and obtain an assignment in writing from each of them. It would be desirable to include an explicit provision in the DIS legislation to provide for an automatic assignment of rights from the depositors to the DIS. Based on the relevant provisions in the Protection of Wages on Insolvency Ordinance, a provision along the following lines is proposed to be included in the DIS legislation:
“Where the Board makes a payment in respect of any deposit with a participating bank, all the depositor’s rights and remedies with respect to the deposit existing immediately before that payment shall, to the extent of the amount of the payment made, be transferred to and vest in the Board for the benefit of the DIS Fund and the Board may take such steps as it considers necessary to enforce those rights and remedies”.
Clarification of the priority claim provisions in the Companies Ordinance
4.11 The cost of the DIS would be affected significantly by how much and how quickly the DIS would be able to recover from the liquidator of a failed participating bank. It is thus important for the DIS to be able to take over the priority claim status of each of the depositors it has paid out. This would be crucial to the reduction of the shortfall risk and financing cost of the DIS. However, the relevant provisions in the Companies Ordinance do not make it clear whether the DIS would have a priority claim in respect of the whole of the aggregate amount it has paid out to depositors or simply the first HK$100,000 of such amount as if the Board were one single depositor. A legislative amendment to section 265 of the Companies Ordinance would be necessary to ensure that the Board has a priority claim in respect of the aggregate amount.
Asset maintenance requirement for banks
4.12 It is also necessary to consider whether participating banks should be required to maintain sufficient assets in Hong Kong to cover their insured deposits in the event of a liquidation. Such an asset maintenance requirement would help to minimise the shortfall risk of the DIS. However, such a requirement is not without cost as it could constrain the ability of banks to freely manage the disposition of their assets. In practice, from the previous surveys undertaken by the HKMA, it appears that banks in Hong Kong (including foreign banks) generally maintain more than sufficient assets in Hong Kong to
cover their deposits that have priority under the Companies Ordinance (and those would be insured by the DIS). In view of this, it does not seem necessary to introduce a general requirement on asset maintenance for all banks. However, it would be necessary for the HKMA to have the ability to monitor, on a regular basis, the extent to which banks’
insured deposits are covered by assets held in Hong Kong. This could be done through a regular (quarterly or half-yearly) statistical return. In case of need, when there is a risk that the ratio of the assets held in Hong Kong to the insured deposits of a particular bank might become insufficient, the HKMA could step up its monitoring of that bank and, if necessary, require it to take remedial action to maintain an appropriate ratio. While the HKMA could use its existing general powers under the Banking Ordinance to require this, it would make the process more transparent for a specific power to be given to the HKMA, either in the DIS legislation or in the Banking Ordinance.
Measures for speeding up reimbursement from liquidators
4.13 The financing cost of the DIS could be reduced if the DIS could get reimbursement from the liquidator within a shorter period of time. From the HKMA’s discussions with the insolvency practitioners, it appears that after a winding-up petition is filed, it would normally take about 3-6 months before a winding-up order is granted by the Court. This means that the DIS would only start to receive payments from the liquidator some months after it has paid out the depositors.
4.14 It would be preferable if this timeframe could be further shortened. One option would be to include an explicit provision in the DIS legislation which would enable, but not oblige, the provisional liquidator to make payment to the DIS, possibly against an indemnity provided by the DIS.26 This discretionary power of the provisional liquidator would need to be subject to Court approval. It is relevant to note that in fact in 1992 the provisional liquidator of the Bank of Credit and Commerce Hong Kong Ltd was able to make an interim payment to all depositors against an indemnity provided by the Government after obtaining the High Court’s approval of such an arrangement.
4.15 Accordingly, it is proposed to include a provision in the DIS legislation which would give a discretionary power to the provisional liquidator of a failed participating bank to make early payments to the DIS subject to approval by the Court.
26 This would reduce the financing cost of the DIS if the interest charged (if any) by the provisional liquidator in respect of early payments to the DIS is less than the interest payable in respect of a loan from the Government or a third party to fund the payout.
Chapter 5 – Funding and Premium Assessment
5.1 This Chapter will consider:
(i) what the appropriate size of the DIS Fund should be to cover losses which might be suffered by the DIS;
(ii) how this target fund size should be built up and maintained; and (iii) how the premium should be assessed on individual participating
banks – in particular, whether a differential premium system should be introduced; and, if so, how this should be structured.
5.2 Detailed proposals on the above issues were the subject of a separate consultation in September last year (the relevant Discussion Paper can be accessed from the HKMA’s website). As such, details of the proposals and the relevant considerations will not be repeated here. It is sufficient to recall that the methodology used to derive the target fund size and premium involved the following steps:
(i) making assumptions about possible shortfall loss and funding costs of the DIS Fund, and the probability of default of participating banks;
(ii) feeding these assumptions into a statistical model in order to calculate the target size of the DIS Fund and the level of annual premium required to build up the Fund to the target level within a reasonable period of time. The target level of the Fund would be designed to cover both expected and unexpected losses up to a given confidence interval. Upper and lower limits of the Fund would also be set to produce a target range;27
(iii) re-calculating the target level of the DIS Fund each year to take account of deposit growth, changes in the risk profile of participating banks and the funding costs of the DIS;
(iv) once the target level of the DIS Fund had been reached, basing the annual premium on the expected loss of the DIS;
(v) paying a rebate or levying a surcharge, when the balance of the DIS Fund rose above the upper limit or fell below the lower limit, as the case may be, of the target range; and
27 In practice, the target fund size and the target range would be expressed as percentages of insured deposits – see para. 5.3 below.
(vi) differentiating the premium paid by individual participating banks, based on their supervisory (CAMEL) ratings given by the MA.
5.3 This methodology produced the following outcome in terms of target fund size, build-up period and premium level:
(i) based on the level of insured deposits at May 2001, the target fund size would be set at HK$1.5bn (or approximately 0.3% of the sector’s total insured deposits). The target fund size would grow in absolute terms in line with the growth in insured deposits;
(ii) based on a flat annual premium of 8 basis points, the target level could be reached within 4 years, taking into account deposit growth;
(iii) once the target fund size had been achieved, the annual premium would be reduced to a much lower level of about 1 basis point (equivalent to the annual expected loss of the DIS);
(iv) a rebate or a surcharge would be triggered once the balance of the DIS Fund rose above the upper limit or fell below the lower limit, as the case may be, of the target range. The upper and lower limits were defined as +/-30% of the target fund size; and
(v) it would be feasible (and desirable) to provide for a differential premium structure linked to an individual bank’s CAMEL rating as set out below :
CAMEL Rating Premium during fund build-up (bp)
Premium after fund build-up (bp)
1 5 0.75
2 8 1.0
3 11 1.5
4 & 5 14 2.0
5.4 Results of the consultation exercise indicated that the respondents largely agreed with the suggested methodology for estimating the target fund size and premium both during and after the fund build-up period. There was also support for a differential premium system and for the use of CAMEL ratings for this purpose. It was considered preferable to adopt a risk-based approach towards calculating the premium so that banks would be rewarded for having strong management and good asset quality.
5.5 The Hong Kong Association of Banks (“HKAB”), however, proposed certain variations aimed at lowering the cost of the DIS further. These included a lower
target fund size, a lower upper fund limit, a longer fund build-up period, a cap on surcharge and government contribution to the DIS Fund.
A smaller fund size
5.6 HKAB considered that the proposed $1.5 billion target fund size based on a 99.8% confidence interval was overly conservative. It proposed targeting at a lower confidence interval of 98% or even 95% “as recommended in the Consultant’s report”28. It considered that a much smaller fund capable of coping with the failure of 2 to 3 small banks or one medium-sized bank would be adequate.
5.7 The HKMA considers that further reduction of the proposed $1.5 billion target fund size would make it more difficult to meet certain international standards and benchmarks for credibility. The main considerations are as follows:
• the proposed 99.8% confidence interval matches an investment grade rating of BBB (which is also the rating for a typical local bank whose depositors would be insured by the DIS); whereas 98% and 95% confidence intervals correspond to speculative grade ratings of BB- and B respectively;
• a HK$1.5 billion fund meets the IMF’s benchmark of being able to cope with the failure of 2 medium-sized banks; whereas the fund sizes corresponding to 98% and 95% confidence intervals29 would be capable of meeting losses arising from the failure of only one typical medium-sized bank and one smaller medium-sized bank respectively;
• at around 0.3% of insured deposits, the target fund size is at the lower end of the range for comparable schemes; and
• to achieve an 8% capital ratio under the New Capital Accord, the DIS would need a fund size of $1.76 billion (based on the risk-
28 It is true that the original Consultant’s report suggested lower confidence intervals. However, the assumptions used by the Consultant, in particular, on default frequency were much more conservative, hence giving rise to a much higher target fund size notwithstanding the lower confidence intervals. The HKMA has subsequently refined the Consultant’s assumptions, while adopting more conservative confidence intervals. The overall result is a significant reduction in the target fund size.
29 Confidence intervals of 98% and 95% would correspond to fund sizes of $730 million and $384 million respectively.
weighted assets of the DIS of $22 billion).30 HKAB’s suggested levels would be significantly below this requirement.
5.8 For the above reasons, it is proposed not to reduce the fund size further since this might undermine the credibility of the DIS.
Government contribution
5.9 HKAB proposed that the Government should contribute to the fund build- up, for up to 50% ($0.5-0.8 billion at the minimum) of the target fund size. It argued that in most countries with a DIS the government is one of the funding sources.
5.10 According to a recent survey by the IMF, governments’ support for DISs in most countries is in the form of backup liquidity. This form of support is what the Hong Kong Government has already agreed to provide through the Exchange Fund. Out of the 66 jurisdictions surveyed by the IMF, only one third of the surveyed countries’
governments contributed to the start-up capital of their DISs. In view of the above and in line with the user-pays principle, it remains the Government’s position that it would be inappropriate for it to provide a direct contribution to the capital of the scheme.
A lower upper limit for the target fund
5.11 HKAB considered that the proposed +/- 30% target range was excessively wide, in particular, the upper limit. In response to this, the HKMA proposes to adopt an asymmetric target range by reducing the upper limit to +15% while maintaining the -30%
lower limit. This would increase the likelihood and frequency of rebates.
A cap on surcharge
5.12 HKAB suggested to set a cap on the surcharge to the amount of the premium if the DIS Fund had to be replenished following losses. The HKMA agrees to this proposal. The benefit of introducing a cap would be to reduce the procyclical impact of DIS funding. It would avoid levying too heavy a surcharge at a time when the banking sector might already have been weakened by bank failures. It is proposed therefore that the surcharge and annual premium taken together should not be more than the premium that would be paid in the initial period while the DIS Fund is being built up (see the figures in the table in para. 5.3).
Extending the build-up period and reducing the build-up premium
5.13 HKAB considered that a build-up period of 3-4 years was too short and that it should be extended through lower premium (less than 8 basis points) in the initial
30This treats the DIS as if it were itself a bank with risk exposure to the banks it insured. The figures take into account the latest proposals from the Basel Committee.
years. However, the premium of 8 basis points is only the central rate applicable to most banks. In the Discussion Paper, the suggested differential premium structure of 5,8,11,14 basis points would actually give a weighted average premium of 7 basis points and hence the target fund size would be reached in 5 years instead of 3-4 years (see Annex F of the Discussion Paper). This seems a reasonable length of time to allow the DIS Fund to build up and thus it is not proposed to extend the period further.
Rules on funding and premium assessment
5.14 It is proposed that the target fund size, target range and premium structure should be set out in the DIS legislation at the outset so as to provide greater certainty to banks about their financial commitments. As noted earlier, the target fund size would be set as a percentage of insured deposits (say 0.3% initially). This figure and the other parameters would be subject to change in the light of factors such as changes in the risk profiles of the participating banks and in the DIS’ funding costs. For this reason, it is proposed that the relevant rules should be set out in a schedule to the DIS legislation which would be subject to amendment by the Chief Executive in Council. A set of the Rules on Funding and Premium Assessment is given in Schedule 2 of Annex B.
Funding of administrative costs
5.15 The issue of how the administrative costs of the DIS should be funded was not addressed in the Discussion Paper on Funding and Premium Assessment.
5.16 Given the limited functions of a “pay-box” scheme, the administrative costs should be relatively modest.31 If so, charging the administrative costs to the DIS Fund should not in any significant way affect the ability of the Fund to attain its target level, and there seems no need to impose a separate levy on participating banks to cover administrative costs. It would be specified in the DIS legislation that the administrative costs of the DIS should be charged to the DIS Fund.
De minimis premium
5.17 In some cases, e.g., where a participating bank only has a small amount of insured deposits, the premium charge on the bank would be minimal. The HKMA has considered whether the premium charge on such institutions should be waived if the cost
31It is expected that a “paybox” scheme would require approximately 12-15 staff members. This would include the Chief Executive Officer, a chief accountant and supporting staff for premium assessment, administration and accounts management. Based on this structure, a rough estimate of the annual administrative costs of the DIS would be in the range of $12-15 million, around 0.8%-1% of a target fund size of HK$1.5 billion. The above estimate is proportional to the operating expense of the Hong Kong Mortgage Corporation in 2000 (HK$98 million), which has a staff force of about 100.
of collection would be disproportionate to the amount received32 or whether there should be a minimum premium for all participating banks33.
5.18 The former approach would give rise to a free-rider problem whereby certain institutions (including new entrants to the DIS) can benefit from free insurance.
We therefore prefer the latter approach which would not only help to avoid the free-rider problem, but also contribute to sharing of some of the administrative costs of the DIS. It is proposed therefore that the annual premium payable by a participating bank should be subject to a minimum level of, say, $10,000. This minimum fee would also be payable by new entrants to the DIS upon being granted a banking licence by the MA.
32This approach is adopted by the UK scheme.
33This approach is adopted by the CDIC.
Chapter 6 – Premium Collection, Refund & Fund Management
6.1 This Chapter will consider how:
(i) premiums should be collected; and (ii) the DIS Fund should be invested.
Premium collection
6.2 Premium collection is an important aspect of the work of any DIS. In keeping with the principle of maintaining a lean management structure for the Board, it is proposed that the Board should have the power to appoint an agent to collect insurance premiums. However, given the sensitivity of premium information, which would reflect the risk ratings of individual participating banks, it would not be appropriate for the Board to collect premiums through ordinary bank accounts. Accordingly, it is proposed that the Board should appoint the HKMA as its agent to collect insurance premiums from participating banks via the RTGS system.34 The relevant HKMA staff would be subject to the secrecy provisions in the DIS legislation.
6.3 To ensure punctual payment of premiums, the Board could serve assessment notices on participating banks requiring them to credit premium payments to the HKMA for the account of the DIS by a specified date. The DIS legislation should empower the Board to specify the manner and timing in which premium payments should be made. The legislation should also specify the penalty for late or non-payment of premiums.
6.4 A related issue is whether premiums should be paid by instalments.35 Considering that the proposed premium level would not be unduly high, payment by instalments does not seem necessary and would impose unnecessary administrative costs on both participating banks and the DIS. It is therefore proposed that the full annual premium should be collected in one payment.
Refund of premium
6.5 As the premium would be paid in advance, it would be reasonable to refund part of the premium payment made by a participating bank in the year in which it ceases to be a participating bank. Paragraph 2.8 in Schedule 2 of the Rules suggests how the
34 As proposed in Chapter 1 above, the Board should have the power to appoint an agent to discharge any of its functions on its behalf. In practice, the arrangements could be effected by the Board instructing banks to credit its account maintained with the HKMA via the RTGS.
35 For example, the FDIC and CDIC collect premium on a semi-annual basis.
