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Jake's View
PUBLISHED : Thursday, 30 January, 2014, 5:01am
UPDATED : Thursday, 30 January, 2014, 5:01am

Not everyone will be safe when banks go bust

[The Hong Kong Monetary Authority] wants banks to set aside as much as 3.5 per cent of their capital as a countercyclical buffer compared with a maximum of 2.5 per cent required by Basel ...

Countercyclical buffers are meant to be built up during times of earnings growth so that they can be drawn down when things are not going well.

SCMP, January 29

Time for a reminder of Jake's No 7 Rule of Investment - No matter how wide you build the exits, they are never wide enough when a stampeding crowd wants out.

The thing about bank runs is that they do not happen in isolation. When things start to go truly bad for any one bank within a financial system, they generally go bad for every bank in that system and there is no steel-clad security for anyone's savings.

I concede that all other local banks remained sound in 1991 when the local operations of Bank of Credit and Commerce International were liquidated by government order. But this was because of a BCCI scandal abroad. The local operations proved in top shape. Creditors and depositors got all their money back.

Single bank failure may happen because of fraudulent practice but the occasion that comes to mind here was the failure in 1985 of seven local banks controlled by Malaysian interests who raided their Hong Kong deposit base to prop up their failed companies at home. Bad news tends to come out everywhere at the same time, even with fraud.

No countercyclical buffer could have saved those seven, however. They were already too deeply insolvent and there had been regulatory failure. The banking commissioner never knew what they had been doing.

The remedy on that occasion was the one that had always previously been used. The financial secretary went around a line of bigger banks and said, "You, you and you, they're yours now. Live with it and don't give me no grief."

But the Hong Kong total deposit base back then was about HK$350 billion. It is now more than HK$9 trillion, 25 times as great. Can failed banks anywhere be picked up any longer by simply passing the hat this way?

The answer is that they probably cannot be, which is why the Bank for International Settlements in Basel has taken it on itself to set standards for minimum amounts of capital that banks must maintain relative to their risk assets. It is also why our own monetary chief, jittery by nature, wants to do Basel one better.

But it still does not get around the basic problem that when banks go bust, they tend all to go bust at the same time. Upping that extra safety margin to 3.5 per cent from 2.5 per cent of risk assets will then give the system perhaps four more hours of solvency, perhaps five, not much more.

In the end, it will still have to be government that fixes things by very publicly lashing out money and making weighty pronouncements of standing behind all deposits, or at least making people think it has made such pronouncements. The relevant officials will have their fingers crossed behind their backs throughout.

And one day it will happen that people will not believe even government promises.

It will happen because every time that new protective measures are devised to prevent bank failure they only increase the propensity for risk-taking. They do not actually make things safer.

It's called moral hazard in the business. Every form of investment, even a bank deposit, carries risk and when you try to remove deposit risk you only make the depositor careless of the bank in which he has his money and more willing to put that money at higher risk for a higher return.

It's sad to think that to keep a banking system safe you need the occasional bank to fail and depositors to find they can only get back 70 cents on the dollar. Yet it is probably true. Pain is the best disciplinarian of sound practice.

I relish this prospect no more than you do but the alternative to personal prudence in banking relationships is wilder swings in the economic cycle and system wide financial crises again and again. No one can build exits wide enough to get everyone out safely.



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This article is now closed to comments

JVDK today’s column could be thinly veiled support for our Financial Secretary. Save government revenue to save your deposit in time of a bank run.
I will rather go to the heart of bank problem – not the whole aspect though. I ask the question why we still need bank. The logic of having a bank is to gather money from the depositors and lend it out to business and industry. In the process the depositors earn some interests and the business and industry earn a profit. The bank of course earns a fee and a profit. Nowadays we have many other ways to do what banks traditionally do. In fact it seems business and industry prefers other ways than going to the bank for a loan.
but Jake, you don't address the root causes of bank failure risks.
ie, they are playing the leverage game, derivatives, etc to make fat profits, and not traditional bank loans and losses.
fact is, regulators don't want to take away their punch bowl, and still don't demand segregation of traditional banking and investment speculation but the bailouts will be from public money.
Like forex, a 10% loss w/ 10:1 leverage can wipe out your capital.
Love to see some investigative journalism on this.
No amount of surplus will save anyone if the banks go bust. And that's not even the problem. The problem is speculation, overheated real estate fuelled by massive cash in-flows from China. Solve real-estate, solve liquidity.
Mr van der Kamp appears to not understand the very fundamental difference between liquidity and capitalisation concerns. His stampeding herd exit analogy is a liquidity concern. Indeed, no market in the world can offer an exit wide enough for all investors to get out at the same time.

The countercyclical buffer however has nothing to do with that, nor with bank runs. It addresses bank capitalisation concerns and is aimed at limiting vulnerability to soaring loan defaults during a recession. Such a buffer would be used for capital write-downs without necessarily raising new capital, public or private.
We can almost do away with banks. They still exist mainly there are folks who aren’t as smart using their cash to earn profits from stocks and bonds that must still rely on banks for a traditional purpose in safe keeping with or without any interest.
For these folks, I think they should turn to other means since a bank ultimately may not be as safe. I think one’s money can’t be safer than parking it with their government. For the simple folks, safety is the paramount concern and let them have it.
For the government, it needs not to put aside a large sum for use in the event of bank runs -- there will be no more banks around or banks with deposits from simple folks.
Yes goveernment may even want to lend money too especially in mortgage.
if it has nothing to do with bank runs then it has nothing to do with HKMA, too


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