Jake's View

Why HK needs to be cautious about deposit guarantee

When a government backs liabilities but gives crooks free rein over assets, it invites a crisis

PUBLISHED : Monday, 04 August, 2014, 3:14pm
UPDATED : Tuesday, 05 August, 2014, 2:46am

At the onset of the global financial crisis in 2008, when the Government, in October that year, provided a full guarantee for all deposits in Hong Kong through the Exchange Fund, total deposits amounted to HK$5.8 trillion. So, without a sizeable Exchange Fund to back the blanket guarantee, we could not have restored the confidence of depositors and the market to maintain financial stability.

Norman Chan Tak-lam,
Blog, HKMA


I can't remember if that guarantee on all deposits is still in place. But, if not, it doesn't really change things. In good times we don't need it and at the first hint of bad times Norman would put it all in place again anyway.

It bespeaks a dangerous misunderstanding of how financial markets work but what can one expect from a career civil servant with a degree in sociology and only 19 months of sitting behind a desk at Standard Chartered ("Just sit behind that desk, Norman") as the sum total of his real world experience?

He might have been sitting still there except that the roadblock to the top of the Hong Kong Monetary Authority was suddenly unblocked when his predecessor declared a through train on mainland investment in our stock market without checking whether Beijing had cleared that train to leave.

It hadn't. Whoopee! New job for Norman.

Take note first of all that only half of this HK$5.8 trillion of deposits, which we guaranteed six years ago, consisted of Hong Kong dollar deposits. The rest was all foreign currency.

Deposits sourced from abroad, mostly US dollars, held in Hong Kong as a staging post and then directed right back abroad by people who might or might not have any other connection with Hong Kong, were guaranteed in full by the fiscal savings built up through your thrift and hard work.

In fact, the guarantee was made without sufficient assets to back it. The foreign currency deposits at the time outweighed our free fiscal savings by more than three to one. They were the equivalent of 166 per cent of our annual gross domestic product. We are talking very big money.

And we are talking even bigger money now. That HK$5.8 trillion in total deposits to which Norman refers has now grown to HK$9.6 trillion and half of it still represents foreign currency, mostly yuan now.

But what's a guarantee here and there? The way some critics talk you'd think there was real money involved.

There is more silliness here than this alone, however. When a government guarantees the liabilities side of a bank balance sheet but still gives the same old crooks at the bank free rein over the assets side of that balance, it invites financial crisis.

The depositors no longer care whether they have put their money with crooks. They are safe no matter what happens.

And no matter how risky the investments the crooks then make with the money, they know it won't be taken back from them. They are thus induced to take these big risks. If they win they take all, less a pittance for deposit interest. If they lose, the government picks up the loss.

This risk conundrum is formally called moral hazard. The crooks call it a no-brainer. I see no way of refuting their view of the matter.

Norman also fools himself in his notion that confidence would have failed without government intervention. It is a notion common to bureaucrats around the world at times of financial difficulty and invariably they act on it without asking themselves whether it is true.

It rarely is and it certainly was not so in Hong Kong in October 2008, the beginning of a period of record strength for the currency's exchange rate. Some harbinger of crisis that.

There were plenty of bargain hunters about and confidence would have fared much better if they had been allowed to prove the market's strength. Intervention also meant that speculators were not taught to fear their greed as they ought to have been. This will only make the next crisis worse.

But most of all, Norman, what gives you the right to put Hong Kong people so blithely at risk, without any public discussion, for the equivalent of HK$1.3 million for every member of the population?