Co-operation among banking supervisors is important.
The supervision of large, complex financial institutions that have international networks of operations is a difficult task, obviously requiring co-operation among supervisors in different jurisdictions. In the supervision of international banks, we place a lot of emphasis on what we call the home-host supervisory relationship. The home supervisor is of course the supervisor for the home base of the international bank, while the host supervisor is the supervisor of the jurisdiction in which the branch or subsidiary of the international bank is licensed to operate. As an international financial centre, we have many foreign banks operating in Hong Kong. There are also, more significantly in terms of their role in Hong Kong, subsidiaries of foreign banks.
The HKMA, as the host supervisor of branches and subsidiaries of foreign banks, maintains close working relationships with the banking supervisors of their home jurisdictions. We are of course also the home supervisor of locally incorporated banks that have branches and subsidiaries overseas, and we therefore also maintain close working relationships with the host supervisors. But this home-host relationship can be a delicate one. There is arguably a conflict of interest between the home supervisor and the host supervisor. Both have the primary responsibility of protecting the interests of depositors in their jurisdictions and also the responsibility of promoting the stability and integrity of their own banking systems. These responsibilities require the taking of measures in individual jurisdictions, where necessary, to limit the possibility that problems within individual international banks will spread across jurisdictions. This is sometimes the source of conflict.
Readers may be aware of the term "ring-fencing" frequently used among banking supervisors to refer to measures aimed at ensuring that the banks they supervise in their own jurisdictions are not adversely affected by problems experienced by their parent banks or even their subsidiaries overseas. This of course is understandable, particularly in situations where international co-operation among banking supervisors in the supervision of international banks is not yet well developed. Ring-fencing measures are of course specific to individual banks, but generally speaking they fall into three categories.
Taking the case of the supervision in the host jurisdiction of a subsidiary of an international bank that is experiencing difficulties in its home jurisdiction, the first category of measures would have the aim of retaining adequate capital to support the normal activity of the bank in the host jurisdiction. This is particularly important given that capital or other support is unlikely to be forthcoming from the parent because it is in difficulty. It is quite legitimate, for example, for the host supervisor to require, within reason, the subsidiary bank to operate with a more conservative capital adequacy ratio, which can be achieved through a more conservative dividend policy among other methods.
The second category of measures would have the objective of upgrading the quality of liquidity available to the subsidiary bank in the host jurisdiction. The credit risk associated with the placing of liquid funds with, for example, other financial institutions, including the parent bank and other institutions within the same group, would need to be closely scrutinised. There might be a need, for example, to limit the provision of intra-group funding by the subsidiary bank, although there is no international consensus among supervisors on the imposition of such limits.
The third category of measures would be aimed at preventing a deterioration of asset quality of the subsidiary bank that might be brought about by the booking of doubtful assets originating overseas in the balance sheet of that bank. However unlikely this is, and indeed it would bring into question whether, in allowing toxic assets of the group to be so transferred, the management of the bank continued to be fit and proper, supervisors still need to be vigilant and it is advisable to have specific supervisory requirements to prevent this. The banking supervisor must of course rely on the integrity of the management of the bank it supervises to act in accordance with the prudential supervisory requirements laid down. It is just not possible for the bank supervisor to monitor the operations of a bank on 24 hours a day or require all actions to be pre-approved by the supervisor.
The use of ring-fencing measures does not decrease the need for international supervisory co-operation. Such co-operation in the supervision of large international banks has been organised in the form of supervisory colleges comprising supervisors from the relevant jurisdictions. The current banking crisis in the developed economies points to the need for strengthening this important international initiative.
Joseph Yam
9 April 2009
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