Caveat emptor, Shark sightings
The issue of the government's role in the protection of savers and investors from the sharks and incompetents of the financial services industry needs to be kept under constant scrutiny. That is no less the case because the government has proposed a compulsory deposit insurance scheme for banks to be administered by the Monetary Authority. And it is even more the case now that the whole community is being forced to save through the MPF and has limited control either over the disposition of its savings or of the (high) costs of intermediation of the usual of city slickers will be the primary beneficiaries.
This is not new nanny talk. In one way or another the government, through the major banks, has almost always taken the view that protection of people's deposits was an essential part of the trust need by a stable commercial society. Thus after the Japanese occupation the Hongkong Bank honoured notes issued by the Japanese. During the 1966 banking crisis, HSBC and other stronger banks took over the deposit liabilities of the failing ones, which included the Hang Seng Bank. In the mid-1980s a whole slew banks were bailed out either directly by the government (Overseas Trust Bank and Ka Wah Bank) or by other banks with the help of official guarantees. Indeed, there has only been one case - and a disgraceful one it was - where the authorities walked away from responsibility to depositors in respect of a locally incorporated and supervised bank.
That exception was the collapse of the local subsidiary of Bank of Credit and Commerce International a decade ago, an exception never adequately explained but probably related to its non-Chinese origins. So why do we need a formal and compulsory deposit insurance scheme now? It seems a curious juncture to demand one.
Elsewhere in the world they mainly exist where (as in the US) there is a multiplicity of small local banks and supervision is divided between federal and state authorities. That is hardly the case in Hongkong where the UK-based HSBC group accounts for almost a third of deposits, the state-owned Bank of China group for another huge chunk, and huge foreign banks such as Citibank for a further chunk. Even in the US the role of deposit insurance is under critical scrutiny from Mr Greenspan. In a May 10 speech he said that only a third of the funding of the top ten US banks came from insured deposits. He also noted that insurance was subsidised and did not enhance prudence in banking.
For Hongkong the proposed maximum for compulsory insurance is HK$100,000. On the face of it this suggests concern for small depositors while letting the larger ones absorb their own risk. But it is also a burden on these depositors. The HKMA is responsible for the prudential supervision of local banks, ensuring adequate capital adequacy and liquidity ratios and generally keeping an eye on lending standards, spreads etc.
So why does it not put its own money where its prudential commitment stands? That should not be difficult. The number of banks is much reduced from the mid-80s and a HK$100,000 deposit is tiny compared with some beneficiaries of the HKMA bailout of, for example, OTB. The scheme purports to help small depositors. In reality it is designed to benefit the smaller local banks who do want to avoid being forced into full competition with the big boys.
In the past the interest rate cartel, and the government's past informal deposit guarantee enabled them to prosper. However, with the end of the cartel they need new protection. What better than a compulsory insurance premium which will raise costs for all banks regardless of their quality! The scheme also runs contrary to the HKMA's avowed intention of seeing bank mergers here, to produce bigger but more efficient players. The process has been going on all over Asia, not least in Singapore. It has been happening here too, to some extent. But it could go a lot further.
The HK$100,000 ceiling for insured deposits is also likely to be inefficient as it could well result in multiple accounts. It will also be another burden on smaller savers. Interest rates on deposits of up to HK$100,000 will bear the cost of insurance whether the depositor wants it or not. The scheme may go further contradict market principles. It is not yet clear whether the insurance premium will be fixed or vary according to the credit rating of the particular bank.
It would be interesting to see the HKMA issue a creditworthiness league table for local banks - but that seems unlikely given local sensibilities. So who would decide? That is not an idle question because the whole international bank industry is supposed, under the latest Basle accords, to be moving towards more active grading of credit risk. So if bank deposits are to be insured, the premiums must reflect the standing of each bank. If the HKMA wants to provide a voluntary window for deposit insurance and charge a market rate, let it do so.
Even better it could invite outside agencies to offer cover, should they be willing. But the present proposal approved by the Executive Council without much public debate and in the face of opposition from the more efficient banks is a disaster. With luck it will go the way of so many half-baked government ideas and never get to implementation.
Banks have always played an inordinately large role in financial intermediation in Hongkong, to the detriment of bonds, mutual funds etc. But that is changing partly as a result of the Mandatory Provident Fund which promises to be a bonanza for the providers. So there needs to be much greater awareness of the little tricks that fund managers get up to improve their profitability or image.
Average investors are often unaware of them as they hold funds through a provident scheme or insurance policy. One such device is simply to abolish or change the name and/or investment objectives of a fund by merging it. Three examples have recently come to my attention.
Merrill Lynch, whose analysts (if you can so dignify them) were once the most bullish boosters of internet stocks, is abolishing the US version of its Internet Strategies Fund, merging it with a broader technology fund. HSBC likewise abolished its poorly performing Asia Tactical Fund, formerly known as the Japan Warrants Fund, at the end of March - typically, probably at about the bottom of the market - though surely there are still investors interested in Japan warrant funds. The US-listed Central Europe Value Fund run by Clemente Capital originally attracted those who wanted to invest in emerging European markets such as Hungary. It changed its name to Cornerstone Strategic Fund and switched into US tech stocks!.
Though not all these specific funds were registered for sale in Hongkong the managers are all major players and thus their attitudes deserve attention. The practice is unfortunately widespread and needs combatting. The requirement for fund holders' consent before making these changes is no defence against the practice of abolishing or radically altering poorly performing funds. In reality the managers have the whip hand when dealing with passive investors and often do as they please. Investors buy into such funds because they were promised a specific asset class. If they cease to want it they can sell the funds.
For managers to change fund investment objectives to improve their image - and quite likely their own remuneration -- is underhand.. A government which requires everyone to save through a small number of fund providers should ask the MPF authority to make sure that MPF providers avoid fund management companies which resort to such practices.
Financial institutions often get away with manipulating retail investors partly because the regulatory bodies are stuffed with people from the industry involved - much like Hongkong's self-protecting doctors. They lack lay members, as though only a select bunch of investment bankers, brokers and lawyers are capable of understanding commonplace rip-offs. In practice in a small and incestuous place like Hongkong members of panels seldom want to upset colleagues by acting in ways which protect the public against the abuses of the financial services industry. Stock investment for Hongkong people via the MPF is now pension money not gambling money.
The people need better protection than they are getting. The government and SFC can do much more. But share and fund holders also need to help themselves, confronting abuses by controlling shareholders with exposure, proxy fights and lawsuits. So let's give a warm welcome to the proposal from David Webb, that most expert of activists, for the formation of a Hongkong Association of Minority Shareholders. ends
ends
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