## _cr14209 - EXECUTIVE SUMMARY

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### Executive summary — key points
- HKSAR financial sector is "large, complex and interconnected with other financial centers," amplifying the need for an effective framework for crisis management and bank resolution.
- The IMF identified "29 jurisdictions, including HKSAR" as having systemically important financial sectors subject to FSAP surveillance every five years.
- "Twenty seven out of the twenty nine global systemically important banks (G-SIBs) identified by the Financial Stability Board (FSB) as of November 2013 undertake banking activities in HKSAR."
  - "For around a third of these banks, the home authorities have identified the operations in HKSAR as significant to the global group."
- Existing institutional framework:
  - Facilitates communication and coordination domestically and cross-border; information sharing and coordination are supported by sound legal bases for the exchange of confidential information.
  - HKMA engages in coordination and exchange of information with foreign counterparts and "has demonstrated a cooperative approach to cross-border bank resolution in recent cases."
- Macro- and microprudential supervision:
  - Complementary structures are in place contributing to prevention and identification of bank problems.
  - HKMA uses early warning indicators, such as the "bank capital trigger ratio," to facilitate timely supervisory action.
- Crisis management tools:
  - Authorities can provide emergency liquidity or capital support to banks in exceptional cases, supported by resources from the Exchange Fund.
  - HKMA’s lender-of-last-resort policy is transparent and in line with best international practices, limiting ELA to solvent banks and to circumstances where not providing liquidity may threaten the exchange rate or the "stability and integrity of the monetary and financial systems of HKSAR."
  - Terms and conditions for capital support are provided in practice with the Financial Secretary’s (FS) approval but "are not formally established or publicly disclosed."
  - "Regular crisis simulation exercises are carried out to test preparedness."
- Resolution regime assessment:
  - "The resolution regime needs significant strengthening" and there is presently "no comprehensive resolution framework in place."
  - Good international practice suggests empowering an administrative resolution authority to override rights of shareholders and creditors to secure continuity of critical services and protect financial stability.
  - Local challenges noted: a resolution authority "should have operational independence from government"; a resolution authority "could face obstacles in a legal system bound by rigorous procedures"; "The ready resources of the Exchange Fund should not limit the imperative to ensure the private sector bears an appropriate share of any costs."

### Table of select recommendations (summary)
- Powers to Deal with Problem Banks
  - "Continue efforts to develop a comprehensive resolution regime, in line with emerging international good practices."
- DPS
  - "In connection with developing the resolution framework, consider broadening the functions of the DPB to include financing the transfer of protected deposits to a healthy institution or bridge bank, on a least-cost basis (i.e., when such financing carries lower costs than direct payouts to depositors)."
  - "Review the modalities (target size; normal premium level; surcharge premiums for replenishment) for ensuring that DPS Fund has the appropriate resources without undue reliance on the Exchange Fund."
  - "Continue to seek ways for speedier payouts, including: (i) changing the netting rule for calculation of payouts to a gross rule and (ii) developing new payment channels."
  - "Formalize the identified early warning indicators for the HKMA to notify the DPB of bank distress."

---

### Institutional arrangements — domestic and cross-border coordination

### Domestic roles and delegation
- Government role:
  - "The Hong Kong Government plays an active role in financial and monetary stability."
  - The Financial Secretary (FS) is responsible for determining monetary policy objective, the structure of the monetary system, and exercising control over the Exchange Fund.
  - The Secretary for Financial Services and the Treasury (SFST) presides over the FSTB and formulates specific policy objectives for the financial system.
  - FS and SFST are "accountable to the Chief Executive." The Chief Executive, after consultation with the Executive Council, "retains discretion to exercise authority" on some implementation matters related to financial sector policies.
- Delegation to regulators:
  - Primary responsibilities delegated to regulatory authorities: Banking—Monetary Authority (MA); Securities and futures—Securities and Futures Commission (SFC); Insurance—Insurance Authority (IA).
  - Each regulator’s functions and objectives "extend to the promotion and maintenance of financial stability."
- Exchange Fund delegation:
  - Under the Exchange Fund Ordinance, the FS has "substantially delegated his powers for the use and management of the Exchange Fund to the MA."
  - Exchange Fund primary deployment: "matters affecting, either directly or indirectly, the exchange value of the currency."
  - Additional permitted use: the FS or MA may use the Exchange Fund "to maintain the stability and integrity of the domestic monetary and financial systems." In this capacity, the MA serves as the "lender of last resort (LOLR) for the banking sector."

### Domestic information exchange and formal mechanisms
- Formal mechanisms:
  - Council of Financial Regulators (CFR): chaired by the FS; members include SFST, MA, CEO of SFC, IA, MD of MPFA; meeting frequency: quarterly.
  - Financial Stability Committee (FSC): chaired by the SFST; comprises MA, CEO of SFC and IA; meeting frequency: monthly; provides regular reports to the FS and refers matters to the CFR.
  - Financial Services Branch Coordination Centre (FSBCC): operated on demand by the FSTB; activated in high market volatility or contingency events (e.g., failure of Lehman Brothers).
  - Memoranda of Understanding (MoUs): MA has comprehensive MoUs with the SFC and IA; MoUs identify points-of-contact, commit to regular meetings, and commit to information-sharing on specified trigger events.
- Legal powers and obligations:
  - Regulatory authorities have powers to consult with, notify, or report to the FS or the Chief Executive (after consultation with the Executive Council) on various matters.
  - Example: MA must notify the FS of any contravention by an AI of minimum requirements for capital adequacy or liquidity and consult with the FS before taking supervisory interventions under Section 52 of the Banking Ordinance.

### Cross-border coordination
- HKMA powers to share non-public information when disclosure is in the interests of depositors or the public interest.
- HKMA has MoUs or similar arrangements with more than 20 foreign authorities to:
  - Share supervisory information related to AIs operating in both jurisdictions;
  - Hold regular meetings and informal contacts;
  - Consult on planned cross-border establishments or investments by an AI;
  - Keep shared information confidential when needed.
- HKMA membership in CMGs of nine G-SIBs with significant operations in HKSAR; CMGs discuss and oversee development of recovery and resolution plans (RRPs).

### Findings and recommendation (institutional)
- Institutional arrangements contribute to efficient and effective communication and coordination domestically and cross-border.
- Clear mandates and divisions of labor exist; explicit coordination mechanisms and solid legal bases for confidential information exchange are in place.
- Recommendation: as integrated resolution framework work progresses, certain legal powers and obligations of the MA (and potentially other regulatory authorities) in relation to the Government warrant further review, given emerging international good practice that calls for resolution authorities to have operational independence.

---

### Prudential supervision — macroprudential and bank supervision

### Macroprudential surveillance
- HKMA established a Macroprudential Surveillance Committee, chaired by the MA, and a framework for macroprudential analysis.
- The Financial Stability Surveillance Division conducts focused macroprudential risk analyses and shares results with microprudential supervisors; Banking Supervision Department also conducts macroprudential analyses.
- Macroprudential tools deployed:
  - Since October 2009, six rounds of macroprudential countercyclical measures on property mortgage lending (e.g., more stringent loan-to-value caps for higher-value residential properties, non self-use properties, commercial and industrial properties).
- Macroprudential monitoring has influenced microprudential supervisors to require banks to ensure robustness of exposures to vulnerable markets abroad.

### Bank supervision (microprudential)
- Supervision is risk-based and forward-looking: onsite inspections, offsite monitoring, contacts with banks, thematic reviews.
- Use of forward-looking indicators and Management Information Packages to spot excessive loan growth or funding structure changes.
- Capital requirements and stress testing:
  - HKMA requires each AI to observe a non-statutory trigger ratio of capital above the minimum capital adequacy ratio (CAR), specific to each bank and determined by its risk profile (in addition to the Pillar 2 capital add-on).
  - HKMA conducts regular stress tests; if capital is vulnerable or declines towards the trigger level, the HKMA will enter into discussions with AI management or shareholders.
- Supervisory actions and procedures:
  - AI must send a Management Letter normally within 30 days outlining remediation and timetable for onsite examination deficiencies.
  - Banking Supervision Department monitors implementation via offsite surveillance and onsite examinations; external auditors used if necessary.
- Internal information-sharing:
  - Weekly meetings with HKMA management where incidents are reported; regular senior executive meetings chaired by the Chief Executive of the HKMA; ad hoc meetings when necessary.

---

### Crisis management — ELA, capital support, simulations

### Emergency Liquidity Assistance (ELA)
- HKMA published a policy for granting ELA; resources drawn from the Exchange Fund.
- Conditions for ELA include (among other things):
  - The situation constitutes a systemic threat to the stability of the monetary and financial systems or to the stability of the exchange rate;
  - The problem bank is solvent, defined as reporting a CAR level of at least 6 percent after making any necessary loan loss provisions;
  - No prima facie evidence that management is unfit or that the problem is due to fraud;
  - Problem bank has sought other reasonably available funding and shareholder controllers have made all reasonable efforts to provide liquidity and/or capital support before seeking ELA;
  - The bank can present eligible collateral, including Exchange Fund Bills and Notes, other eligible debt securities denominated in Hong Kong dollar or acceptable foreign currencies, eligible residential mortgage portfolio, deposits in other creditworthy AIs, or investment grade securities denominated in foreign currencies;
  - Provision of ELA will normally be conditioned on remedial measures (e.g., disposal of certain assets).
- Role of Banking Supervision Department: submit report with recommendations on whether to grant ELA; supervisors must visit AI premises to physically verify existence of some assets.
- Duration and pricing:
  - ELA may be provided for a period of a maximum 30 days, with a possible 30 days extension.
  - HKMA will charge an appropriate interest rate decided case-by-case; rate will not be set so high that rescuing the bank is endangered.
- Limits on ELA amounts:
  - For banks with CARs of 6 percent, ELA is limited to 100 percent of the bank’s own capital base.
  - This increases to up to 200 percent for a bank with a CAR in excess of its statutory minimum.
  - There is an absolute limit of HK$25 billion to a single bank.
  - HKMA may provide ELA in foreign currencies; HKMA has a swap agreement with the People’s Bank of China to obtain renminbi funding if needed.
- Branches of foreign banks:
  - Higher hurdles for ELA; primary LOLR policy generally applies to locally incorporated AIs.
  - ELA to branches of foreign banks would be limited to (i) swapping Hong Kong dollars for U.S. dollars held by the branch if no suitable counterparty could be found, or (ii) providing urgently required bridging finance on a secured basis pending receipt by the branch of funds from head office and on assurances from the home supervisor.
  - HKMA may require branches of foreign banks to maintain a specified level of liquidity locally.
- MA’s discretion:
  - If conditions in the HKMA policy statement are not met, the MA has sufficient discretion to provide ELA as he sees fit to maintain stability and integrity of the monetary and financial system, although in practice he would likely consult with the FS. This discretion could include extending ELA in excess of the limits outlined above if necessary.

### Capital support
- The Exchange Fund may be used to provide capital support to a problem bank.
- Terms and conditions for capital support are not formally established or publicly disclosed as is the case for ELA.
- Past use:
  - During 1983–86, seven local banks got into difficulties, including Overseas Trust Bank; rescues used the Exchange Fund, with three banks taken over by the Government through acquisition ordinances, and assistance provided to facilitate takeover of the other four by private sector entities.
  - In recent years, a capital support facility was temporarily made available during the Global Financial Crisis along with other crisis measures, although it was never drawn.

### Crisis simulation exercises and preparedness
- FSTB organizes bi-annual, cross-market exercises; latest exercise noted took place in December 2012.
- HKMA conducts annual internal simulation exercises; latest internal exercise noted took place in March 2012; HKMA has a "Contingency Plan for Handling a Banking Crisis."
- DPB conducts separate exercises to test preparedness to make swift pay-outs.
- Findings: HKMA possesses a comprehensive framework for preventing bank problems and addressing problems swiftly; early warning indicators (e.g., violations of the "trigger capital ratio") must be immediately reported by a bank to the HKMA.

---

### Resolution powers, liquidation, and recovery & resolution planning

### Supervisory intervention (Section 52) and liquidation
- Section 52 of the Banking Ordinance authorizes the MA, in consultation with the FS, to:
  - (i) require an AI to take any action in relation to its affairs, business and property;
  - (ii) direct an AI to seek advice from an "Advisor" appointed by the MA;
  - (iii) appoint a "Manager" to manage the affairs, business and property of the AI in accordance with an objective specified by the MA; or
  - (iv) report on the situation of the AI to the Chief Executive in Council (as a prelude to filing a winding up petition by the FS).
- Outside Section 52, MA can withdraw consent from chief executive and executive officers, and (for locally incorporated AIs) directors; and suspend, impose conditions on or revoke authorization.
- Rigorous administrative procedures apply; appeals can be made to the Chief Executive in Council and judicial review is available.

### Recovery and Resolution Plans (RRPs)
- HKMA is developing formal requirements for AIs in relation to RRPs; consultation began in late 2012.
- Implementation expected in phases, prioritizing institutions whose failure could pose the greatest risk to financial stability.
- Expected timing:
  - First group of AIs required to submit recovery plans in the third quarter of 2014 and resolution plans will follow.
- HKMA participates in CMGs for the nine G-SIBs with significant operations in HKSAR; CMGs focus on designing group-level RRPs.
- HKMA proposes local entities adapt group-level plans to address local concerns; eventual application to all AIs with proportionate requirements.

### Gaps relative to Key Attributes and recommendations
- Gaps identified:
  - Powers to assume control of an AI are limited. Neither the MA nor a Manager may assume powers of shareholders.
  - Explicit powers to restructure an AI are absent: no explicit powers to transfer assets/liabilities to a healthy institution, bridge bank or asset management company; to transfer shares of a distressed AI to a healthy institution; or to effect statutory bail-in (debt-for-equity).
  - Lack of statutory override of third-party consent requirements for transfers of assets and liabilities.
  - Key supporting powers lacking: MA lacks power to require group entities to continue providing essential services unless group entities are AIs or a Manager exercises voting powers; limited powers to stay creditor actions or temporarily stay early termination rights unless the counterparty is also an AI.
- Recommendations:
  - Authorities encouraged to continue efforts to enact a resolution framework in line with emerging international good practices as a matter of priority.
  - Resolution regimes developed in accordance with the KAs should apply to any financial institution that could be systemically significant or critical if it fails—and not just banks; include holding companies, non-regulated operating entities within a financial group or conglomerate, and local branches of foreign institutions.
  - Tailor KAs to local circumstances; pay particular attention to:
    - The Role of Government: consider whether procedures for appeals to the Chief Executive in Council serve aims of operational independence and transparent processes.
    - Expediency vs. Procedural Safeguards: balance speed, transparency and predictability with safeguards that protect stakeholders.
    - Private Sector Resolution Funding: where necessary, use private rather than public resources to fund resolution (e.g., statutory bail-in powers, ex ante funded resolution funds, ex post levies). Ensure the existence of the Exchange Fund does not diminish imperative to secure private sector contributions.

---

### The DPB and the Deposit Protection Scheme (DPS)

### Structure and operations of the DPB
- DPB started operations in 2006; operates the DPS defined in the Deposit Protection Scheme Ordinance (DPSO).
- DPB is a statutory body, independent from the banking regulator and the banking industry.
- Governing body:
  - Nine members from different professions; two ex-officio members representing the SFST and the MA.
  - No currently serving banker may become a member of the DPB.
- Operational remit:
  - DPB operates as a pay-box only; it cannot be drawn on to fund resolution, has no mandate to effect resolution of banks, nor to supervise or regulate banks.
  - The pay-out function has never been used during the DPB’s existence.
- Staffing: staff of some 20 persons; some provided by the HKMA, others recruited externally.

### Membership, premiums and coverage
- Compensation limits and basis:
  - Deposits may be compensated by up to HK$500,000 (approx. US$63,000) per depositor and bank.
  - Compensation is granted on a net basis, i.e., after deducting liabilities from the deposits of the same customer in the same bank.
  - No coinsurance element—the DPB will compensate for the full net amount up to HK$500,000.
- Coverage and membership statistics:
  - All licensed banks are members of the DPS; membership is a condition for a banking license.
  - The DPS covers 91 percent of all depositors and 21 percent of the total amount of deposits in the banking system.
  - Exceptions: branches of two German banks are members of their home country deposit guarantee system for their deposits in HKSAR; DPS allows exemptions for banks incorporated in a country with an adequately underpinned deposit protection scheme not less generous than the DPS.

### Funding and liquidity backstop
- Premium structure:
  - DPS is prefunded by a yearly fee levied on member banks.
  - Premium varies between 0.0175 percent and 0.0490 percent of the total amount of covered deposits, depending on the CAMEL risk profile.
  - Board has power to set a surcharge on bank premiums should the DPS Fund decline below a defined level.
- Target fund size and current level:
  - Target size for the DPS Fund is 0.25 percent of the total amount of covered deposits.
  - Based upon the present level of covered deposits, this implies a target amount of HK$3.8 billion (equivalent to US$0.6 billion).
  - Currently, some HK$1.8 billion has been accumulated.
- Investments and liquidity backstop:
  - DPS Fund invested in safe but liquid assets (deposits with HKMA, Exchange Fund bills, U.S. Treasury Bills).
  - If DPS Fund proves inadequate, DPB may borrow up to HK$120 billion (US$17 billion) from the Exchange Fund; drawdown can be made in a short time period.

### Payout procedures, targets and early warning
- Preparatory measures: ensure banks can report depositor information in specified format; conduct crisis simulations; refine tools and procedures for swift pay-out.
- Early warning:
  - DPB will be informed by the MA when agreed early warning indicators are triggered (e.g., bank downgraded to a certain supervisory rating; MA takes remedial measures; capital adequacy falls below specified level; liquidity concerns).
  - No legal impediments on such information exchange.
- Target timeframes:
  - Goal: make preliminary pay-outs within two weeks of the trigger event, and complete payment within six weeks.
  - Trigger events: court decision on winding-up a member bank, or a notice to the DPB from the MA that depositors should be compensated by the DPS.
  - Recent crisis simulations (one medium-sized bank) proved successful in completing pay-outs within targeted timeframes.
- Post-pay-out rights:
  - After a pay-out, depositor rights are subrogated to the DPB; DPB claims have same priority as a depositor.
  - Legislation provides for "depositor preference"; DPB claims would rank fairly high in liquidation.

### Findings and recommendations on DPS
- Core principles:
  - Objectives of the DPS should be clear and separate from those of the HKMA and other authorities, with complementary tasks.
  - Rules, procedures and features should be transparent and aim to counteract moral hazard; public awareness is important.
  - DPS should be reliable, requiring immediate access to sufficient liquidity for swift pay-outs.
- Areas for improvement:
  - Review modalities of funding: replenishment through surcharges may take prolonged periods; given Exchange Fund credit line, limited target size may not impede credibility, but funding arrangements warrant review to ensure appropriate burden sharing with banks.
  - Replace netting policy with gross-basis payouts to increase speed and reduce complexity and legal uncertainty.
  - Increase payout speed by replacing or complementing checks with faster instruments (electronic payments).
  - Formalize advance notice arrangements between the MA and the DPB based on identified early warning indicators.
  - Consider extending Scheme’s mandate to include financing transfer of protected deposits to a healthy institution or bridge bank on a least-cost basis (i.e., when such financing carries lower costs than direct payouts to depositors).

---

### Key statistics and facts (selected)
- Around 200 authorized deposit-taking institutions (AIs).
- Top four banks hold almost 50 percent of banking sector assets.
- Banking sector total assets of 705 percent of GDP at end-2013.
- Net asset value of unit trust, mutual and pension funds represented 505 percent of GDP (as of end-2012).
- Gross premiums of the insurance sector amounted to 13 percent of GDP (as of end-2012).
- DPS coverage limit: HK$500,000 per depositor and bank (approx. US$63,000).
- DPS premium range: 0.0175 percent to 0.0490 percent of total covered deposits.
- DPS Fund target size: 0.25 percent of total covered deposits → target amount HK$3.8 billion (equivalent to US$0.6 billion).
- DPS Fund current accumulation: HK$1.8 billion.
- DPB potential borrow limit from Exchange Fund: up to HK$120 billion (US$17 billion).
- ELA constraints:
  - Solvency requirement: CAR of at least 6 percent after provisions.
  - ELA limits: 100 percent of bank’s own capital base for banks with CARs of 6 percent; up to 200 percent for a bank with CAR in excess of statutory minimum; absolute limit HK$25 billion to a single bank.
- Expected timeline for RRP implementation: first group required to submit recovery plans in the third quarter of 2014.

*Source: EXECUTIVE SUMMARY, INTRODUCTION, INSTITUTIONAL ARRANGEMENTS, Crisis Management, Box 2, and DPB/DPS sections of the IMF technical note (excerpts from the provided chapter content).*

### EXECUTIVE SUMMARY ___________________________________________________________________________ 5

### _cr14209 - EXECUTIVE SUMMARY ___________________________________________________________________________ 5

### EXECUTIVE SUMMARY
- The financial sector of HKSAR is "large, complex and interconnected with other financial centers," amplifying the need for an effective framework for crisis management and bank resolution.
- The IMF has identified "29 jurisdictions, including HKSAR" as having systemically important financial sectors subject to FSAP surveillance every five years.
- "Twenty seven out of the twenty nine global systemically important banks (G-SIBs) identified by the Financial Stability Board (FSB) as of November 2013 undertake banking activities in HKSAR."
  - "For around a third of these banks, the home authorities have identified the operations in HKSAR as significant to the global group."
- Existing institutional framework:
  - Facilitates communication and coordination domestically and cross-border.
  - Information sharing and coordination among domestic regulatory authorities and with the Government are undertaken through a variety of formal mechanisms, supported by sound legal bases for the exchange of confidential information.
  - HKMA engages in coordination and exchange of information with foreign counterparts and "has demonstrated a cooperative approach to cross-border bank resolution in recent cases."
- Macro- and microprudential supervision:
  - Complementary structures are in place contributing to prevention and identification of bank problems.
  - HKMA uses early warning indicators, such as the "bank capital trigger ratio," to facilitate timely supervisory action.
- Crisis management tools:
  - Authorities can provide emergency liquidity or capital support to banks in exceptional cases, supported by resources from the Exchange Fund.
  - HKMA’s lender-of-last-resort policy is transparent and in line with best international practices, limiting ELA to solvent banks and to circumstances where not providing liquidity may threaten the exchange rate or the "stability and integrity of the monetary and financial systems of HKSAR."
  - Terms and conditions for capital support are provided in practice with the Financial Secretary’s (FS) approval but "are not formally established or publicly disclosed."
  - "Regular crisis simulation exercises are carried out to test preparedness."
- Resolution regime assessment:
  - "The resolution regime needs significant strengthening" and authorities are encouraged to continue efforts to establish a comprehensive resolution regime.
  - There is presently "no comprehensive resolution framework in place."
  - Good international practice suggests empowering an administrative resolution authority to override rights of shareholders and creditors to secure continuity of critical services and protect financial stability.
  - Local challenges noted:
    - Hong Kong Government's active role in financial stability reflects the constitutional framework, but "good practice suggests that a resolution authority should have operational independence from government."
    - A resolution authority "could face obstacles in a legal system bound by rigorous procedures."
    - "The ready resources of the Exchange Fund should not limit the imperative to ensure the private sector bears an appropriate share of any costs."
- Deposit Protection Scheme (DPS) assessment:
  - DPS is "transparent, and trusted"; introduced in 2006 and "has never been triggered."
  - DPS is pre-funded, but the "target fund" size and premium levels (including surcharge premiums after a payout) should be reviewed to ensure private sector assumes appropriate responsibility and to avoid undue reliance on the Exchange Fund.
  - Suggested enhancements to DPS effectiveness:
    - Consider broadening Hong Kong Deposit Protection Board (DPB) functions to include financing transfer of protected deposits to a healthy institution or bridge bank "on a least-cost basis (i.e., when such financing carries lower costs than direct payouts to depositors)."
    - Consider changing the present rule of covering deposits on a "net basis (as opposed to gross)" and developing new payment channels to make swifter pay-outs.
    - Formalize identified early warning indicators for the HKMA to notify the DPB of bank distress.

### TABLE 1 — Recommendations on Crisis Management and Bank Resolution (select)
- Powers to Deal with Problem Banks
  - "Continue efforts to develop a comprehensive resolution regime, in line with emerging international good practices."
- DPS
  - "In connection with developing the resolution framework, consider broadening the functions of the DPB to include financing the transfer of protected deposits to a healthy institution or bridge bank, on a least-cost basis (i.e., when such financing carries lower costs than direct payouts to depositors)."
  - "Review the modalities (target size; normal premium level; surcharge premiums for replenishment) for ensuring that DPS Fund has the appropriate resources without undue reliance on the Exchange Fund."
  - "Continue to seek ways for speedier payouts, including: (i) changing the netting rule for calculation of payouts to a gross rule and (ii) developing new payment channels."
  - "Formalize the identified early warning indicators for the HKMA to notify the DPB of bank distress."

### INTRODUCTION — key facts and context
- Scope and motivation:
  - The Technical Note examines the existing framework for crisis management and bank resolution in five key areas: institutional arrangements (domestic and cross-border), macro- and microprudential supervision, crisis management tools (ELA and capital support), powers to deal with problem banks, and the DPS.
  - While focused on banks, many issues are "also relevant for other types of financial institutions" expected to be covered by the proposed resolution framework.
- Financial sector scale and composition:
  - HKSAR has "around 200 authorized deposit-taking institutions (AIs)," majority subsidiaries or branches of international groups.
  - "The top four banks (all of which are subsidiaries of G-SIBs) holding almost 50 percent of banking sector assets."
  - Banking sector dominance: "total assets of 705 percent of GDP at end-2013."
  - Asset measures in other sectors:
    - "Net asset value of unit trust, mutual and pension funds represented 505 percent of GDP (as of end-2012)."
    - "Gross premiums of the insurance sector amounted to 13 percent of GDP (as of end-2012)."
  - HKMA is "a member of nine Crisis Management Groups (CMGs) organized by the home authorities of the G-SIBs."
- Policy trajectory:
  - Authorities plan to launch the first stage of public consultation on a proposal for a cross-sectoral resolution framework covering systemically important financial institutions, in line with the FSB’s Key Attributes.
    - The authorities "issued the first stage public consultation on January 7, 2014."
    - Following a second round of public consultation (expected later in 2014), "draft legislation is expected to be introduced to the Legislative Council for consideration during 2015."
  - FSB member jurisdictions committed to introduce resolution regimes consistent with the Key Attributes "by end of 2015."

### INSTITUTIONAL ARRANGEMENTS — domestic roles and delegation
- Government role:
  - "The Hong Kong Government plays an active role in financial and monetary stability."
  - The Financial Secretary (FS) is responsible for determining monetary policy objective, the structure of the monetary system, and exercising control over the Exchange Fund.
  - The Secretary for Financial Services and the Treasury (SFST) presides over the FSTB and formulates specific policy objectives for the financial system.
  - FS and SFST are "accountable to the Chief Executive."
  - The Chief Executive, after consultation with the Executive Council, "retains discretion to exercise authority" on some implementation matters related to financial sector policies.
- Delegation to regulators:
  - Primary responsibilities delegated to regulatory authorities in key policy areas.
  - Three primary regulators:
    - Banking: the Monetary Authority (MA).
    - Securities and futures: the Securities and Futures Commission (SFC).
    - Insurance: the Insurance Authority (IA).
  - Each regulator’s functions and objectives "extend to the promotion and maintenance of financial stability."
- Exchange Fund delegation:
  - Under the Exchange Fund Ordinance, the FS has "substantially delegated his powers for the use and management of the Exchange Fund to the MA."
  - Exchange Fund primary deployment: "matters affecting, either directly or indirectly, the exchange value of the currency."
  - Additional permitted use: the FS or MA may use the Exchange Fund "to maintain the stability and integrity of the domestic monetary and financial systems."
  - In this capacity, the MA serves as the "lender of last resort (LOLR) for the banking sector."

*Source: EXECUTIVE SUMMARY, INTRODUCTION, and INSTITUTIONAL ARRANGEMENTS sections of the Technical Note (IMF)._*

### 6.      The Hong Kong authorities have adopted a multi-pronged approach to ensure

### _cr14209 - 6.      The Hong Kong authorities have adopted a multi-pronged approach to ensure

### Domestic information exchange and coordination
- Authorities operate under a universal banking model, making coordination and information exchange important during normal times and times of market stress.
- Regulatory authorities have broad powers under their respective ordinances to share non-public information among themselves, and with the Government, where statutory criteria are met.
- For the HKMA, sharing is permitted (inter alia) where it will enable or assist the recipient to perform its functions, and the disclosure is not contrary to the interests of depositors or potential depositors or the public interest.
- Formal arrangements facilitate information sharing and coordination, while each agency remains independently responsible for discharging its statutory duties.
- Ad hoc communication and coordination among regulatory authorities and with the Government is common outside formal arrangements.

### Formal mechanisms for domestic exchange of information and coordination (Box 1)
- The Council of Financial Regulators (CFR)
  - Purpose: platform to review regulatory and supervisory issues with cross-sectoral implications to minimize gaps or duplication.
  - Chaired by the FS; consists of the SFST, the MA, the Chief Executive Officer of the SFC, the IA and the Managing Director of the Mandatory Provident Fund Schemes Authority.
  - Meeting frequency: quarterly.
- The Financial Stability Committee (FSC)
  - Purpose: monitors functioning of the financial system and deliberates on cross-market and systemic issues.
  - Chaired by the SFST; comprises the MA, the Chief Executive Officer of the SFC and the IA.
  - Meeting frequency: monthly.
  - Provides regular reports to the FS; refers matters to the CFR where regulatory action is needed.
- The Financial Services Branch Coordination Centre (FSBCC)
  - Operated on demand by the FSTB to facilitate communication in circumstances of high market volatility or contingency events.
  - Ensures front-line regulators’ actions and media responses are consistent and that information flow between regulators is unobstructed.
  - Can facilitate sharing of information with segments of the Government not normally involved in financial sector matters.
  - Has been activated on several occasions, including with respect to the failure of Lehman Brothers.
- Memoranda of Understanding (MoUs)
  - Support bilateral information exchange and coordination between regulatory authorities.
  - MA has comprehensive MoUs with the SFC and IA; MoUs identify points-of-contact, commit to regular meetings, and commit to information-sharing on specified trigger events.
- Legal Powers and Obligations
  - Regulatory authorities have powers to consult with, notify, or report to the FS or the Chief Executive (after consultation with the Executive Council) on various matters.
  - Example: MA must notify the FS of any contravention by an AI of minimum requirements for capital adequacy or liquidity and consult with the FS before taking supervisory interventions under Section 52 of the Banking Ordinance.

### Cross-border exchange of information and coordination
- The HKMA has clear powers to share non-public information that will assist a foreign supervisory authority in performing its functions if (inter alia) disclosure is in the interests of depositors or potential depositors or the public interest.
- HKMA has entered into MoUs or similar formal arrangements with more than 20 foreign authorities, providing a framework to:
  - Share and exchange supervisory information related to AIs operating in the jurisdictions of both signatories;
  - Hold regular meetings and have informal contacts;
  - Consult on planned cross-border establishments or investments by an AI;
  - Keep shared information confidential, when needed.
- The HKMA is a member of the CMGs of nine G-SIBs with significant operations in HKSAR; main task is to discuss and oversee development of recovery and resolution plans (RRPs) in accordance with the KAs.
- HKMA has demonstrated a cooperative approach to cross-border bank resolution in recent cases.

### Findings and recommendations (summary)
- Institutional arrangements contribute to efficient and effective communication and coordination domestically and cross-border.
- There are clear mandates and divisions of labor for domestic authorities.
- Explicit coordination mechanisms and solid legal bases exist for exchange of confidential information domestically and cross-border.
- These features facilitate policy communication and decision-making among key stakeholders and effective use of tools to manage crises and problem banks.
- As integrated resolution framework work progresses, certain legal powers and obligations of the MA (and potentially other regulatory authorities) in relation to the Government warrant further review, given emerging international good practice in the KAs that calls for resolution authorities to have operational independence.

### Prudential supervision — Macroprudential surveillance
- HKMA established a Macroprudential Surveillance Committee, chaired by the MA, and a framework for macroprudential analysis to identify risks to the banking system and AIs.
- The Financial Stability Surveillance Division conducts focused macroprudential risk analyses and shares results with microprudential supervisors.
- The Banking Supervision Department also conducts macroprudential analyses.
- Macroprudential analyses can lead to macroprudential tools to stop or reverse dangerous developments:
  - Since October 2009, the HKMA has introduced six rounds of macroprudential countercyclical measures on property mortgage lending to strengthen banks’ resilience to property market downturns and potential interest rate rises.
  - Measures included more stringent loan-to-value caps for higher-value residential properties, non self-use properties, commercial and industrial properties.
- Macroprudential monitoring has influenced microprudential supervisors to request banks ensure robustness of exposures to vulnerable markets abroad.

### Prudential supervision — Bank supervision
- HKMA objectives and means: ascertain AIs comply with regulations and operate safely and soundly.
- Supervision is risk-based and forward-looking: onsite inspections, offsite monitoring, contacts with banks, thematic reviews.
- Use of forward-looking indicators to spot excessive loan growth or funding structure changes; review of Management Information Packages.
- Prioritization reflects assessed risk profile of institutions.
- Capital requirements and stress testing:
  - HKMA requires each AI to observe a non-statutory trigger ratio of capital above the minimum capital adequacy ratio (CAR), specific to each bank and determined by its risk profile (in addition to the Pillar 2 capital add-on).
  - HKMA conducts regular stress tests; if capital is vulnerable or declines towards the trigger level, the HKMA will enter into discussions with AI management or shareholders.
- Identification of weaknesses enables prompt progressive supervisory actions proportionate to the situation.
  - Supervisors can request further information, take remedial action, and are expected to act before formal violations occur.
  - For onsite examination deficiencies, AI must send a Management Letter normally within 30 days outlining how it will meet requirements and a time schedule.
  - Banking Supervision Department monitors implementation via offsite surveillance and onsite examinations; external auditors used if necessary.
- Internal information-sharing:
  - Weekly meetings with HKMA management where incidents are reported, including proposals to require an AI to provide further information or take action.
  - Regular meetings of senior executives chaired by the Chief Executive of the HKMA analyze general banking or individual AI developments; ad hoc meetings arranged when necessary.
  - Established channels exist for external communication with domestic or foreign authorities, especially in crisis situations.

### Crisis management — Emergency Liquidity Assistance (ELA)
- HKMA published a policy for granting ELA; resources drawn from the Exchange Fund.
- Conditions for ELA (including, among other things):
  - The situation constitutes a systemic threat to the stability of the monetary and financial systems or to the stability of the exchange rate;
  - The problem bank is solvent, defined as reporting a CAR level of at least 6 percent after making any necessary loan loss provisions;
  - No prima facie evidence that management is unfit or that the problem is due to fraud;
  - Problem bank has sought other reasonably available funding and shareholder controllers have made all reasonable efforts to provide liquidity and/or capital support before seeking ELA;
  - The bank can present eligible collateral, including HKSAR Government debt securities in the form of Exchange Fund Bills and Notes, other eligible debt securities denominated in Hong Kong dollar or acceptable foreign currencies, eligible residential mortgage portfolio, deposits in other creditworthy AIs, or investment grade securities denominated in foreign currencies;
  - Provision of ELA will normally be conditioned on remedial measures (e.g., disposal of certain assets).
- Role of Banking Supervision Department in ELA:
  - Submit a report with recommendations on whether to grant ELA.
  - Banking supervisors must visit AI premises to physically verify existence of some assets, such as residential mortgages and securities.
- Duration and pricing:
  - ELA may be provided for a period of a maximum 30 days, with a possible 30 days extension.
  - ELA is intended for short-term liquidity support.
  - HKMA will charge an appropriate interest rate decided case-by-case; rate will not be set so high that rescuing the bank is endangered.
- Limits on ELA amounts:
  - For banks with CARs of 6 percent, ELA is limited to 100 percent of the bank’s own capital base.
  - This increases to up to 200 percent for a bank with a CAR in excess of its statutory minimum.
  - There is an absolute limit of HK$25 billion to a single bank.
  - HKMA may provide ELA in foreign currencies; HKMA has a swap agreement with the People’s Bank of China to obtain renminbi funding if needed.
- Branches of foreign banks face higher hurdles for ELA:
  - LOLR policy generally applies to locally incorporated AIs whose failure might have systemic implications.
  - ELA to branches of foreign banks would be limited to (i) swapping Hong Kong dollars for U.S. dollars held by the branch if no suitable counterparty could be found, or (ii) providing urgently required bridging finance on a secured basis pending receipt by the branch of funds from head office and on assurances from the home supervisor that funds would be forthcoming.
  - HKMA may require branches of foreign banks to maintain a specified level of liquidity locally.
- MA’s discretion:
  - If conditions in the HKMA policy statement are not met, the MA has sufficient discretion to provide ELA as he sees fit to maintain stability and integrity of the monetary and financial system, although in practice he would likely consult with the FS.
  - This discretion could include extending ELA in excess of the limits outlined above if necessary.

### Crisis management — Capital support
- The Exchange Fund may be used to provide capital support to a problem bank.
- Terms and conditions for capital support are not formally established or publicly disclosed as is the case for ELA.
- The Exchange Fund has been used for capital support in the past:
  - During 1983–86, seven local banks got into difficulties, including Overseas Trust Bank.
  - In light of systemic implications, banks were rescued using the Exchange Fund; three banks were taken over by the Government through acquisition ordinances, and financial assistance (e.g., guarantee of assets, liquidity support) was provided to facilitate takeover of the other four banks by private sector entities.
  - In recent years, a capital support facility was temporarily made available during the Global Financial Crisis along with other crisis measures, although it was never drawn.

*Source: IMF staff assessment (extracted from the provided chapter content).*

### Box 2. Crisis Management During the Global Financial Crisis

### Box 2. Crisis Management During the Global Financial Crisis

### Crisis measures adopted (2008–10)
- Between 2008-10, the HKSAR authorities adopted a range of tools, backed by the resources of the Exchange Fund, to restore public confidence and ensure the normal operation of the local banking system. Other than the liquidity measures, these tools were not drawn upon.
- Liquidity Measures:
  - The HKMA’s normal discount window operations were expanded to accept a wider range of collateral, increase the tenor of loans, and reduce the interest rate.
  - Two new discretionary facilities were offered: (i) foreign exchange swaps, and (ii) term repos (up to three months).
  - The discount window extension was terminated in March 2009, but the two discretionary measures have been incorporated into the ongoing monetary operations framework so that the HKMA can provide liquidity assistance to individual banks on a case-by-case basis if needed.
- Blanket Deposit Guarantee:
  - The Government introduced a general guarantee of customer deposits held with all AIs in HKSAR up to 100 percent of their value following the principles of the DPS.
  - The Blanket Deposit Guarantee expired at the end of 2010.
- Capital Support:
  - A Contingent Bank Capital Facility was announced to provide comfort that additional capital would be available to locally incorporated licensed banks should it be needed.
  - The Capital Facility expired at the end of 2010.

### Crisis simulation exercises
- The FSTB organizes bi-annual, cross-market exercises, applying stress scenarios affecting several financial market sectors. The latest exercise took place in December 2012, was overseen by the FS, and involved the HKMA, DPB, the Mandatory Provident Fund Schemes Authority (MPFA), IA, SFC and Hong Kong Stock Exchange.
- The HKMA conducts its own simulation exercises annually, testing contingency scenarios such as liquidity contingencies. The HKMA has developed a “Contingency Plan for Handling a Banking Crisis”, containing various relevant internal documents. The latest internal HKMA exercise took place in March 2012.
- The DPB conducts its own separate exercises to test its preparedness to make swift pay-outs to depositors.

### Findings on preparedness and early intervention
- The HKMA possesses a comprehensive framework for preventing problems in banks and to address any actual problems swiftly and adequately.
- Various channels are used to identify both increasing general and intrinsic risks. Early warning indicators are used to identify and address adverse developments swiftly. For instance, violations of the “trigger capital ratio” must be immediately reported by a bank to the HKMA, which will require the bank to take appropriate action.
- The framework for identifying problem bank situations is generally sound. Potential risk factors are identified and presented swiftly in appropriate HKMA internal (and, when relevant, also external) committees for consideration. Deliberations have often led to further actions, such as communications with the supervised institutions. In a few cases of significant bank problems, remedial measures have been implemented such as appointing a Manager of a bank.
- The LOLR policy—being transparent and setting clear conditions limiting the use of liquidity support—generally follows international “best practice.” Hence it mitigates potential moral hazard.

### Dealing with problem banks — Supervisory intervention (Section 52)
- The MA’s powers to intervene in a problem bank are concentrated in Section 52 of the Banking Ordinance. Section 52 authorizes the MA, in consultation with the FS to:
  - (i) require an AI to take any action in relation to its affairs, business and property;
  - (ii) direct an AI to seek advice in relation to the management of its affairs, business and property from an ”Advisor” appointed by the MA;
  - (iii) appoint a “Manager” to manage the affairs, business and property of the AI in accordance with an objective specified by the MA not inconsistent with the provisions of the Banking Ordinance (e.g., to preserve the AI’s assets); or
  - (iv) to report on the situation of the AI to the Chief Executive in Council (as a prelude to the filing of a winding up petition by the FS as further described below).
- Outside of Section 52, where certain conditions are met, the MA also has the ability to withdraw his consent from (and thereby cause the removal of) the chief executive and executive officers of an AI and, (in respect of a locally incorporated AI), its directors; and to suspend, impose conditions on or revoke the authorization of an AI.
- Section 52 powers can be used separately or in combination to address circumstances including where:
  - an AI is carrying on its business in a manner detrimental to the interests of its depositors and creditors;
  - an AI is insolvent or likely to become unable to meet its obligations, or is about to suspend payments;
  - an AI has failed to comply with the provisions of the Banking Ordinance or with any licensing condition;
  - there are sufficient grounds for the MA to propose the revocation of an AI’s authorization; and
  - the FS has advised the MA that it is in the public interest to do so.
- Past uses of Section 52:
  - 2005: Manager appointed to Delta Asia Credit Limited to conserve assets and restrict increases in liabilities; appointment later revoked and AI’s authorization revoked.
  - 2008: Manager appointed to Indover bank (Asia) Limited; Section 52 used against the Hong Kong branch of Melli Bank in light of financial sanctions on the bank and its parent bank.
  - 2009: Restrictions to protect depositors were imposed on the Hong Kong branch of United Commercial Bank under Section 52 powers, in conjunction with U.S. supervisory and resolution actions against the home institution.
- Rigorous administrative procedures apply to supervisory interventions:
  - After consultation with the FS, under grounds specified in the Banking Ordinance, the MA may propose to revoke the authorization of an AI by serving a written notice.
  - Before proposing revocation, the MA is required to inform the AI of the grounds and provide the institution with an opportunity to respond.
  - In response, the AI may: (i) notify the MA that such notice will not be appealed; (ii) allow the statutory time frame for lodging such an appeal to lapse; or (iii) appeal the proposed revocation of authorization to the Chief Executive in Council.
  - Appeals to the Chief Executive in Council are administrative remedies subject to full review of the merits; the Chief Executive in Council may confirm, vary or reverse the MA’s decision, substitute the decision, or make any other order deemed fit.
- Supervisory interventions are also subject to judicial review proceedings. The Court will consider whether actions are within powers, whether required procedures were followed, and whether powers were exercised for a proper purpose and in a reasonable and proportionate manner. Remedies can include compelling, prohibiting, or setting aside actions by the MA (or Manager).

### Recovery and Resolution Plans (RRPs)
- The HKMA is developing formal requirements for AIs in relation to RRPs.
- In late 2012, the HKMA began a consultation process on the requirements for RRPs. The HKMA is currently refining its proposed guidance on recovery planning.
- Implementation of the requirements is expected to occur in phases, prioritizing institutions whose failure could pose the greatest risk to financial stability.
- It is expected that the first group of AIs will be required to submit recovery plans in the third quarter of 2014 and resolution plans will follow.
- The HKMA is participating in CMGs for the nine G-SIBs that have significant operations in HKSAR. At present, the CMGs are focused on designing group-level RRPs.
- The HKMA proposes to require local entities to be able to satisfy much of the RRP requirements by adapting the group level plan in a manner that addresses local concerns.
- Ultimately, it is proposed that the RRP requirements would apply to all AIs, albeit RRPs would be proportionate and so less detailed for small and non-complex institutions.

### Liquidation
- Winding-up of an AI is governed by the Companies Ordinance under the same rules that apply to any other company albeit subject to certain modifications under the Banking Ordinance.
- Any creditor may petition the court for a winding up of an AI; the Court may grant the petition under standard grounds (i.e., the company/AI is unable to pay its debts).
- The FS can petition for winding-up of an AI under the Banking Ordinance, either at the direction of the Chief Executive in Council (following a report by the MA in exercise of Section 52) or on his own initiative, following an investigation by the FS (conducted at the behest of the MA) into the state of conduct of the AI’s affairs, business and property.
- Where a petition for winding up of an AI is presented by a person other than the FS, a copy of the petition must be served on the MA, and he shall be entitled to be heard on the petition.
- In cases where an AI has been liquidated, the MA has refrained from revoking the authorization of the AI until late in the liquidation process to ensure retention of statutory powers, including the power to gather information about the AI’s affairs.
- The Companies Ordinance was last applied to the liquidation of a bank in 1992, when the local subsidiary of Bank of Credit and Commerce International Group was liquidated.

### Findings and recommendations on resolution powers and framework
- Overall assessment:
  - The MA’s existing powers to intervene in problem banks are useful but incomplete, particularly as they relate to the resolution powers which according to international good practices (as set forth under the KAs) should be available.
  - Past practice has been limited to dealing with AIs whose failure, taking into consideration market conditions, did not have systemic implications and where orderly liquidation might be possible in a case of non-viability.
  - When powers were used with respect to branches of foreign AIs, the MA’s role was primarily to take protective measures in conjunction with foreign authorities resolving institutions overseas.
- Broad categories of resolution powers under the Key Attributes (summarized):
  - Assume Control
    - Assume powers of management and shareholders
    - Replace management
  - Restructure
    - Transfer assets, liabilities to an existing entity, a bridge institution, or an asset management company
    - Merge, sell, amalgamate, spin-off parts of the financial institution
    - Recapitalize the bank through a debt restructuring (e.g., Bail-in) or capital increase
  - Support
    - Suspend payments to unsecured creditors; stay creditor actions
    - Temporarily stay early termination rights
    - Obligate related group entities to continue to provide essential services and functions
- Gaps relative to Key Attributes:
  - Powers to assume control of an AI are limited. Neither the MA nor a Manager may assume powers of shareholders. The lack of such powers may impede restructuring transactions that could be in the interest of depositors or the public.
  - Explicit powers to restructure an AI are absent. The authorities lack explicit powers to:
    - transfer assets and liabilities from a distressed AI to a healthy institution, a bridge bank, or asset management company;
    - transfer shares of a distressed AI to a healthy institution; and
    - restructure the share capital of a locally incorporated AI by cancelling the whole or any part of the share capital, requiring the AI to issue new shares, and/or through the statutory conversion of creditors’ claims to equity (i.e., “statutory bail-in”).
  - Weaknesses are compounded by the lack of a statutory override of third-party consent requirements for the transfer of assets and liabilities, and the inability of the MA or a Manager to assume power of shareholders.
  - Key supporting powers for resolution are generally lacking. The MA does not have powers to require group entities to continue to provide essential services and functions to the firm in resolution unless the group entities are themselves AIs or where a Manager appointed to an AI exercises his voting powers in respect of operational subsidiaries for such purposes.
  - While the MA could direct an AI to suspend payments to unsecured creditors by means of section 52(1)(A), the MA does not have power to stay creditor actions, or temporarily stay early termination rights unless the counterparty is also an AI.
- Recommendations:
  - Authorities are encouraged to continue efforts to enact a resolution framework in line with emerging international good practices as a matter of priority.
  - Resolution regimes developed in accordance with the KAs should apply to any financial institution that could be systemically significant or critical if it fails—and not just banks. The regime should also extend to holding companies, non-regulated operating entities within a financial group or conglomerate that are significant to the business of the group or conglomerate, and to local branches of foreign institutions.
  - Tailoring the KAs to local circumstances will be important. Particular attention should be paid to:
    - The Role of Government: Consider whether the model in terms of relation to Government used for existing legal powers and obligations of the MA (and other regulatory authorities that could be “resolution authorities”) is appropriate in a resolution context. In particular, consider whether procedures for appeals to the Chief Executive in Council serve aims of operational independence and transparent processes.
    - Expediency vs. Procedural Safeguards: Balance speed, transparency and predictability with procedural safeguards that protect stakeholders (creditors and shareholders).
    - Private Sector Resolution Funding: Where necessary, and to the extent possible, private rather than public resources should be used to fund resolution. Consider forms of private sector resolution funding, including statutory bail-in powers, ex ante funded resolution funds and/or imposition of ex post levies or taxes on the financial industry. In HKSAR, ensure that the existence of the Exchange Fund does not diminish the imperative to secure private sector contributions to resolution funding and thereby pose moral hazard. Other than the DPS, the current framework does not provide for private sector resolution funding.

*Source: Box 2. Crisis Management During the Global Financial Crisis (excerpt).*

### 37.      The DPB started its operations in 2006. The DPB, operates the DPS, which is defined in the

### The DPB and the Deposit Protection Scheme (DPS)

### A. Structure and Operations of the DPB
- The DPB started its operations in 2006. The DPB operates the DPS, which is defined in the Deposit Protection Scheme Ordinance (DPSO).
- The DPB is a statutory body established under the DPSO; it is independent from the banking regulator and from the banking industry.
- Governing body composition:
  - Nine members from different professions.
  - Two ex-officio members representing the SFST and the MA.
  - Other members appointed based on skills in relevant fields, such as financial, legal, accounting, or consumer protection.
  - No currently serving banker may become a member of the DPB.
- Governance and management:
  - The DPB rules establish a clear division of responsibilities between the Chairperson, the Chief Executive Officer, and the governing board.
  - The management team is responsible for executing the board’s decisions.
- Stated objectives of the DPS (as interpreted by the DPB):
  - Reducing the probability of failure by reducing the risk of rumor-driven runs.
  - Providing an orderly means of compensating depositors should a failure occur.
  - Reducing the potential contagion effects of a bank failure.
- Operational remit:
  - The DPB operates as a pay-box only. It cannot be drawn on to fund resolution, has no mandate to effect the resolution of banks, nor to supervise or to regulate banks.
  - The pay-out function has never been used during the DPB’s existence.
- Staffing and support:
  - Staff of some 20 persons; some provided by the HKMA, others recruited externally.
  - The DPB may rely on ordinary HKMA staff resources, including joint working groups.

### B. Membership, Premiums and Scope of Coverage
- Compensation limits and basis:
  - Deposits may be compensated by up to HK$500,000 (approx. US$63,000) per depositor and bank.
  - Compensation is granted on a net basis, i.e., after deducting liabilities from the deposits of the same customer in the same bank.
  - There is no coinsurance element—the DPB will compensate for the full net amount up to the limit of HK$500,000.
- Definition and exclusions of “covered deposit”:
  - Broad definition: includes most forms of deposits, including deposits denominated in foreign currencies and deposits from non-bank financial institutions.
  - Main categories exempted from coverage:
    - Deposits from banks or other AIs;
    - Off-shore deposits; and
    - Time deposits with a maturity exceeding five years.
- Membership and coverage statistics:
  - All licensed banks are members of the DPS.
  - Membership is one of the conditions for being granted a banking license.
  - The DPS covers 91 percent of all depositors and 21 percent of the total amount of deposits in the banking system.
  - Note: exceptions—branches of two German banks are members of their home country deposit guarantee system covering their deposits in HKSAR; the DPS allows exemptions for banks incorporated in a country with an adequately underpinned deposit protection scheme providing protection not less generous than the DPS.

### C. Funding
- Premium structure:
  - The DPS is prefunded by a yearly fee levied on member banks.
  - The premium varies between 0.0175 percent and 0.0490 percent of the total amount of covered deposits, depending on the risk profile of each bank as measured by the CAMEL framework of the HKMA.
  - The Board has the power to set a surcharge on bank premiums should the DPS Fund decline below a defined level.
- Uses and target fund size:
  - DPS premiums are used for (i) pay-outs to depositors, and (ii) to cover the expenses for the ongoing operations by the DPS.
  - The target size for the DPS Fund is 0.25 percent of the total amount of covered deposits.
  - Based upon the present level of covered deposits, this implies a target amount of HK$3.8 billion (equivalent to US$0.6 billion).
  - Currently, some HK$1.8 billion has been accumulated.
- Investments and liquidity backstop:
  - The DPS Fund is invested in safe but liquid assets, such as deposits with the HKMA, Exchange Fund bills and U.S. Treasury Bills.
  - If the DPS Fund proves inadequate to cover the full pay-out, the DPB may borrow up to HK$120 billion (US$17 billion) from the Exchange Fund; the drawdown can be made in a short time period to support a fast payout.

### D. Payout Procedures
- Preparatory measures to achieve swift pay-outs:
  - Ascertaining whether banks can report depositor information according to a specified format in a timely manner.
  - Conducting crisis simulations, both separately and together with other parties.
  - Continuing refinement of its tools and procedures for swift pay-out.
- Early warning and triggers:
  - According to early warning indicators agreed between the two authorities, the DPB will be informed by the MA about problems in member banks, including:
    - When a bank does not operate in a safe and sound manner or its supervisory rating is downgraded to a certain level.
    - When the MA takes measures to remedy deficiencies in financial soundness or other serious matters of concern.
    - When capital adequacy has fallen below a specified level.
    - When there are concerns about the liquidity of a bank.
  - There are no legal impediments on the exchange of information on the above matters.
- Target timeframes and performance:
  - Current goal: make preliminary pay-outs to depositors within two weeks of the trigger event, and complete payment within six weeks.
  - Trigger events include a court decision on winding-up a member bank, or a notice to the DPB from the MA on his decision that depositors should be compensated by the DPS.
  - Recent crisis simulations (comprising one medium-sized bank) proved successful in completing pay-outs within the targeted timeframes.
  - The DPB is developing and implementing enhancements to further increase the speed of payouts.
- Post-pay-out rights and communication:
  - After a pay-out, the rights of the depositor will be subrogated to the DPB; the claims of the Board will have the same priority as a depositor.
  - Relevant legislation provides for “depositor preference”; consequently, DPB claims would rank fairly high in any bank liquidation.
  - The DPB uses a variety of communication channels to enhance public awareness of the DPS.
  - Recent surveys indicate close to 80 percent of surveyed individuals were aware of the existence of the DPS, and similarly high numbers knew about its key features.

### E. Findings and Recommendations
- Core principles for a DPS in crisis management and bank resolution:
  - The objectives of the DPS should be clear and separate from those of the HKMA and other authorities, while tasks should complement each other.
  - Rules, procedures and features of deposit protection must be transparent and aim to counteract moral hazard; the general public should be aware of the DPS and its key features.
  - The DPS should be regarded as reliable, requiring immediate access to sufficient liquidity to facilitate swift pay-outs and augment system credibility.
- Areas for further improvement:
  - Review modalities of funding:
    - The MA may require a problem bank to maintain assets up to 200 percent of its covered deposits under the DPSO to minimize shortfall risk; the DPB is entitled to priority claims under the insolvency regime through subrogation under section 38 of the DPSO.
    - Pay-outs in liquidation could reduce the DPS Fund substantially or even exceed the target size, depending on the size of the bank.
    - Recoveries in liquidation could take several years and may be partial.
    - Replenishment through surcharges on banks would take a prolonged period given constraints on the maximum size of surcharges if the shortfall is sizeable.
    - Given the Exchange Fund credit line, the limited target size may not impede credibility or functioning, but funding arrangements warrant review to ensure appropriate burden sharing with banks of the costs of their own actions and losses; this would be in line with international good practice.
  - Replace netting policy with gross-basis payouts:
    - Gross payouts would significantly increase speed by reducing complexity and potential legal uncertainty in calculations.
    - Netting may cause unintended depositor behavior (e.g., large value deposit holders protecting themselves above HK$500,000 by maintaining corresponding liabilities with the same bank).
    - Paying out on a gross basis aligns with practice in many other countries.
  - Continue steps to increase payout speed:
    - Replace or complement checks (a “slow medium”) with faster instruments, including electronic payments.
    - Formalize advance notice arrangements between the MA and the DPB based on identified early warning indicators (e.g., downgrading of CAMEL rating, AI’s total CAR falling below a certain level) so the DPB can prepare early for potential payouts.
  - Review deposit protection and DPB mandate in context of crisis resolution framework:
    - Given the structure of the Hong Kong financial system, liquidation and consequent pay-outs would be contemplated in a limited number of cases.
    - Consider extending the Scheme’s mandate to include financing the transfer of protected deposits to a healthy institution or bridge bank on a least-cost basis (i.e., when such financing carries lower costs than direct payouts to depositors).

### Annex I — Key Attributes of Effective Resolution Regimes (summarized)
- KA1. Coverage: Scope should cover any financial institution that could be systemically significant or critical if it fails, including holding companies, non-regulated operational entities within a financial group or conglomerate, and branches of foreign firms.
- KA2. Resolution authority: A designated resolution authority should be operationally independent, with clear mandates, roles, and responsibilities.
- KA3. Broad resolution powers: Authorities should be able to assume control and restructure to achieve continuity of critical financial services, transfer ownership or business to sound institutions or bridge institutions, and use debt-for-equity swaps or bail-in powers.
- KA4. Legal clarity for set-off/netting/collateral: Rules governing set-off, netting, collateralization, segregation of client assets should be clear, transparent and enforceable during a crisis or resolution; authorities may be able to temporarily suspend netting/set-off subject to safeguards.
- KA5. Safeguards and compensation: Legal safeguards should allow for compensation to creditors assessed to be worse off in resolution compared with liquidation and allow judicial review of resolution decisions.
- KA6. Minimize public funds: Authorities should minimize use of public funds; costs met by shareholders and creditors, and thereafter by the wider industry; public funds use should be temporary.
- KA7. Cross-border cooperation framework: Resolution authorities should be empowered and encouraged to achieve cooperative solutions with foreign resolution authorities.
- KA8. CMGs for G-SIFIs: Home and key host authorities should maintain CMGs that actively review and report on resolvability and recovery and resolution planning for G-SIFIs.
- KA9. Institution-specific cross-border agreements: Such agreements should be in place among relevant authorities for G-SIFIs to manage information sharing and specify responsibilities.
- KA10. Resolvability assessments: Regular assessments for all G-SIFIs; authorities should be able to require changes to promote resolvability.
- KA11. Recovery and resolution planning: Jurisdictions must require planning for firms with local operations where those could be critical or systemically significant.
- KA12. Information sharing: Jurisdictions should eliminate impediments to domestic and cross-border exchange of information among authorities, both in normal times and during a crisis.

*Source: IMF staff technical note on the DPB and the Deposit Protection Scheme as provided in the supplied content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14209.pdf_