Bankers' losses covered, profits are theirs to keep

PUBLISHED : Tuesday, 13 April, 2010, 12:00am
UPDATED : Tuesday, 13 April, 2010, 12:00am

But it will now take until 2018 to collect the HK$2.8 billion needed to insure depositors at each bank for up to HK$500,000.

SCMP, April 10

Imagine an earthquake-prone town in which an insurer has convinced the town council to support universal earthquake coverage. Every resident of this town is to get back the full value of his home if an earthquake knocks that home down. It's guaranteed.

Now imagine several other things. This is the only kind of insurance policy our insurer has ever devised, he is offering it only in this town, he is carrying all the risk himself rather than laying it off with re-insurers and he thinks he can sleep calmly at night with a cushion of only $1 for every $2,000 of value he insures, although his premium income will not give him even that $1 for another eight years.

It's a brilliant idea in Year 1 of the scheme. Our town suffers a big earthquake only once about every seven or eight years, and Year 1 is not one of those years, nor is Year 2. Our insurer is soon acclaimed a star, a titan of financial ingenuity, well worth the big bonus he is paid.

But along comes the big earthquake, and it destroys many more than one out of every 2,000 homes. Our insurer then finds it convenient to be at the airport quickly, and the populace is left to confront the town council. Where is our money? It was guaranteed.

Don't laugh. This is very much what we have with our government's proposal to raise deposit protection from HK$100,000 to HK$500,000 per bank per person this year.

It is the only insurance policy our government has ever devised, it will be a universal policy covering virtually all deposits, the risk of it will not be spread out to other underwriters and our bureaucrats think they need only HK$2.8 billion in the kitty to underwrite HK$6.3 trillion of deposits, although they will not collect even that much until 2018.

Make no mistake about the nature of the risk. This is not like fire, marine or car insurance, with their steady levels of claims.

This is general catastrophe insurance, and the earthquake comparison is entirely apt. Banks do not go wrong one or two at a time. In most years they are all in good shape, but when there is a financial crisis they are all affected.

There is no escaping a financial tsunami. Everyone on the beach is rolled over when the big wave hits.

To make things worse, deposit insurance itself makes those big waves bigger, in a phenomenon known as moral hazard.

When you tell bankers that their deposits are guaranteed, you encourage riskier lending. They now know they can keep the winnings if they win, while if they lose, they can pass the losses to the deposit scheme and walk away.

Heads I win, tails you lose - what a wonderful way to make money.

Call that cynical if you will but, in the same way that bad coin drives out good, bad banking practices have a way of driving out prudent ones in boom times.

A prudent banker who turns down a risky piece of business that a more adventurous competitor takes up and turns into an apparent success will soon face questioning looks from his bosses.

In the normal run of things the bust succeeds the boom, and prudence is once again rewarded. But when rash bankers can expect to suffer few ill effects of their rashness, then financial booms can only grow wilder and the busts more painful.

Deposit insurance aggravates the very evil it is meant to alleviate.

And let us not fool ourselves that HK$2.8 billion is the pay-out limit of this deposit insurance scheme. Nowhere in the world has that line in the sand ever withstood the tide.

Our government has effectively guaranteed the entire HK$6.3 trillion of deposits in the system, a mere four times our annual gross domestic product. If the scheme runs out of money, the entire public purse will quickly stand behind it.

What we have effectively done here is nationalise the banking system to protect ourselves against the incompetence or malfeasance of bankers whom we have yet left in full control of those banks.

It is a ludicrous state of affairs. If you really want to nationalise the banks, Mr Financial Secretary, then do it, but all you have done here is promise bankers that you will nationalise their losses. Their profits they will continue to keep.

I think that I shall get into this 'insurance' business myself.

Hey, psssst, give me your spare change and I promise to pay you a million dollars if Hong Kong is ever flattened by an earthquake. Don't worry. It's guaranteed. Where did you say the airport was again?